UK: Quoted Business - A Briefing For Quoted Companies, June 2007

In this edition of Quoted Business, we investigate the recent US jibes on the integrity of AIM. We explore post-flotation issues for executive remuneration and hear about the recent listing of Vycon. We review the impact of the Budget on aim and evaluate changes to aim rules for nomads.

AIM UNDER ATTACK: A CASE OF SOUR GRAPES?
Smith & Williamson’s head of AIM, John Cowie, discusses US criticism of AIM

In January this year, John Thain, chief executive of the New York Stock Exchange, said that AIM "did not have any standards at all".

Then, in March, Roel Campos of the US Securities and Exchange Commission (SEC) branded AIM "a casino". He went on to say that "it is a losing proposition to tout lower standards as a way to promote your markets."

These charges from across the pond caused ripples in the City. The London Stock Exchange (LSE) issued strong rebuttals, drawing further press attention to the slurs.

The premise behind these comments is that AIM is lightly regulated and therefore likely to attract poor quality companies. To us, these attacks sound like sour grapes over AIM’s obvious appeal to businesses worldwide compared to US markets, where the administrative burden (and cost) of complying with Sarbanes-Oxley (SOX) tends to discourage smaller companies from listing. US market practitioners doubtless feel that SOX ought to have been imposed worldwide rather than in just their backyard. It may even be that these remarks are a deliberate attempt to belittle the LSE, to help US rival Nasdaq’s bargaining position should it make another bid for the UK exchange.

Whatever the reasons for these criticisms, it is worth reminding ourselves of AIM’s strengths and why it has been so successful. Since its launch in 1995, it has raised more than £34bn of capital to help all sorts of companies fund development, pursue their goals and, in some cases, make the transition to the LSE’s main market.

AIM is a successful growth market because it purposely takes a flexible approach to minimum listing requirements, devolves interpretation of its rulebook to the Nominated Adviser (Nomad) network and provides funding and liquidity to budding companies. Many testify to their success and positive experiences, as we see in the case of Vycon, a US ‘clean tech’ company profiled in this edition of Quoted Business.

In addition to his ‘casino’ comment, Campos remarked that "30% of issuers that list on AIM are gone in a year". His figures are questionable. If you look at how many companies fail on AIM, the proportion is virtually identical to the Official List in terms of percentage. For a growth company market – which investors accept is likely to carry higher risk than a market which caters for larger, established companies – that’s an exemplary record. In fact, company failures on AIM probably run at below 3%; so the origin of Campos’ 30% figure is a mystery and suggests that he has either not researched the facts properly or, more worryingly, has a fundamental misunderstanding of what AIM is about.

The view of many informed commentators is that SOX runs counter to AIM’s essential principles. Rather than an overarching regulatory body like the SEC (which oversees the US exchanges) and the UK Listing Authority, which fulfils the same role for AIM’s bigger brother, the Official List, AIM is largely policed by the Nomad community. Getting the Nomad to take responsibility for the suitability of a company coming to AIM (we have to sign a declaration to that effect) was AIM’s masterstroke. Tying the fortunes of the regulator to those of its client helps to ensure that the decision to take a company to AIM is not made lightly and goes some way to explaining the remarkably low failure rate of companies joining AIM

Unlike Campos, most believe AIM’s regulations are sufficient, despite a recent slowdown in admissions that has coincided with the implementation of new rules governing companies and Nomads (which we discuss later in this issue). In fact, it is likely that this slowdown reflects wider economic conditions rather than the new AIM rules.

Most Nomads are already doing what the new AIM rules require as a matter of good practice. The underlying regulatory environment for Nomads is unchanged and doesn’t look like it will alter. That’s what makes AIM so successful – and may explain why others can only look on in envy.

For companies that joined AIM around the turn of the millennium, it is likely that business goals will have extended beyond the strategy for the early years, which unsurprisingly tends to focus on shortterm goals and enhancing the value of the business.

Three to six years on from f lotation, many companies will have updated and adjusted their original business strategy to reflect the current marketplace, adapting to new demands to keep pace with the competition. If acquisitions have taken place, this can change the original business model, introducing new performance measures and strategic goals.

