You might have heard stories of how people held on to the shares of certain companies for many years and then sold them much later for phenomenal returns.
While direct equity investment is often associated with long-term wealth creation, it can also be used by investors aiming to make short-term gains. Whether it be the excitement of watching an investment grow over time or the attractiveness of capitalizing on market fluctuations for more rapid returns, direct equity investment has a little something for everyone.
In this guide, we’ll learn what it is, how it works, and how you can start on your journey toward potential financial success.
What is Direct Equity Investment?
Direct equity investment means buying shares of a company to own a part of it. It involves an individual or a business who buys another business’s shares. Typically, these shares are traded through the stock market or directly with private companies.
For example, you may invest $1,000 to buy shares of a coffee shop chain. If the chain grows, the value of your shares can increase, and you might earn profits (called dividends) or sell the shares later for a higher price.
How does Direct Equity Investment work?
Direct equity investment starts with buyer interest in owning a part of a company and earning returns from its growth. Following are the steps to understand how direct equity investment works:
1. Researching and choosing a company
The first step is identifying a company worth investing in. Investors typically analyze financial reports, industry trends, and market conditions to check whether the company has the potential to grow and be profitable.
Some look for established businesses with consistent returns, while others prefer startups or emerging companies for higher risk and potentially higher rewards.
Here’s a mini checklist to choose a company:
- Look up financial records
- Analyze industry trends (is this industry growing?)
- Read company news (expansion plans, leadership changes)
- Compare stock performance via tools like Yahoo Finance or MarketWatch
2. Opening a demat and trading account (if needed)
To invest in shares, you need a demat account (to store your shares electronically) and a trading account (to facilitate buying and selling). These accounts can be opened through stockbrokers or financial institutions. The process involves submitting identity proof, and bank details and completing the necessary formalities.
To make a decision, decide if you want a tax-efficient stocks and shares ISA or a regular trading account. You may choose a UK broker like Hargreaves Lansdown, AJ Bell, or Trading 212 before preparing your personal documents.
3. Buying shares
Once your accounts are set up, you decide how much to invest and place an order to buy shares.
If the company is listed on the stock exchange, the transaction occurs through the market, where you pay the current market price for the shares. For private companies, you may negotiate directly with the business or participate in funding rounds.
4. Ownership and monitoring
After purchasing the shares, you officially become a part-owner of the company. This ownership entitles you to a share in the company’s growth, profits, or losses. You can actively monitor the company’s performance through financial updates, stock prices, and industry news to make informed decisions about holding or selling their shares.
Make a note to add your shares to your portfolio tracker and review regularly, especially after major events.
5. Earning returns or selling
As a shareholder, you can earn returns in two main ways. The company might pay dividends, which are a share of the profits distributed to shareholders. Alternatively, you can sell your shares when their value increases, earning a profit known as capital gains.
However, there’s always a risk of losses if the company underperforms.If the company pays dividends, opt for direct deposit into your UK bank account or reinvest them via a Dividend Reinvestment Plan (DRIP).
Note: In the UK, capital gains tax (CGT) might apply when you sell shares. Use your annual CGT allowance (£6,000 in 2024) to minimize taxes. If unsure, consult a financial advisor or accountant.
Advantages of Direct Equity Investment
Direct equity investment can be advantageous for investors in the UK, considering its dividend potential and capital growth opportunities.
- Investing in shares of companies allows investors to benefit from increase in stock prices, leading to capital gains
- Investors can be assured of a regular income stream in addition to capital gains
- Direct equity grants partial ownership and voting rights, empowering investors to impact company decisions.
- Investors can diversify their portfolio across various sectors and industries
- The UK offers Stocks and Shares ISAs, where investors can invest up to £20,000 annually without incurring capital gains tax or income tax on dividends
Disadvantages and Risks of Direct Equity Investment
Direct equity investment comes with its own risks and disadvantages that investors need to consider before jumping in.
1. Market volatility
The stock market can rise or fall unexpectedly, influenced by global and UK-specific events like Brexit negotiations or changes in Bank of England policies. This makes it hard to predict returns and increases the chance of losses.
2. No guaranteed returns
Unlike savings accounts or bonds, investing in equities doesn’t promise fixed returns. If the company underperforms, investors may see little to no growth or even lose money.
3. Capital gains tax (CGT)
Profits from selling shares over the annual CGT allowance (£6,000 in 2024–2025) are taxable. This means you could owe a significant amount if your investments do well, reducing your actual gains.
4. Concentration risk
Investing heavily in UK-based companies or a single sector (e.g., real estate or energy) can amplify risks if that sector faces challenges, such as regulatory changes or market changes.
5. Time commitment
Successful equity investing in the UK requires constant monitoring, research, and understanding of financial markets. For beginners, this can be overwhelming and lead to mistakes without proper guidance or tools.
Types of Direct Equity Investments
Direct equity investments can be categorised into major types based on company size, market behaviour, and investment objectives.
1. Based on company size
- Blue-chip stocks: These are large, well-established, and financially stable companies known for reliable performance and dividend payments. Blue-chip stocks are often leaders in their industry and have a long history of steady earnings, making them a safer choice.
- Mid-cap stocks: Mid-cap companies offer a balance between risk and reward, including companies with a market capitalization between small-cap and blue-chip stocks. These companies are typically growing and expanding.
- Small-cap stocks: Small-cap companies are typically newer or smaller companies with a market cap of under £1 billion. These companies often have high growth potential but can also be risky due to their limited financial history.
