While most of the focus (rightly) is on what the ultimate impact on investors will be, what does his failure mean for the unlisted companies across the firm's portfolio, including businesses such as Ratesetter, Atom Bank and Seedrs?
Firstly, we need to understand how we got here and why it is unusual. Traditionally, a fund of this size and type would usually allocate a large proportion of its assets to listed shares, which are highly liquid (sellable) and usually have a lower risk (albeit lower reward) than smaller businesses. Woodford was different and sunk a significant proportion of assets into unquote companies, expecting these companies to produce larger rewards, offsetting the risk (the model of Private Equity and Venture Capital where there are usually long investment horizons than with listed stocks) and investors are happy to lock in to get a higher return.
Initially Woodford did well, outperforming the FTSE all share, but a series of falls in portfolio share prices resulted in under-performance. Unfortunately, as Woodford was a listed as a focused fund investor the expectations were not aligned and immediate results were demanded, unlike patient PE and VC investors. With investors worried, there was a run on the fund with investors withdrawing nearly two thirds of the funds’ assets before trading was suspended.
So, what does this mean for Woodford's portfolio companies?
Unfortunately, the news is unlikely to be positive. The downside of having unlisted stocks in a generalist fund is that when some of the listed stocks under-performed and investors start to withdraw cash, the fund doesn't have the liquidity (cash) available to be able to repay them all. With a large proportion of Woodford's fund in small companies that don't have a large market for their shares, Woodford was forced to sell some of his larger stocks, crystallising a loss.
In turn, this resulted in even more of the fund being in smaller unquoted shares and relying on investors having more patience to see the higher rewards from the unlisted stocks. Unfortunately, with investors spooked, patience has worn thin and this cycle continued until the point at which the fund was far more weighted to unlisted stocks than ever intended and very illiquid.
Against this story, I want to note that investments in smaller companies can yield great returns, but investors need to understand these are longer-term investments and you will not make the short-term gains that you will in the capital markets.
So, why does this matter for portfolio companies?
The likelihood is that Woodford will now have to sell shareholdings in a number of his unlisted investments to balance his portfolio and achieve a sustainable level of liquidity. Importantly, because of the time pressure on Woodford to sell these shares, the sales are likely to be undervalue.
For a smaller company, having a significant proportion of its shares up for sale, especially at undervalue, can be damaging. For any portfolio company that is looking to raise new capital or sell shares themselves, having shares available at a discount will compete for capital and the discount is likely to win over fresh investment at full value shares. Potential buyers may also ask questions over a large investor looking to offload shares, although at least the publicity over Woodford is likely to be helpful to the companies in this situation.
While having a fund like Woodford enter the market has generally been positive for entrepreneurs looking to raise capital, broadening the access to capital, especially at the growth capital stage, shows that there can be risks of taking money from 'non-traditional sources'.
While not often the primary concern of an entrepreneur when raising money, understanding an investor’s fund structure and their investment hold periods can be important to ensuring that the right exit happens at the right time.
Financial Planning Senior Manager, David Horowitz, will be releasing an article looking at portfolio construction, its role in effective financial planning and the factors that contribute to consistent long-term performance. Keep an eye out!