OFEX offers its rewards for doing research

It has taken five years for the success of OFEX to be widely recognised. What began in 1995 as a trading facility for companies that did not fit onto AIM (Alternative Investment Market), has grown into a market that spans more than 200 companies. Although many are small, valued at less than £10m, a number of much larger companies are traded.

It has taken five years for the success of OFEX to be widely recognised. What began in 1995 as a trading facility for companies that did not fit onto AIM (Alternative Investment Market), has grown into a market that spans more than 200 companies. Although many are small, valued at less than £10m, a number of much larger companies are traded.

Some have been attracted by the lower costs and less onerous demands of being traded on OFEX, as compared with a full stock-exchange listing, but others have used it as a stepping stone towards the main market. Indeed, it has given birth to some substantial businesses. Turbo Genset, for example, is now capitalised at almost £1bn, despite only moving up to a full listing six months ago. It is the possibility of unearthing one of these big winners that has attracted so many private investors to OFEX companies, despite the greater risks.

This off-exchange share market for dealing in the shares of unlisted and unquoted companies is operated by JP Jenkins. Although it does not deal directly with private investors, most stockbrokers are able to deal with Jenkins on behalf of individual investors. Generally, this will require clients to have some experience as investors. OFEX may be a nursery for companies planning to grow up into the main market, but it is not a place for individuals to gain their first experience with shares.

The mechanics of dealing are similar to making an investment in an AIM or fully listed company. But there is one crucial difference. Most dealings on OFEX involve directly matching buyers and sellers, and there is therefore a greater risk that actual dealing prices might differ from those indicated. Investors in smaller companies will recognise this problem as also affecting many AIM and listed companies when they are trying to buy or sell. In fact, increasingly the stock market as a whole is showing more daily variation in share prices, even for larger companies. Dealing is not always easier even where there are more market-makers.

These dealing considerations tend to restrict institutional investors' interest to the larger companies, which gives private investors a good chance of spotting opportunities in the smaller companies before the institutions do. And, the more limited amount of information available on many OFEX companies also tends to level the playing field. Investors can find information provided by companies on the OFEX website, as well as in a number of other sites and investment publications.

For investors who enjoy doing some research, there can be big rewards backing winners on OFEX. It can boast many success stories. Po Na Na, the leisure group, saw its share price rise more than tenfold on OFEX. Although now capitalised at £40m and quoted on AIM, it entered OFEX in 1996 valued at just £2m.

This type of growth from small beginnings is not unusual. Indeed, the nature of the market seems to favour cautious managements. The expenses of fund raising are typically lower. But companies must still produce a prospectus and involve external advisers, such as accountants, in sponsoring their introduction to OFEX. The relative informality allows smaller sums to be raised cost effectively. This focus on minimising business expense and any dilution of founders' shareholdings is usually a hallmark of management concern for shareholders. OFEX can also allow investors to participate in growing businesses at an earlier stage than would be typically available on the main stock market.

Companies can therefore build their business gradually, and founders tend to raise only what they need for business development. OFEX can also be a good preparation for those wishing eventual promotion to a full listing as it allows founders to build up experience in investor relations over time. It can be easier to move into the public arena at a small size and learn something of the City's agenda before moving to the main stock market.

While there are many companies on OFEX with interesting technology, there are others from traditional sectors. Brewers and football clubs are well represented, but there are companies spanning almost all other sectors. Many of these will be in niches, aiming to exploit a specialist opportunity.

OFEX seems set to grow in importance in the coming years, and a number of companies using the facility have attracted major stockbrokers as sponsors. This demonstrates the ambitions of some of these companies, and the involvement of big financial names should also offer investors a degree of reassurance. But investors must have experience and do their homework. Risks are higher, but for a small component of private investors' portfolios, OFEX is worth considering.

The writer is managing director of Scottish Value Management, which manages SVM OFEX Fund plc, an investment trust investing in OFEX companies.

Derek Pain is away