Up to the end of November, there had been more admissions to AIM than in the whole of 2012 and it looks like, with a fair wind, the 2011 total will also be exceeded.

So what has caused this revival in AIM’s fortunes? To my mind, it’s the generally improving economic climate. The UK economy, having avoided what many thought would be a triple dip recession earlier this year, is posting some pretty decent economic growth figures and this looks like it will continue into 2014. On the international front, the Eurozone crisis has not blown up again, as it did in 2011 and in the first half of 2012. The US economy is growing nicely, although the Federal Reserve starting to taper its QE may cause a wobble or two. And the Iranian crisis has been resolved for the next six months at least.

So with this positive backdrop, institutional investors have been keen to invest in IPOs and there has been a rush of companies looking to come to market. In fact, for the first time in many years, a number of companies are undertaking investor roadshows right up until Christmas in the hope of getting on AIM before the end of the year. This is really a turnaround from the advice traditionally given by brokers to aspiring companies that they need to be on AIM by mid December because after that, the City is winding down for Christmas.

AIM has also been helped by the Government’s decision to allow AIM shares to be put into ISAs: it seems this has increased demand for AIM shares and has thus boosted liquidity. It is hoped that the removal of stamp duty from AIM shares in April 2014 will provide a similar boost.

In terms of sectors, it seems that mining and oil and gas companies, for so long the darlings of the AIM IPO market, have been less popular in 2013. Instead, more technology companies have been floating and this is definitely something we at BDO have seen.

So what is the outlook for 2014? Unless anything changes drastically on the macro economic front, I think it will continue positively, as companies take advantage of investor demand for floatations. There are two threats to this rosy picture, however. The first is AIM specific, in that too many companies attempting to float at the same time may give the market indigestion and, therefore, only the cream of the crop will be successful. Therefore, think carefully if you are looking to float and choose reputable advisers that will represent your company in the best light. The second is that one of the big macro economic issues that has been quiet in 2013 flairs up again, but who can foresee that? Instead, let’s all take in the positivity while it lasts.

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AIM – the return of the IPO

AIM is owned by the London Stock Exchange and is the market for smaller, growing companies, as opposed to the Stock Exchange’s Main Market for larger, more established companies, such as BP, Vodafone etc.  AIM was established in 1995 and in the 2000s attracted a large number of companies, not only from the UK, but also from around the world, who wanted access to capital to fund their growth.  The number of companies on AIM peaked at 1,694 at the end of 2007, since when the number has declined as many companies delisted and fewer floated.  At the end of September 2013, there were 1,090 companies on AIM.  The number of admissions to AIM peaked at 519 in 2005 but in recent years have been below 100.

As economic sentiment has improved in recent months, there has been an increase in the number of companies floating, and this looks set to continue

So how does an AIM float work?  First, a company must appoint the following advisers:

• a nominated adviser (or “nomad”), usually a smaller merchant bank or stockbroker.  The role of nomad is similar to that of sponsor on the main market of the London Stock Exchange in that it is responsible for project managing the flotation process.  However, because a company being floated on AIM is not pre-vetted in the same way as a company being floated on the main market, the onus falls on the nomad to ensure that a company is suitable for flotation.  Furthermore, the company must retain a nominated adviser at all times subsequent to the flotation (if an AIM company’s nomad resigns, the shares are suspended.  If it has not replaced the nomad within 30 days, the shares are delisted);
• a broker who will be responsible for raising the money from new investors and who will subsequently act as a conduit for the company’s relations with its shareholders.  It is usual for the same firm to be both nominated adviser and broker, although there are still some independent nomads;
• a reporting accountant which will be responsible for the accountancy work on the flotation.  This will include the preparation of a long form report on the company (this reviews all aspects of the company’s business and financial history), an accountant’s report that is included in the admission document (basically a summary of the audited accounts for up to the last three years) and a working capital report on the company’s projections which support the directors’ statement on the sufficiency of working capital in the admission document.  This statement is designed to reassure investors that the company will not run out of funds in the year to 18 months following the flotation.  If a company has not been subject to an audit, time must be allocated in the process for the audit of up to three years’ accounts;
• lawyers for the company who will be responsible for undertaking legal due diligence on the company and for drafting the statutory part of the admission document;
• lawyers for the nomad who will draft the placing agreement; and
• others, such as public relations advisers and printers to print the admission document.  Companies appoint public relations advisers to provide publicity for the flotation by, for example, placing stories on the company in newspapers.