Aligning incentives and goals Where share and other cash-based incentives are performance or target-based, it will be necessary to revisit performance conditions to align them with business goals. This is important because if incentives aren’t properly aligned to the business, it makes it difficult for staff to earn their performance-based rewards. In a tough market, where it’s difficult to recruit and retain the best people, this is a situation all companies should avoid.

Even where the business has not changed significantly, how often should incentive schemes and share plans be reviewed? There is no definitive answer, although every three years is a good rule of thumb.

So what decision should you make regarding incentive schemes and share plans? First, ask yourself: do the incentives maximise the profit to the employee at the lowest cost to the company? Both tax and National Insurance Contributions (NIC) can be significant factors in the level of take-home pay for staff. Where possible, share and other incentive awards should be delivered through tax-effective vehicles. This could be through HM Revenue & Customs (HMRC) approved share plans or through other tax deferral arrangements, such as employee benefit trusts.

Be warned though, the Government and HMRC have made it clear that they will not tolerate unacceptable tax and NIC planning, so any planning, other than via HMRC-approved plans, could be subject to scrutiny.

HMRC is focused on ensuring that employers comply with the reporting requirements of employment-related shares, so companies need to be certain that their share awards are properly disclosed. Also, companies should make sure that correct procedures are in place to collect the right amounts of income tax under PAYE and NIC on any option exercises.

On a brighter note, you can provide significant amounts of shares to employees under HMRC-approved schemes and, where an AIM company has a good liquidity of shares, the extension of share ownership to all staff should be seriously considered.

There have been changes over the past year to accounting standards in relation to share and share option awards. Typically, there’s a charge to the profit and loss account in relation to all share awards, so the accounting implications should be considered in advance of any new awards, as this may impact adversely on reportable profits. We have certainly seen accounting changes impact on overall trends in equity reward, and the structure of the share award and imposition of performance conditions can have an impact on the overall profit and loss charge.

For the company board, the most important issue is the validity of performance conditions that applied at flotation stage, and whether the business model has changed to such an extent that the conditions need revising.

In considering appropriate performance conditions, AIM companies need to be mindful of the Association of British Insurers’ (ABI) guidance on share-based incentives. While AIM companies are not obliged to adhere to the guidelines as closely as fully listed companies, there is the expectation that AIM companies will make every effort to do so.

The ABI updated its guidelines in December 2006, so AIM companies need to be aware of the latest position on sharebased incentives to demonstrate good corporate governance.

In broad terms, the share awards should align the interests of executives with the interests of shareholders. The scheme should be transparent to shareholders, with performance conditions linked to the strategic objectives of the business and details of cost and dilution readily available.

Based in California, Vycon makes highspeed, flywheel-based systems capable of storing a large amount of energy and then releasing it quickly. A 400lb vacuum-sealed flywheel created by Vycon spins without friction on an electromagnetic field. It’s designed to work with engines such as those found in dockyard cranes to reduce pollution, collecting energy as loads are lowered and releasing energy quickly when a load is raised.

Importantly, Vycon’s technology results in lower fuel consumption while, at the same time, reducing emissions of greenhouse gases and other pollutants. Vycon’s technology also has applications in areas where high reliability and availability of power are critical, for example, in uninterruptible power supply units used in hospitals.

Prior to its initial public offering, an international investor base of venture capitalists and multinational corporations funded Vycon through its development stage. The onset of commercial sales provided a natural opportunity to widen the shareholder base while securing the additional funding necessary to scale up production facilities. None of the existing investors sought to sell shares in the flotation.

Vycon raised $18m of new capital on flotation, the upper limit of what the company was seeking. The fundraising attracted global interest, with new investors from New Zealand, Hong Kong, the US and Switzerland.

In addition to Vycon’s cutting-edge technology, investors were attracted to the quality of the management team, which has many years’ experience in the sector – much of it gained within Fortune 100 companies. Prior to the listing, the board was further strengthened by the appointment of John Uttley, former finance director of the National Grid Group, as non-executive chairman. John was introduced to the transaction by Smith & Williamson Corporate Finance. He brings considerable experience to Vycon as it adapts to life as a public company.

