Why AIM could miss out on the next ASOS

There is a danger that the London Stock Exchange is losing sight of what AIM is for. An example of this is the suggestion that there should be minimum fundraising levels for companies that join the junior market.

Bringing in minimum fundraisings could block the flotation of small companies seeking to grow their business and, even worse, could mean that AIM misses out on the next ASOS.

Forcing a company to raise a minimum amount of cash that they do not immediately require is not doing shareholders any favours. It may also put off a good company from bothering to join AIM.

Online fashion retailer ASOS joined AIM on 3 October 2011, less than one month after 11 September 2001 so it was not an easy time to raise cash.

A placing raised £225,000 and £130,000 of that went on costs - itself an interesting figure because it would probably cost at least three times as much to float now.

There was a share issue to acquire a cash shell with £350,000 in the bank but even if this is included the cash raised was modest. The market value of ASOS on flotation was £12.3 million and it is now valued at nearly £5 billion.

There was a further £216,000 raised in July 2013 and these initial investments helped ASOS to build a base from which to grow prior to larger cash calls at later dates.

Of course, there are other online retailers that have not been successful but the amount raised at the time of the flotation has little to do with that unless the company and its adviser have failed to assess the cash requirement correctly.

It is more important that the right amount of cash is raised for the company's requirement rather than setting an arbitrary minimum.

If investors are unwilling to put more money in subsequently that is an indication that the business has not done well and cannot attract funds.

AIM should not be frightened of companies that have tried to build a business and failed. It is there to provide opportunities and some will lead to success and others to failure.

Successful small flotations

There are other examples of companies raising limited initial amounts that have subsequently raised more to finance expansion and grown substantially.

Pizza restaurants operator ASK Central raised £1.2 million when it floated in 1995 and less than a decade later it was acquired for £213 million.

Infection control products supplier Tristel raised £2 million in 2005, valuing the company at £8.82 million, and the most recent dividend cost more £2 million.

Two of the top 50 AIM companies raised less than £4 million when they joined AIM. Ticketing systems supplier Accesso Technology, then known as Lo-Q, was previously on Ofex.

First Derivatives raised £1 million, which valued the software services company at £6 million and that valuation has risen to £700 million.

Animal genetics firm Genus raised £2.75 million when it switched from Ofex in 2000 and it subsequently moved to the Main Market and is a constituent of the FTSE 250 index.

Looking back over the history of AIM it appears that nearly 1,100 companies raised nothing when they joined the junior market.

However, the majority were either readmissions after reverse takeovers or changes in domicile, moved from the Main Market or in the early days moved from the Unlisted Securities Market and rule 4.2, which were replaced by AIM.

That leaves just over 500 companies, but many of these were gaining a dual listing from Toronto (TSX), Australia (ASX) or other overseas markets or, like Lo-Q, had moved from Ofex/Plus/ISDX/NEX Exchange (as it is now known) and they raised money when they joined the rival market.

For example, self-storage sites operator Lok'nStore did not raise any cash when it switched from Ofex to AIM according to the new issues spreadsheet on the London Stock Exchange website (there are some quirks, to put it mildly, in the London Stock Exchange figures so it is best to treat some of the figures with caution).

Although it appears that nearly one-fifth of new admissions have not raised money, this is more of a historical fact than one that is particularly relevant in the present.

Since the beginning of 2014, there appear to be four companies introduced to AIM, excluding readmissions and transfers from the Main Market, that have not raised money.

Of these, one switched from the ASX and another was a TSX-listed company that gained a dual quotation. Oil and gas company i3 Energy combined a conversion of loan notes with the flotation.

The fourth is emerging markets investor APQ Global Ltd, which, according to the spreadsheet, raised nothing but in its admission announcement says that it raised £60.9 million.

One of the things that the AIM discussion paper talks about is raising the cash immediately before or on admission. It may be that this cash was deemed to have been raised before admission but it means that the bar charts used in the document to show the levels of fundraising by new admissions are likely to overstate the number of companies raising between nil and £6 million.

There are also seven companies that had share placings but are not deemed to have raised additional cash for the company.

For example, at the end of 2014, audio equipment supplier Focusrite generated just over £22 million for existing shareholders but did not raise cash for itself. There is talk of exceptions to the potential rule but it is unclear whether that would include a company that has placed existing shares.