The flotation process starts with the reporting accountant and the company’s lawyers commencing their due diligence work.  Throughout the flotation process, weekly progress meetings or conference calls are held between the company and its various advisers to discuss any issues arising.  These meetings are also used to draft the admission document.  Towards the end of the process, the broker starts to market the company to fund managers to assess whether they will be interested in buying shares in the flotation.  To the extent that they are, shares are “placed” with them.  Most AIM flotations tend to be placings rather than offers to the public at large and hence the company should know by the date of completion how much money has been raised.  At the end of the three or so months that this process typically takes, a completion meeting is held at which all the documentation is signed off.  Because the suitability of the company for AIM is the responsibility of the nomad, the actual admission to AIM is usually a foregone conclusion.

The broker will give an indicative valuation of the company floating during the course of the process and will issue a research note to its institutional clients several weeks in advance of completion of the admission document.  However, in the end, the valuation of the company will be the price at which investors are prepared to invest, and this is likely to be affected by factors such as demand for the company’s shares and general market conditions at the time of the fund raising.

What companies need to be aware of is that their flotation can fail at the last minute, usually because of general market conditions.  These cannot be foreseen three to four months in advance and it can happen that the investor roadshow is undertaken in turbulent market conditions.  Shareholders and directors may then have a difficult decision to make as to whether to accept a lower valuation of their company and possibly a lower fund raising, or even whether to abandon the flotation altogether.  If the latter decision is taken, another attempt at flotation is unlikely to be feasible for several months.

Typically, the cost involved in a successful AIM flotation could be of the order of 8% to 12% of the proceeds raised.  If the flotation is unsuccessful, the cost will fall because the broker’s and part of the nomad’s fee will only be payable if the flotation is successful.  However, a company should budget to pay the costs of the other advisers in the event of an unsuccessful flotation.  If the flotation is successful, all the advisers’ fees will be met from the funds raised.  If it is not, the company will have to pay the other advisers from its existing resources.

This is a short summary of what is a very intense process for the management team of the company floating and it should not be commenced lightly.

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The AIM flotation process

In the UK, we have the most developed public equity capital markets in Europe and, in AIM, the most successful junior stock market in the world. Undertaking a flotation of your company may, therefore seem like the most obvious way to raise capital and to enhance its profile. But such a decision should not be taken lightly – you should assess the advantages and disadvantages carefully before proceeding and a final decision should be based on discussions with your directors, your shareholders and your advisers.
So what are the principal advantages and disadvantages of a flotation?

Advantages
(a) The new shares that your company issues in the flotation can finance organic growth and enable your company to grow at a faster rate than might otherwise be the case.
(b) Being quoted places a market value on you shares and so if you want to grow by acquisition, you can issue new shares to the vendors of target companies instead of using cash or borrowings. This will also help “tie in” the owners of the acquired company if you consider that they are important to its success. This may be particularly important in “people” businesses.
(c) You and your fellow shareholders may be able to realise part or all of your existing investment in the company and establish a market value for your retained shareholdings. But you should note that if you are to have an ongoing management role in the company after the flotation, it is unlikely you will be allowed to sell more than a small proportion of your shares, if any. You will also have to agree not to sell any further shares for anything between six months and two years after the flotation. If you want to sell all your shares, you should consider a trade sale instead.
(d) The status of your company will be enhanced – in the eyes of your customers, suppliers, the financial community and the media – giving your products or services a higher profile and improving your credit rating. Some customers prefer buying from a public company.
(e) A flotation enables you to motivate management and employees with more attractive share participation schemes. Management and employees will be able to see the market price for their shares and options on a daily basis and will be able to sell their shares more easily than if the company was private.

