By Michael Feng. Edited by Arjun Chandrasekar.
While people are focused on trading stocks and turning a profit, they often ignore the key concept of investing: owning a stake in a company. However, it is reasonable as to why investors and traders ignore this concept since almost no individual investors have the capital to purchase a significant enough portion of a company to gain seats on a company’s board of directors. But for the few people who can afford to invest enough to gain seats in one company’s board of directors, they have the capability to influence decisions a company makes in the hopes of improving a business and earning money. These people are called activist investors and this is what we’ll be discussing in this article.
The main people or corporations that will become shareholder activists are: private equity firms, hedge funds, and wealthy individuals. One important aspect to remember is that with new people or corporations taking up a significant share of a company, this will change the outlook and future of a company, in both short-term and long-term horizons. Because of this, when you’re investing in companies, it is important to evaluate whether or not you want to continue holding a stock after someone new is introduced to their board of directors.
To illustrate, with a new member in a company’s board of directors, they may act in interests benefiting themselves, perhaps only looking to make a short-term profit and sell out their stake of the company, giving a disadvantage to long-term shareholders. Thus, if you were a long-term shareholder in this company, you may want to reconsider your position. However, there comes the problem of not knowing whether or not a company has shareholder activists. Fortunately, there’s a simple solution. If a company files a Schedule 13D, a form necessary for when an investor acquires 5% or more of a company’s voting class shares, then you’ll be able to notice a change in the board of directors of a company.
The first type of investor that may become a shareholder activist is an individual. While few people have access to this sort of capital, individuals like Carl Icahn, Nelson Peltz, and more widely known people such as Bill Ackman, all are activist investors in companies such as Apple, Starbucks, and Berkshire Hathaway, a hedge fund managed by Warren Buffet. By taking significant stakes in these companies, individuals like Carl Icahn were capable of convincing Apple’s CEO, Tim Cook, to increase Apple’s share buyback program.
Another type of investor that may become an activist investor are private equity firms. As a brief sort of overview, private equity firms employ capital provided by a few wealthy individuals in hopes of turning a profit in the long-term. According to corporatefinanceinstitute.com, with the access to lots of money and a long-term time horizon to make money, private equity firms may invest in different situations including:
- Leveraged buyouts: Buying a company as a whole with the intention of restructuring its capital structure to increase its value and exiting the investment by reselling the company or conducting an IPO (initial public offering)
- Distressed investment: Seeking companies or business lines that are distressed (on the verge of bankruptcy)
- Venture capital: Providing capital to startups or entrepreneurs, possibly helping the entrepreneur grow their venture and, in return, receiving an equity stake of the seed investment
Finally, the last form of activist investment comes with hedge funds. Hedge funds are similar to individual activist investors in their hopes to strictly turn a profit. Therefore, they don’t have to conform to any rules of strategies: anything is fair game (at least anything that’s legal or doesn’t get noticed by the SEC). However, it’s often been noted that hedge funds typically underperform the broad market and provide very volatile returns.
While activist investing may seem something insignificant and unnecessary to know for many, activist shareholders acquiring significant stakes in companies that you are also investing in may change the outlook you have from initially researching and investing in this company. Therefore, understanding the goals and intentions of different forms of activist investors are necessary to protect your capital and financial future.