2. Based on market behaviour
- Cyclical stocks: These stocks are highly sensitive to economic cycles. They perform well when the economy is performing well, and also when consumer spending is high.
- Defensive stocks: Defensive stocks belong to companies that provide essential goods or services that are always in demand, regardless of economic conditions.
3. Based on investment objectives
- Growth stocks: Growth stocks are companies that reinvest their profits into expanding their business rather than paying dividends. These companies are typically in the early stages of development or are heavily investing in future growth.
- Income stocks: Income stocks are companies that pay high, regular dividends to their shareholders. These are usually well-established, mature companies in stable industries.
- Value stocks: Value stocks are stocks of companies that are perceived to be undervalued by the market. These companies often have strong fundamentals but are trading at lower prices due to temporary market conditions or investor sentiment.
Who Should Consider Direct Equity Investment?
Direct equity investment may not be for everyone due to its possible risks and the need for thorough market knowledge. Below are the top 7 parties who should consider direct equity investment:
1. High net-worth individuals
High-net-worth individuals often have larger pools of capital and the financial flexibility to manage risks more effectively. For those with a broader financial portfolio, direct equity investment offers opportunities to diversify through stocks and real estates.
Here’s further how it can work for these individuals:
- They can afford to take on higher risks for higher returns
- They can tap into promising start-ups or fast-growth sectors
- They can influence the direction of businesses they invest in
2. Institutional investors
Institutional investors have substantial capital to deploy, and direct equity investment offers them a chance to focus on long-term, growth-oriented investments.
Legal regulations in the UK, which includes protections like the Financial Services Compensation Scheme (FSCS) for certain investments, helps shield institutional investors from some of the risks.
3. Experienced retail investors
Real investors who understand market fluctuations and the risks involved, direct equity investments can be an excellent opportunity for targeted investments in growing sectors or innovative companies.
They can also benefit from tax-advantaged schemes like the Seed Enterprise Investment Scheme (SEIS), which offers tax relief for those investing in smaller, early-stage companies.
4. Entrepreneurs or business owners
Entrepreneurs can diversify their holdings while gaining new insights into business trends or forging valuable partnerships.
In the UK, many start-ups offer equity investment opportunities through government-backed initiatives like the EIS or SEIS, providing additional incentives for entrepreneurs to invest in innovative businesses.
5. Long-term investors
Long-term investors often seek companies with strong growth potential that may not be immediately obvious in the public markets.
Direct equity investment provides access to businesses that may be undervalued in the short term but are expected to experience significant growth over the long term. With this, investors can understand market fluctuations and focus on growth.
How to Start with Direct Equity Investment
Getting started with direct equity investment may seem complicated, but you can get started with these three simple steps:
1. Assess your financial situation and goals
Before jumping into direct equity investment, determine how much capital you can commit and what kind of return expectations are realistic for you. Consider the time horizon for your investments (whether short-term or long-term) and your comfort level with risk.
- Review current financial portfolio
- Assess your risk tolerance
- Set financial goals
- Consult with an advisor
2. Research and identify investment opportunities
Look for companies or sectors you believe have strong growth potential or are undervalued. Use various research tools, such as market reports, industry trends, and financial statements, to identify promising investment opportunities.
Explore platforms that facilitate direct equity investment, such as Crowdcube or Seedrs, where you can find early-stage start-ups seeking funding. For additional security, consider businesses that offer equity investments under tax incentives like the SEIS or EIS in the UK.
3. Select and investment method and make your first investment
You can either invest directly through private negotiations with companies or through equity crowdfunding platforms. After choosing the method that suits you, initiate your investment. Remember, this process involves a legal agreement and a commitment of capital, so ensure you’re comfortable with the terms.
Starting with direct equity investments can be a smart move, especially when you have access to the right expertise and resources. Mergers Acquisitions UK Group, with its specialized focus on mergers and acquisitions (M&A), business valuations, and equity investments, provides an invaluable advantage to those looking to enter the world of direct equity.
The firm’s in-depth industry knowledge and personalized approach can help you identify high-potential opportunities, understand the true value of a business, and align your investments with long-term financial goals. Contact us today to achieve your financial goals!
Frequently Asked Questions (FAQs)
1. What is the difference between direct equity investment and mutual funds?
Direct equity investment involves buying individual stocks, while mutual funds pool money to invest in various stocks, offering diversification and professional management. Direct equity allows greater control and potentially higher returns with risk, while mutual funds provide diversification and reduce risk through a mix of assets.
2. How much money do I need to start investing in direct equity?
You can start investing in direct equity with as little as £50, depending on the stock price and broker requirements. Some brokers may have higher minimum investment amounts, so it’s important to research specific platforms for their terms and fees.
3. What are the tax implications of direct equity investment?
Direct equity investments are subject to capital gains tax on profits, with potential tax exemptions like the ISA or EIS in the UK. You can also offset losses against future gains, reducing your overall tax liability. Ensure you understand your tax obligations and consider professional advice.
4. Can I invest in direct equity through a retirement account?
Yes, you can invest in direct equity through retirement accounts like ISAs or SIPPs, which offer tax advantages. These accounts provide a tax-efficient way to grow your investments over time, helping you save for retirement while reducing your taxable income.
5. How do I choose which stocks to invest in?
Research companies’ financial health, market trends, and growth potential. Use tools like P/E ratios and industry analysis to select stocks with strong growth prospects.