Disadvantages
(a) Once your company is quoted, it will be subject to public scrutiny. In addition, the need for accountability to outside shareholders means you must distinguish more precisely between company and private assets. You must also expect and accept criticism when the company has a bad year.
(b) Your vulnerability to an unwelcome takeover bid increases according to the percentage of the company’s share capital in public hands. If another company can buy 51% of your issued share capital, it will be able to take control of your company.
(c) A flotation may not necessarily increase the marketability of your company’s shares. This is particularly the case for small companies where trading can be ‘thin’ and, in many instances, effectively only undertaken on a matched bargain basis. This means that even the purchase or sale of a small number of shares can cause big swings in the share price.
(d) As well as the significant financial cost, you should not underestimate the hidden cost of the extensive time that your company’s management will have to devote to the flotation – time that could otherwise be spent running and developing the business. However, this will only last for the duration of the flotation, say two or three months, and there are ways around it if your management team is big enough – for example, a small team could be assigned to project manage the flotation. This is therefore more of an issue for companies with smaller management teams.
(e) Your company’s costs will increase because of the need to strengthen its reporting function and because you will have to appoint non-executive directors. Quoted companies have to release their results every six months and even between these dates, they must keep the market informed of anything that may affect the price of their shares. You will also be expected to have a robust and reliable accounting and internal control system in place prior to flotation.
(f) There will be increased outside pressure on your company’s directors, especially concerning profit levels and dividends expected by outside investors. Unwelcome or unexpected news can cause a sharp reduction in your share price – and it may take a long time for it to recover.

These are just some of the factors that should shape your final decision but should provide some initial guidance. A flotation certainly widens the future options available to your business but it should be weighed against the extra pressures and responsibilities that ‘going public’ places on a company and its management. All of this should be explored carefully with you advisors and shareholders in order to be sure which road is best for you.

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Is a flotation right for your business?

I use this term to distinguish them from retail bonds which have been issued by larger companies to retail investors and which are traded on the London Stock Exchange’s Order Book for Retail Bonds.

Mini bonds are a type of unsecured debt that are not transferable by investors. In other words, once an investor has purchased a mini bond, they cannot sell them but have to hold them until the company buys them back, which is typically after three to five years.

The return obtained by investors is in the form of interest which is paid in cash, interest paid in kind (for example, discounts on the company’s products or services) or a mixture of the two.

Here at BDO, we have worked on three mini bond issues: King of Shaves, Hotel Chocolat and, most recently, The Jockey Club. Our role was to approve the bond documentation as financial promotions, using our authorisation from the Financial Conduct Authority. Since the mini bonds are not transferable, the offering documentation is not a prospectus but is a financial promotion which cannot be issued by a company that is not authorised by the FCA.

It needs to be stressed that these mini bonds are not a source of funding for all companies. In particular, start up or early stage companies should really be funded by equity, or possibly bank overdrafts, rather than these bonds. Even for more established companies, our experience has shown that really only consumer facing companies (such as retailers, restaurants etc) that have a database of customers and potential customers should consider issuing these bonds since these customers and potential customers will be the main target for the fundraising. Since these mini bonds are a very specialist type of financing, a scatter gun offer to the public at large will not work.

So if you are a consumer facing company, you have got over the most important hurdle. What else do you need to consider?