There are also a limited number of new companies, since the start of 2014, that have raised less than £6 million. There are 17 that have raised less than £2 million, including three from NEX, one from ASX and one from TSX, 25 from £2 million to less than £4 million and 14 from £4 million to less than £6 million.

As expected there is a mixed performance by these companies. Some of the share prices have fallen by more than 75% while others have more than doubled.

Restaurants operator Fulham Shore initially raised cash when it was on NEX Exchange, so when it moved to AIM in 2014 the fundraising was limited to £1.61 million at 6p a share. Six months later, £4.75 million was raised at 11p a share to finance an acquisition.

Raising that cash at the start would have represented much greater dilution for the existing shareholders. Since flotation, the share price has trebled.

Angling equipment retailer Fishing Republic's share price has more than doubled since flotation and it also raised more cash subsequent to its flotation at a much higher share price.

The company was valued at £4 million when it floated and it raised £1.5 million. Two subsequent placings have raised £4.25 million in total.

The success of Fishing Republic also attracted the attention of its rival Angling Direct, which recently raised £7.4 million when it joined AIM.

Exceptions to the rule

The London Stock Exchange proposes limited exceptions, such as when a company is already on another market, such as the Main Market. That assumes that the company has built up a track record and has a level of financial strength.

Real Hotel Group moved from the Main Market to AIM on 2 December 2008 following the setting up of a new holding company but without raising new money. An administrator was appointed on 21 January 2009.

This shows that enabling companies to move from another market without raising cash is no better than forcing a company to raise more than it needs.

JJB Sports, Wagon, Manganese Bronze and Slimma are among the companies that have made the move to AIM and gone bust, although not as quickly as Real Hotel.

There are many former Main Market companies that have prospered on AIM, such as James Halstead, but one of the reasons there are so many tiny companies on AIM is that they are exported by the Main Market.

This includes the third smallest company on AIM HC Slingsby and the fifth smallest Tricor, which when it operated a different business was on the Main Market.

More recently the standard listing is becoming a popular way of shells gaining a quotation, but these companies do not have to follow all the rules of a premium listed company and are not eligible for any FTSE index. Some of these companies, such as Satellite Systems Worldwide, move to AIM after a deal is done.

A decade ago the move to put a £3 million minimum fundraising level on investment companies stopped shells with spurious strategies dreamed up in the pub from joining AIM.

That did a good job of limiting very small companies on AIM. This level has since been raised to £6 million. This shows that a management team that has no business has serious intentions.

While this targeted move has been successful, there seems little point in widening it to all new AIM companies. The upper limit of £6 million is certainly ridiculous if AIM wants to hang onto any pretence of being a market that helps small companies grow.

In the past AIM was obsessed with increasing the number of companies and this seems to have morphed into an obsession with making the companies on AIM larger. Both obsessions are foolish.

It also depends on why the company wants the money. Parcel deliverer DX raised £200 million when it floated and this went on paying off most of its debt. The business has performed poorly and the market capitalisation of DX is currently well below £20 million.

It is not necessarily companies that have raised small amounts of money on flotation that are the smallest on AIM. Many were much larger companies in the past.

AIM seems to think that raising more money will require institutional investment and therefore more rigorous assessment of a company but that does not mean it will succeed as DX shows.

There is an obsession with the idea that larger companies are better than small companies. Tungsten Corporation raised £160 million in 2013 and, even after further smaller cash calls, it is still heavily loss-making and valued at less than £80 million.

Somehow, this is deemed to be fine but a company raising £2 million which fails is a terrible thing.

Surely a better way is to make the cash levels part of the assessment by advisers concerning whether a company is fit for a quotation. Companies need to show that they have sufficient working capital and maybe this assessment should have more rigorous criteria that provides more slack for negative events.

If too little cash is raised at flotation that is the fault of the adviser and if sufficient cash cannot be raised then the flotation should not go ahead.

Minimum fundraising levels would not prevent fraud or other nefarious activities, or even incompetence, and would not necessarily improve liquidity if the shares go to firm institutional holders that do not deal in them.

The focus on arbitrary fund raising levels is unlikely to improve the quality of companies and it may prevent good companies joining AIM.