Float, drift or power into rich waters

Private businesses have resisted the temptation to float on the stock market in recent years, but they could be missing a trick. Elizabeth Pfeuti reports


Napoleon’s claim that Britain is a nation of shopkeepers was more an accurate description than a disparaging insult. The power and economic backbone of the country lie with its small and medium-sized enterprises which keep citizens working and finances strong.

Businesses with an annual turnover of £10 million to £500 million account for just 1 per cent of UK companies, but they contribute 22 per cent of economic revenue and provide 16 per cent of the country’s jobs, according to the Confederation of British Industry (CBI). It is through these companies that true growth spreads throughout the country – and there has been little growth of late.

The solution lies with how these businesses can afford to grow. Bank lending has fallen each year since the onset of the financial crisis. Project Merlin, with which the government wanted to restart loans to the small and medium-sized sector, fizzled out with a net contraction in lending over 2011. Bank of England figures show even less capital was lent to UK businesses of all sizes during 2012.

As personal cash piles are not a sustainable method for growth, should smaller firms take the lead from the giants of industry and go public?

Along with the reluctance of banks to lend, some small and medium-sized businesses preferred to use their own cash reserves to fuel future growth, while larger firms tapped capital markets. But, as personal cash piles are not a sustainable method for growth, should smaller firms take the lead from the giants of industry – and is now the right time?

Since mid-November, the FTSE has been on an upward trajectory, and confidence in European and US markets has returned, despite some mediocre payroll and manufacturing data. Unlike the erratic movements over the past two years, markets are on a relatively even keel, yet so far very few businesses have sought to take advantage.

By the second week of February, there had been just one initial public offering (IPO) on the UK market, raising £100 million and marking an 81 per cent decrease in volume year-on-year, according to data from Thomson Reuters. As 2012 was not a vintage year for equity capital markets, this year’s figures are even less impressive. Overall, equity capital markets have seen their slowest start to the year since 2008.

“There is a general reluctance among smaller businesses in the UK to raise finance through equity,” says Hayley Conboy, principal policy adviser at the CBI. This reluctance means 88 per cent of them have never sought equity finance.

“Some business owners are fearful they may lose control of their business if they sell stakes on the open market. If they finance through a bank, their personal finances may be on the line, but at least they have control,” she says.

They may also have to release information, including margins and produce development, to the open market, which is something they may not have done before and may feel uncomfortable doing, says Ms Conboy. “The challenge is to combat the bias against equities by many of the smaller firms.”

The CBI has launched a network of “M Clubs” around the country, where businesses considering new ways of accessing capital can speak to those who have explored different avenues, and learn the potential advantages and disadvantages.

If they decide to list, the London Stock Exchange (LSE) has created a new structure to better suit their entry to the UK market.

“The ‘High Growth Segment’ is an entry point to the main market,” says Marcus Stuttard, head of UK markets at the LSE. “It aims to support companies that are bigger than the usual AIM-quoted firm. They usually have had venture capital backing and have grown quickly; they therefore want to enter the main market. However, the regulations to do so are too restrictive for some.”

For example, the minimum 25 per cent free float necessary on the premium section of the main market is not suitable for some new companies whose founders do not want to sell down at this early stage of development, says Mr Stuttard. The new structure only requires 10 per cent.

The initiative could solve not just the capital worries of businesses, but also the dearth of stocks available to investors in smaller companies.

The decline is shown in figures from Liberum Capital, a mid-size investment bank, that worked on the largest IPO in UK history – Glencore.

Between 2000 and the end of 2012, the number of listed small-cap companies, with relatively small market capitalisation, fell from 438 to 135. The number of AIM-listed stocks also fell from 1,068 to 828 in the five years to the end of December, but this decline may be about to turn around.

Simon Stilwell, chief executive of Liberum Capital, says that, for the first time in five years, there is confidence to list at the smaller end of the market.

“So many small-caps have delisted, there has been a lack of companies in which to invest,” says Mr Stilwell. “Fund managers have seen good inflows to equity funds – the much-mooted ‘Great Rotation’ seems likely to happen in some form and at least some of this will flow into small and mid-caps.”

The pipeline is not ready yet but it is filling, he says. “Listing a business is a massive distraction for any company, so they have to be sure it is what they want to do – there are other options available.”

Companies imagining markets are back in the golden age of the IPO may have a surprise though. Many equity fund managers have experienced good returns over the past 18 months with very little new issuance, so a convincing story is needed for them to hit “buy” in 2013.

Robert Churchlow, head of equities at Legal & General Investment Management, says: “More companies listing bring more investment opportunities, but new companies have to understand that fund managers know all the stocks they have in their portfolio very well – and they are in there for a reason. To sell them in order to buy something else, a fund manager would have to be convinced it was a very good business and being sold at a good price.”

Recent history bodes well, however. Figures from Deloitte showed the share price of ten firms that listed on the main UK market between 2011- 2012 rose by 19.2 per cent to the end of January this year. The rest of the market rose just 8.8 per cent.

“There are still pockets of growth in the UK, so if you have the right business model and the company directors understand the changes in their sector – meaning even if there is limited growth they may still take market share – they should do well,” says Mr Churchlow.

“Once the 2008 numbers have been shifted out of the five-year figures, we will see that small-caps have been some of the best-performing indices,” says Liberum’s Mr Stilwell.

Jane Reoch, investment director at the £10-million Cass Entrepreneurship Fund at City University, praises the LSE’s move to aid the sector, saying it could help keep valuable, high-growth companies in the UK rather than see them list elsewhere.

“Accessing capital markets is a question of timing for each individual business,” she says. “New investors will be looking for both rapid growth and a robust business model. They will also need genuine liquidity to have confidence in a smaller market.”

Mr Stuttard at the LSE concludes: “The UK has a public market ecosystem for small and medium-sized businesses that is unrivalled. There are many stakeholder groups that want to protect and support that.”