AIM attraction

The Alternative Investment Market, a wholly owned subsidiary of the London Stock Exchange, has in the past 10 years become a highly successful stock exchange in terms of attracting listings from around the world. Indeed, the AIM is currently touring the United States in a bid for IPO candidates? and with a good deal of success.

The AIM has several attractive features. Thus, the IPO registration process is quite different from that which candidates must plod through in the US. The candidate is shepherded, if you will, by a nominating member, known colloquially as a Nomad – a responsible investment bank (typically) which manages the due diligence process in direct contact with the issuer and reduces the frictional drag which the SEC's iterative processes, including elaborate letters of comment, can impose on a fledgling IPO candidate. There are, as well, other time and cost advantages to the AIM IPO regime, which the AIM is enthusiastically explaining to receptive audiences in the US. In addition, various commentaries (including the VC Experts Encyclopedia of Private Equity and Venture Capital) have collected data and analytics on the AIM, its achievements, trading metrics, its cost, its governance rules, the matrix of its listed companies, etc.

The consensus view is that the AIM, while at its inception a venue principally for natural resource plays (including mining companies – witness the Vancouver Stock Exchange), has graduated to a full blown trading platform for companies across a variety of business and financial sectors. AIM valuations are reputed to be somewhat less frothy than the average of successful flotations on the NASDAQ, but, from the issuer's standpoint, more generous of course than a private placement. The buyers are (as is the case in the United States) typically institutions; after-market trading is, however, not as active as in the States. The institutions reputedly tend to hold onto the securities for the long term; hence, the conventional wisdom in the States is an AIM flotation is the equivalent of a late venture round. That observation is, incidentally, not meant as a derogatory comment. Some of the US investment banks take that notion quite seriously, suggesting to their clients that, if they meet the $50 million threshold in market capitalization for an AIM IPO, they consider a flotation on the AIM and then, as the company builds itself up by, say, an order of magnitude, the issuer reverts to the United States for full dress flotation on the NASDAQ.

Pond hopping
For a US company to migrate to the AIM, there are some tricky issues to solve, although these are by no means impossible. First, it is only common sense that the US issuer have operations in the UK and the EU and/or elsewhere around the globe; a company with roots and outreach confined to the US is probably not a good AIM candidate. Secondly, if the issuer wants to escape regulation in the US entirely, there are tax questions involved in migrating to a parent holding company in, say, Guernsey and qualifying under the US law as a foreign private issuer or, alternatively, floating directly on the AIM but keeping a number of shareholders of record in the United States under the magic number of 500.

Assuming a US company can get over those hurdles, the most compelling case for the AIM has to do with the different IPO climate in the United States. As things now stand, the AIM is positioning itself as a global alternative for so called ?mid-cap companies? – firms with an expected market capitalization from, say, $50 million to $600 million or $700 million. Post melt-down, it would appear the NASDAQ window is more or less shut for IPOs which fail to anticipate at least, say, a $600 million market capitalization. The problem is that, under today's rules in the US, with sell-side analysts walled off from corporate finance revenues, trading volume for a mid-cap security is generally not robust enough to compensate the analyst community to maintain coverage on any company under, say, $600 million market cap. And, absent analytical coverage, shares tend to flutter down into the so called ?orphanage.? NASDAQ does offer listed companies the opportunity themselves to fund a pool of three disinterested analysts. But the cost ($100,000 annually) has apparently discouraged participants.

Moreover, the $2 million or so added annual costs of complying with Sarbanes-Oxley, particularly Section 404, entails a significant drag on earnings for smaller companies. Finally – and this may be the single most important (and least heralded) fact – the UK Law Society does not allow for contingent fees and entails a ?loser pays? regime, all meaning that the humongous class actions brought by opportunistic (and hugely successful in terms of fees) plaintiffs' counsel are not the threat to corporate managers (and often shareholders) that the same pose in the US.

The significance of the AIM's emergence may be materially enhanced if NASDAQ is successful in its apparent plan to acquire the London Stock Exchange. Thus, if the NASDAQ hitches up with the AIM, perhaps opening an integrated stock exchange which offers trading from 6:00 AM in London to 4:00 PM in New York, a powerful global facility could result. Assuming the AIM retains its point of view, and with enhanced and beefed-up resources resulting from its alliance with NASDAQ, the global exchange could fill in a critical element in the venture capital equation.

To expand on this point, I do not ever recall, in my forty some odd years in the business, as much interest as today exists in spreading the US venture capital metric around the globe, particularly into emerging markets.

Thus, hedge funds have, in recent periods, made a lot of money in trading public securities in emerging markets. That honeymoon may have ended (perhaps of course, to resume) but the significance, for the instant discussion, is that, regardless of the fate of public stock indices in emerging markets, there are an ever increasing number of players looking for private equity opportunities in emerging markets, since the deals in the US and the UK are often overpriced.

As funds and other capital resources focus on private equity in emerging markets, the classic private equity liquidity events are of critical interest. The first exit, a trade sale, is on the horizon everywhere, of course; but trade sale proceeds are not typically the most glamorous and rewarding liquidity events. Indeed, private equity portfolios have historically needed an IPO (or several) in the portfolio in order to elevate the overall returns to the level of those IRR targets which induced the investors to lock up capital in the fund in the first instance.

In short, the significance of the AIM may be its role, with or without NASDAQ, as a potential bonanza for companies and investors in emerging markets – that's the optimist in me looking out at the horizon. Up until the emergence of the AIM, the history of national offshore exchanges, some with visions to become a global resource for flotations by issuers located all over the planet, have been disappointing. The history of EASDAQ and the various national bourses have not been encouraging from the standpoint of venture-backed issuers; thus, private equity around the world has been inhibited by the lack of a global NASDAQ-type market with an open window to emerging growth companies domiciled, say, in Central Europe; the Mid-East; Asia and (hopefully someday ? perhaps soon) Africa.

The real excitement, therefore, is the possibility of either a NASDAQ/AIM alliance or, failing that, a coordinated operation – a joint venture – with worldwide reach. Such an event makes sense given the confluence of factors at work, e. g. globalization, electronic trading platforms, with accompanying best pricing and enhanced transparency, heightened interest on the part of US and EU investors in emerging market profit opportunities, as emerging markets growth patterns robustly curve upward; stock exchanges converting to for-profit status, turning bureaucrats into owner/entrepreneurs and, hopefully, harmonization of international regulatory standards at rational levels, including accounting, transparency and best practices. All in all, an intriguing possibility.

(Parenthetically, nature abhors a vacuum and, as we come up on the 200th anniversary of the 1812 War, the colonies in the US are responding. Thus, the New York Stock Exchange, following its reverse merger with Archipelago, has introduced its own growth exchange, NYSE Arca.)

The short of the matter is that, with robust new entrants ? and global mergers ? maybe the IPO window is at last opening for venture-backed companies in hitherto deprived markets. If so, three cheers! Wealth creation is the path to peace and stability.

Joseph W. Bartlett is Of Counsel in the New York office of Fish & Richardson P. C. He is a member of the Corporate and Securities group with practice emphasizing alternative investments, venture capital, emerging companies, initial public offerings, corporate restructurings, private equity finance, and buyouts.