Rough road ahead for junior market: The planned forum for small company shares must strike the right balance between cost and regulation, says William Kay

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The Independent Online
FEW investors noticed when OmniMedia, an 18-month-old hi-tech company, made its bow at the start of this month on the Stock Exchange's Rule 4.2 matched-bargain facility for lightly traded shares. But OmniMedia could well be one of the first stars of the Alternative Investment Market, which the exchange wants to launch next June.

'It is probably typical of the sort of company that will go on AIM,' said Tiki Yates of Raphael Zorn Hemsley, OmniMedia's stockbroker. 'It has plans to expand and among its shareholders are some major institutions who would not have contemplated investing in a company like this a few years ago. It is entirely appropriate for a move upstairs.'

OmniMedia, based in Kingston-upon-Thames, makes interactive video CDs that you can play on television or personal computer.

'We won't need a lot of capital,' explained Leslie Kent, an OmniMedia director, 'but we have got business in Los Angeles and Japan, and we might look to the new market if we were to find increasing demand from those quarters.'

Nevertheless, the company has only a year's accounts to show, in which it made pre-tax profits of just pounds 24,000 on sales of pounds 191,000. Mr Kent and one of his co-directors, Timothy Rosen, each have three-year contracts worth pounds 144,000 annually from this year plus bonuses.

This is plainly a high-risk and potentially high-reward investment, which a few years ago would have had to go to the venture capital industry for finance before eventually being floated on either the Unlisted Securities Market or the Official List.

But new European Union directives mean that the USM has to be wound up in 1996. This will leave a gap as, since Britain left the European exchange rate mechanism in 1992, investors have recovered their appetite for shares in small companies.

Now this appetite is to be met by the Alternative Investment Market (AIM), on which the Stock Exchange published a consultative document last week. This is a key element in the seven-point plain unveiled in April by Michael Lawrence, the exchange's chief executive, to promote the interests of smaller companies through a programme of education and promotion.

AIM will build on the Rule 4.2 facility, requiring no trading record from companies but insisting on a prospectus and a member firm promising to support dealing in the shares.

It will be up to the company's directors to ensure that their documents are accurate and that they keep the market informed of significant developments. Surveillance and supervision of trading will be the same as for the Official List.

Nevertheless, the history of the USM and the short-lived Third Market suggests that AIM will have more than its fair share of disasters. The danger then is that the new market will reinforce the tabloid image of the Stock Exchange as a casino, with huge fortunes being won and lost apparently on the turn of a coin.

Since it began in November 1980, the USM has raised pounds 4bn of new money for the 881 companies that have been admitted to the market, of which 253 have since moved up to the Official List.

But, as our chart shows, the USM's overall performance has been dismal. The Datastream USM index is back to precisely the position it started, having never risen by more than 50 per cent above its starting point. In the same period, the boring old blue chips that make up the FT- SE 100 index have grown four and a half times.

The comparison is distorted in two ways. The best companies have continually left the USM to graduate to the full list, including such winners as Body Shop International, Carlton Communications and Central Independent Television.

Meanwhile, the laggards of the FT-SE 100 are periodically weeded out and replaced with more promising material. On Thursday, for instance, NFC and Coats Viyella were dropped in favour of Schroders and 3i.

All the same, even that cannot account for such a wide gap in performance. The USM's apologists are quick to point out that no one was ever meant just to buy the index and doze off. But once individual investor preferences are brought into play, it is simply impossible to compare like with like. And it would have taken many sleepless nights to job in and out of the USM's ever-lively crop of shares and come out with consistently good profits.

No fewer than 184 companies, or a fifth of the total, have left the USM in the past 13 years because they were reorganised or their quotation was cancelled - both normally signs of bad news.

One of the most high-profile USM flotations, that of the American coffee shop chain Mrs Fields in 1986, was also one of the worst. The sub-underwriters were left with 84 per cent of the shares. It beat its first profit forecast, but its quote was suspended after five years.

Marina Developments, M6 Cash and Carry and Wooltons Betterware also began their careers on the USM with undersubscribed flotations.

And only two months ago the shares of another American import, Colorgen, were suspended on the USM with the dreaded words 'pending clarification of the company's financial position'.

'Will AIM avoid those pitfalls?' asked David Macnamara, a director of the specialist small-company market makers Winterflood Securities. 'Only time will tell, but I think there will be a few pitfalls, and people should be very, very careful.'

Richard Wood, head of marketing at Charterhouse Tilney, the broking arm of Charterhouse Bank, argued: 'You don't want a Gunfight at OK Corral atmosphere in the new market, but it's got to be fairly free-wheeling or the cost of regulation could kill it. It's got to be hugely caveat emptor, with red neon flashing warning lights.'

Nevertheless, Mr Wood thought that one of Tilney's longest-standing Rule 4.2 clients, the British breakfast cereal group Weetabix, might be interested in transferring to AIM.

'It's going to give companies a higher profile,' he explained, 'and that may suit the Weetabix management if they can obtain it at no extra cost. We will still have a very harsh vetting procedure for AIM, but it gives us an important new marketing tool.'

Another prestigious potential recruit to the new market is Fuller, Smith and Turner, the 149-year-old family-controlled west London brewer that is the only one of the original USM entrants still to be traded on that market.

Fuller had had preference shares quoted on the main market for many years, and was contemplating moving its ordinaries from the USM to the Official List, when the Government removed inheritance tax relief on shares quoted there.

'We were quite happy on the USM,' said Paul Clarke, the finance director, 'but it's being taken away from us. We don't have to make up our mind until 1996, and we shall do whatever is of most benefit to our shareholders - go on AIM or have our shares traded under Rule 4.2.'

But most entrants to AIM will be more like OmniMedia than either Fuller or Weetabix.

'We welcome this initiative,' said Nowell Stebbing, a director of the BioIndustry Association and chairman of the quoted Chiroscience Group. 'It could meet the needs of many of the 150-plus biotech companies in the UK.'

And the British Venture Capital Association, until recently critical of the Stock Exchange plans for small companies, has come into line with AIM.

David Quysner, BVCA spokesman and chairman of Abingworth Management, said: 'It will be the subject of considerable discussion and debate, but we broadly welcome what the Stock Exchange intends to do. The fundamental issue is whether the degree of proposed regulation will be at a level that will attract or deter a volume of investors to make the market viable. If you have low regulation, you have low cost of entry, but you deter investors.'

The Stock Exchange recognises the problem. 'Undoubtedly it will be a question of finding the right balance between freedom and regulation,' a spokesman said. 'We want to hear what people have to say. But we have done a cost- benefit analysis: it is not expensive to require directors to disclose their interests and to lay down when they can deal, and they will be covered by our rules on publishing price-sensitive information: if in doubt, put it out.' As with the USM and the Third Market, investor protection will hinge on the vigilance exercised by the broking firm that acts as a supporter for each AIM company.

In theory, the brokers will want to make sure everything is above board because their reputation is at stake. But the early signs last week were that the firms with the biggest reputations were not eager to join the party.

'It's not worth our while,' said one. 'The commissions are not big enough and the risks to our name are too high. We are better off putting our clients into a small-company investment trust.'

(Photograph omitted)

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