It has been well documented in recent years how many US companies have sought to raise capital in London rather than on US domestic exchanges and markets. This is partly due to the requirements of SOX, which have introduced significant costs to US public companies.

However, the principal attraction to Vycon was AIM’s reputation as the world’s most successful growth market. As a young and rising company operating in global markets, AIM provided the ideal environment for Vycon to attract funds and continue development while raising its global profile.

For Vycon’s president and chief executive officer, Tony Aoun, admission to AIM represents an important milestone for the business. Tony joined Vycon in late 2004 with responsibility for bringing its technology to market. He describes the AIM listing as "providing a firm foundation from which to deliver sustained growth".

Although its commercialisation strategy is only just beginning, Vycon is determined to exploit what it sees as a worldwide market for its products. The company has already received orders from the UK, South Korea and the US. Following the flotation, major steps have also been taken to move the company towards a production scale business, and plans to move to a new 35,000 sq ft production facility were recently announced.

Having successfully completed its flotation on AIM, Vycon is ready to move towards the next stage in its development, which is to meet the increasing demand for clean energy storage solutions. The company is developing a range of higher-capacity products, based on the same technical platform as its current products, which will compete in several new markets, including large UPS systems, quay cranes and the railway sector.

With global emphasis on the reduction of emissions, together with increasing demand for renewable, clean energy, Vycon looks set for an exciting future. This view is shared by Tony Aoun. "Vycon is in a very strong position," he notes, "with patented technology, a strong management team and a solid platform for growth." It’s an apt summary of Vycon’s bright prospects.

NEVER MIND THE BUDGET
John Cowie urges investors not to overreact following the Budget’s apparent threat to AIM.

Immediately following Gordon Brown’s ‘farewell’ Budget speech, news began to spread that AIM shares were in danger of losing their status as unquoted for tax purposes. The potential ramifications were huge. Business Asset Taper Relief for AIM stocks could be gone. AIM companies would no longer be qualifying investments for Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT) purposes and would lose their ability to attract funds from these sources. Inheritance tax (IHT) planning using AIM portfolios could be gone.

Was this the end of the party? Cautious investors were concerned and – keen to retain any gains they had made on AIM stocks and to maximise any tax relief – were talking about selling entire shareholdings. If the journalists were to be believed, AIM prices would collapse, as the wise money went into assets that would allow investors to continue to benefit from the tax reliefs AIM shares were about to lose.

The cause of the panic was in fact the innocuously titled Budget Note 37 (BN 37) that slipped in alongside the other major Budget pronouncements. Although BN 37 was really a small legislative matter that concerned the classification of stock exchanges and their definition as ‘recognised’, it was the quiet way that the note was introduced that created most of the suspicion and consequent noise.

Commentators dreamed up all sorts of theories. One of these was that if it was not always the Treasury’s intention to remove the tax breaks, why make any reference to recognised investment exchanges? This was a ‘no smoke without fire’ argument when, in truth, there was no smoke in the first place. The Quoted Companies Alliance, the champion of the smaller quoted company, was moved to issue a press release condemning Brown’s shortsightedness, stating: "Ominously, [the Treasury] has also given HMRC the power to designate any investment exchange as a recognised stock exchange for tax purposes." Seeking justification for the Treasury’s actions where none was needed, people envisaged a conspiracy, imagining that Brown had tried to slip the note into secondary legislation because there was something to hide.

If the tax breaks were to be removed, in all likelihood AIM would suffer – and it could quite possibly be catastrophic. But does the Treasury really want to dismantle AIM? Nasdaq has made no secret of its interest in the LSE, of which AIM is a major part. Wouldn’t it be politically unwise to break up the AIM party? In any event, if that had been the Treasury’s intention, why wasn’t Brown saying it explicitly? What could Brown possibly gain from hiding his intentions in secondary legislation?

Having spent some time trying to get to the crux of this issue, I returned to the simple answer: the purpose of BN 37 was to correct a fundamental mismatch between the status of overseas exchanges and UK exchanges.