Firstly, don’t assume that your customers will invest in your bonds, so before you engage the lawyers and accountants to help you with the issue, you really should survey your customers to establish whether they would be interested in investing in your mini bonds. Assuming that the feedback from customers is positive, you then need to decide on the structure of the issue, covering the following points:

1. Decide on the target aggregate fund raising, both a maximum and a minimum below which the issue would not proceed. For example, the minimum could be £500,000 and the maximum £3 million. Don’t be too ambitious with a high minimum.
2. Decide whether the interest rate you offer will fluctuate with bank base rate or will be a fixed percentage. Although base rate is likely to remain low for a number of years, at some point it will increase so you may want to maintain the margin over base rate that you are paying your bond holders.
3. Decide what form of customer incentives you might want to offer bond holders, for example discounts off your goods or services.
4. Decide on the minimum individual subscription and whether there should be a maximum. Usually, bonds are issued in tranches of £500 or £1,000 which would form the minimum. Some companies set a maximum, but others don’t mind if investors buy many tens of thousands of pounds of bonds.
5. Check that your bank would let you issue the bonds. Your company is taking on more debt which will rank below bank debt, but it’s still best to check with your bank.
6. Decide on the life of the bonds. Typically, this is three or five years but you can offer bond holders the option to extend beyond the strict term.

To assist in the mini bond process, you need to engage a firm of lawyers to draft the legal documentation, a firm that is authorised by the FCA to authorise the issue of the documentation (such as BDO), and a registrar that will handle the funds from investors and then pay out the interest.

To conclude, these mini bonds are only suitable for a minority of companies but they are a way of both raising money for a company and increasing engagement with customers.

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Mini bonds – a new source of funding for SMEs

In my introductory column, I will give an overview of the pros and cons of the two types of funding, debt and equity. In future columns, I will look at some aspects of these in more detail.

Whether you choose debt or equity depends mainly on how established your company is, so for some companies, there will not be much of a choice. For example, a start up is likely to be financed by equity capital invested by the founders and by their friends and family because it is too risky for debt.

Once you have got past the start up phase, you might then start looking for bank finance in the form of an overdraft, but a bank will only lend if it has security, which may be by way of a charge over the assets of the borrowing company, or it may seek personal guarantees from you.

The main advantage of debt over equity is that you will not have to give up any control of your company, but debt will only be provided for a certain length of time, and overdrafts can be withdrawn by banks with little or no notice which is likely to have a nasty consequence for your company in the form of possible administration unless you can swiftly find another source of funding.

If your company has no assets to offer as security or if you are unwilling to provide a personal guarantee, you will have to look to more equity financing. If your friends and family are unwilling to invest again, external sources of equity will have to be sought, and this will involve you having your shareholding diluted (but your share of your company’s overall value will remain the same).

The most likely starting point for external equity is business angels who will not only provide money in return for a substantial minority stake, but who can also provide you with advice since many are experienced businessmen or entrepreneurs. You shouldn’t overlook this intangible benefit. I can’t help thinking that shareholders get too hung up on being diluted.

For example, if your company has a pre-money valuation of £1 million and you own 100 per cent of the shares, the value of your shareholding is £1 million. If an angel then invests £250,000 for a 20 per cent stake, the company is now worth £1.25 million, you now own 80 per cent, but 80 per cent of £1.25 million is still £1 million.

As your company grows, its risk profile reduces, and it can move up the equity ladder. If you want to remain private, growth capital can be obtained from a private equity fund. Alternatively, you might want to float on a public market, such as ISDX (formerly PLUS) or AIM.

The main disadvantage of the private equity route is that your company will have one large external shareholder (perhaps owning 20 per cent to 25 per cent of the shares) that will allow you to run the company on a day to day basis, but which will be looking for an exit after three to five years, and you might not. The main advantage is that your company can grow away from the scrutiny of the public markets.

Conversely, a float will mean that several institutional investors will end up owning the same 20% to 25% but this will be split amongst several institutions such that none will own more than perhaps 5 per cent. These institutions will let you get on with running the company and will only step in if things go drastically wrong.

The downside is that your company is in the public eye which is fine until things go wrong. However, as with the business angels, both routes will involve your control being diluted to some extent but, as your company increases in value if things go according to plan, so will the value of your shareholding.

So my advice to owners of SMEs who have the choice is to think carefully about what you are willing to give up In return for funding: an element of control in return for the permanent capital that equity provides or the more short term funding offered by debt.

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A look at alternative sources of finance for SMEs