This month, another gaggle of debutantes take their first steps onto the dance floor of the Alternative Investment Market (Aim).
When it was founded ten years ago, Aim was supposed to be the place where young, entrepreneurial British firms, lacking the required qualifications for the London Stock Exchange’s (LSE) main market, could hook up with bold investors happy to take a little extra risk. In recognition of this useful contribution to the domestic economy, nice tax breaks were, and still are, available for investors.
But firms from all over the world are flocking to London. Over 220 of Aim’s 1,426 quoted firms are from countries such as China, Australia, South Africa, Russia, Germany, Israel, Bangladesh – and now the Americans are arriving too.
Investing in Aim: internationalisation
Recent debutantes include Noida Toll Bridge, formed to construct and operate a toll bridge connecting Noida to South Delhi in India; Kalahari Mining, with a portfolio of mineral projects in Namibia; Sinosoft Technology, an IT provider to the Chinese government; Amur Minerals, whose principal asset is a licence to explore for nickel and copper in the far east of the Russian Federation; Elitel, a fixed-line Italian telecoms group; and Legacy Distribution, a wholesaler of candy, cigarettes, and groceries in Arizona, USA.
This internationalisation of Aim – which provides juicy fees for financial advisers but little payback to the domestic economy for those attractive tax breaks – has three causes:
investing in Aim: the aftermath of Enron
The Sarbanes-Oxley Act (2002) is meant to tighten up US corporate governance after the scandals at Enron, WorldCom and Tyco. CEOs and chief financial officers of American-listed firms must now sign statements attesting to the accuracy of their company’s accounts.
But this is time consuming and expensive, especially for small firms. At $2m, the cost of compliance is at least double that of an Aim listing, which is why the number of small firms applying for a listing on US markets has halved.
Investing in Aim: the lure of London
Overseas investors are wary of their domestic markets. Hong Kong has suffered from low-quality Chinese share issues, Singapore’s market suffers from poor liquidity, but when the dotcom bubble burst, few fell from grace as spectacularly as Germany’s Neuer Market.
Founded in 1997 as Germany’s answer to the Nasdaq, at its peak it boasted a market capitalisation of $300bn, before losing 96% of its value and eventually closing in 2003.
German investors still bear the scars. There is no appetite for new issues in the German market, which saw only nine initial public offerings (IPOs) last year. Instead, German firms are coming to London.
London offers a trusted legal and regulatory framework, it boasts a huge pool of capital and expertise, and offers a certain cachet: firms from all around the world believe an LSE listing confers credibility. Keen to capitalise on this opportunity, officials from the LSE and UK financial advisers are racking up the air miles, hosting conferences in foreign cities and selling the Aim story.
The stream of foreign listings threatens to turn into a flood. “I could get 100 Chinese or Indian companies tomorrow,” says Martin Graham, head of Aim. “But that wouldn’t necessarily be the right thing to do. We have to be very careful that as we internationalise, we actually increase the quality of the market.”
While Aim has generated huge fees for the City, it has been much less of a success story for investors. In the ten years of its existence, the index has gained just 2% and has been far outpaced by the FTSE Small Cap index, which includes more mature and generally UK-centric firms.
While only 3% of Aim-listed firms have failed altogether, the index has been hampered by the generally poor early performance of newly floated companies, which have struggled to live up to the promises contained in their glossy prospectuses.
UK private investors have historically found it difficult and expensive to invest overseas, especially in small firms, so the arrival of foreign firms on Aim gives them a cheap, accessible way of investing in overseas economies and into business opportunities that don’t exist at home. But they should be aware of the pitfalls. Here are the three most important ones:
Investing in Aim: lack of transparency
Aim investors need to be diligent. Many Aim firms are all but invisible. Some are happy to be low profile and don’t even have their share price quoted in the newspapers. But for many firms, an Aim listing is a way of raising their profile.
This is especially true for foreign companies, who often appoint PR advisers to broadcast their presence. But the number of small firms is rising faster than both the number of journalists who write about them and the capacity of investors to follow the news.
So the investor must be prepared to trawl the internet via free sites such as Investigate.com, Digitallook.com, or Armshare.com, before looking at the chosen company’s own website.
Investing in Aim: lack of liquidity
Trading liquidity is a huge issue for many Aim companies. Of the index’s 1,424 quoted firms, 866 have a total market value of less than £25m. The ‘free float’ (the shares you can actually buy) is smaller less than this and most holders of the free float will have taken shares in the initial placing and have no intention of selling.
In the Budget, Gordon Brown reduced the maximum size of firms eligible for venture capital trusts (VCTs) from £15m to £7m and increased the length of time investors must hold VCTs from three to five years if they are to qualify for tax relief. This is likely further to tie up VCT money in shares of the smallest companies, increasingly reducing trading liquidity.
Institutions are also put off buying shares in the secondary market because they fear they will be unable to sell them. In the opinion of Charles Breese, founder of Armshare.com, the LSE is too intent on simply recruiting new Aim entrants and is not doing enough to stimulate the secondary market.
Investing in Aim: uncertain prospects
Hopes are high when a firm floats on Aim. It looks forward to a rising share price, to issuing further equity to pursue its growth plans and to encouraging its executives with share options. But it can soon become disillusioned if the share price goes the wrong way.
Many Aim-listed UK companies privately complain that they are not getting value for the £50,000 that they pay to their financial advisers to promote their shares. This problem is worse for overseas firms. First City was the first UK public relations adviser to spot the Chinese opportunity. It now has a Hong Kong office with Mandarin-speaking staff, and is in regular contact with its clients. But others are all too happy to take the fee for the Aim listing and then offer little else besides.
So investors should be cautious. They must be prepared to do their own research and make up their own minds. Short-term traders should rule Aim out altogether. But for those prepared to stay the course, the influx of foreign companies provides some highly attractive investment opportunities.
Tax breaks on Aim
Capital gains tax (CGT): After holding Aim shares for one year, the investor is only charged on 50% of the gain. After two years, this drops to 25%.
Inheritance tax (IHT): Shares in qualifying Aim trading firms can attract 100% relief from inheritance tax, provided they have been held for two years.
Enterprise Investment Schemes (EIS): EIS investors can invest up to £400,000 per year. They receive tax relief on contributions and pay no CGT, provided the investment has been held for three years. Investment can be made into Aim firms, but overseas companies are unlikely to be eligible.
Venture capital trusts (VCTs): VCT investors receive 30% income tax relief on contributions, and pay no CGT as long as the investment has been held for five years. Overseas companies are unlikely to be eligible for VCTs.
Tom Bulford is editor of the Red Hot Penny Shares newsletter.
Investing in shares can lose you some or all of your investment. Never risk more than you can afford to lose. Small company shares can be illiquid and carry higher risk than other shares. Past performance is no guide to the future. Consult a financial advisor if unsure. Fleet Street Publications Ltd. 020 7633 3600