If an overseas exchange wants to be classified as ‘recognised’ in the UK to allow the shares of certain types of company to be listed (for example Real Estate Investment Trusts), it applies to the Financial Services Authority and then to HMRC for designation. Paradoxically, prior to BN 37, if a UK-based exchange wanted to do the same, HMRC did not have the power to grant ‘recognised’ status. BN 37 now gives it that power. What it emphatically does not do is permit HMRC to impose this status against an exchange’s will.

So, nothing has changed. And, if our sources are correct, nothing will change soon. The Quoted Companies Alliance summed it up in its newsletter: "The fears we had have been allayed and we understand that there will be no change to the tax treatment of smaller quoted companies."

One of the key changes the LSE has introduced to the AIM Rules is the new rules for Nomads.

These came into effect on 20 February 2007, together with other changes to the AIM Rules, notably the introduction of a requirement for all AIM companies to maintain websites on which certain information needs to be made available.

A Nomad was already responsible to the LSE under the AIM Rules for assessing the appropriateness of an AIM applicant. However, the new Nomad Rules organise these responsibilities more clearly and set out the eligibility criteria, ongoing obligations and disciplinary procedures that apply to Nomads.

These changes are aimed at improving the quality of Nomads in general, for example, by ensuring that all Nomads have the appropriate experience and number of qualified staff. But Nomads will have little, if any, impact on the day-to-day operations of AIM companies themselves.

The key elements of the Nomad Rules that impact on existing and prospective AIM companies are set out in a schedule which describes how active the Nomad needs to be in assessing the appropriateness of an AIM applicant, and their specific ongoing responsibilities. These tasks include:

• maintaining regular contact with the AIM company to ensure the company continues to understand its obligations under the AIM Rules

• ensuring that the Nomad keeps up to date with developments at the company

• reviewing in advance all notifications made by the AIM company for which the Nomad acts

• monitoring the trading activity of the AIM company’s securities (particularly when the Nomad is aware of unpublished price-sensitive information)

• advising the AIM company on any proposed changes to the board of directors.

The Nomad is now formally obliged to notify the LSE of certain matters. For example, if a Nomad believes there has been, or could be, a breach of the Nomad Rules or the AIM Rules for Companies by either a Nomad or an AIM company.

While the new Nomad Rules are generally considered to reflect what should already be good practice by most Nomads, the changes formalise and make explicit what the LSE expects from advisers.

As a result, while the Nomad Rules are not expected to impact significantly on the management of AIM companies, some companies may see their Nomads take a more active role in monitoring compliance with the AIM Rules for Companies. For example, a Nomad might need to be more stringent about assessing changes to the company’s board of directors or ensuring that the Nomad’s contact details are included in announcements.

The intention and expectation of the LSE appears to be that the new Nomad Rules will help to ensure that the quality of Nomads is at an appropriate level, without overburdening Nomads or AIM companies unnecessarily.

Many of the businesses that we deal with are faced with the fundamental question of how to attract, retain and manage their employees. Across almost every business sector, a company’s valuable human capital is often its greatest asset so it’s not surprising that these issues are right up there on the management agenda.

Our experience in this area has led us to the conclusion that the key is motivation and reward. And this begs a number of questions. How, as an employer, do you offer added financial value to your employees’ total remuneration? How do you maximise your employees’ appreciation of their reward package? And how, at the same time, do you run HR efficiently and seamlessly?

We think the answer is Smith & Williamson Flexible Solutions – a user-friendly technology platform designed to manage, update and deliver human resources and employee benefits information and services.

Smith & Williamson Flexible Solutions was launched at the beginning of 2007, following a gestation period of more than a year while we completed market and product due diligence and testing. It was born out of our combined expertise in advising on flexible benefits package design and implementation, tax and National Insurance matters and employee communication.

The result is a versatile, web-based information tool for your entire workforce that also helps manage costs and administration. And feedback from clients to date has been very positive.

The positive response we’ve had is largely due to the fact that, at its heart, Smith and Williamson Flexible Solutions is about creating choice for employees – from total reward statements to flexible benefits, pensions communication to voluntary benefits and financial education. The big bonus it that it makes things easy for HR too: a powerful absence and holiday management application is included, payroll and HR systems can be integrated, and employee data and records are centrally sourced.

So whether you’re a business start-up or a long-established, mature business, Smith & Williamson Flexible Solutions can run your HR and benefits back office, leaving you to run your business. If you want to find out more, come and talk to us about it.

We held the third in our series of AIM breakfasts in March at 25 Moorgate. Once again, a small gathering of company directors either considering AIM or already listed on AIM, met to hear Marcus Stuttard, deputy head of AIM at the LSE, discuss current issues affecting the environment in which AIM operates and to answer questions on issues which concern today’s AIM companies.

We expect to hold these at regular intervals in the future. If you are listed on AIM, but want a chance to ask those in a position to set the regulatory framework that burning question, get in touch with John Cowie and we will reserve you a place at the next breakfast.

The Growth Company Awards, run by Growth Company Investor, were presented to the nine category winners at Grocers’ Hall on Tuesday 24 April 2007.

The Growth Company Awards aim to recognise the achievements of AIM companies and the positive contributions from their associated advisers. Completely impartial, the award nominee list is only created once Growth Company Investor has consulted the management team of every AIM company.

John Cowie, head of AIM at Smith & Williamson, sat on the panel of judges for this year’s event. Smith & Williamson also sponsored the ‘AIM Lawyer of the Year 2007’ category.

Now in their seventh year, the awards continue to represent a real measure of quality for those involved with growing companies.

You can view the winners and event pictures from the Growth Company Awards 2007 at Millnet’s website – visit www.millnet.co.uk/news/gca07

Smith & Williamson takes AIM to India

Philip Quigley, a director in Smith & Williamson’s Assurance and Business Services division, recently accompanied the LSE to Delhi and Mumbai to explain the merits of AIM to the business and advisory community.

Ibukun Adebayo, the LSE representative responsible for developing business in India, spoke on the attractions of the AIM market for Indian companies. Alongside Ibukun and Philip were representatives of Evolution Securities (AIM brokers), Clyde & Co (lawyers) and Bell Pottinger (financial PR). Around 400 business people attended the two presentations, hosted by the Indian law firm, Khaitans.

"From this brief visit it’s clear that there’s enormous appetite for foreign capital in India and AIM is clearly one of the sources," said Philip. "The opportunities are very wide, with companies across the whole economy looking for investors. We’re now looking forward to working with a number of the companies I met in India."

Smith & Williamson was delighted to present, alongside the LSE, in Frankfurt as part of the LSE’s initiative to promote AIM in Germany. John Cowie made a presentation to over 100 businessmen and women, advisers and lawyers on the role of the Nomad in the AIM admission process.

SJ Berwin and Mazars made presentations on the role of the lawyer and the reporting accountant, respectively. Marcus Stuttard sat alongside John and representatives from SJ Berwin and Mazars on a panel Q&A session afterwards.

Smith & Williamson Corporate Finance acted as Nomad to Speymill Macau Property Company Plc on its listing on AIM in November 2006. Speymill Macau, an Isle of Man company established to invest primarily in the high-quality residential property market of Macau, raised $80m from investors on admission and a further $70m in May 2007.

The listing of Speymill Macau followed the successful launch of Speymill Deutsche Immobilien Company Plc (SDIC) in March 2006. Smith & Williamson Corporate Finance also acts as Nomad to SDIC.

Smith & Williamson Corporate Finance advised Envirotec Ltd, a designer and manufacturer of air door curtains and other commercial air-handling equipment, on its acquisition of Westway Cooling Ltd, a commercial air-conditioning service and maintenance provider. We advised on the management buy-out of the company in 2005.

Smith & Williamson Corporate Finance acted as Nomad to ORA Capital Partners Plc, a company providing capital and expertise for growth and development businesses in the UK, on its admission to AIM. The company raised £35m on admission, with an initial market capitalisation of £120m.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.