Wednesday, January 31, 2024
Author: Hannah Woodley & Iain Baillie
In recent years, the number of funds willing and able to invest in smaller companies (sub £100m) has drastically reduced.
The fund management space has become larger and more concentrated, funds have got bigger and bigger, and consequently the size of the investment they need to make has grown. Meaningful investments are tens or hundreds of millions, not millions. So when most can only invest up to 10% in any one company, large companies with big market caps dominate their attention.
The vast majority of companies on AIM do not meet this benchmark, and it’s causing a drying up of volumes.
It wasn’t always so. At the end of the 2000s and start of the 2010s, all the bulge bracket investment banks had AIM trading desks. If you were a broker, raising money for companies with a sub-£100m market cap, there were plenty of pension funds, insurance companies and wealth managers you could tap. Now, it’s a different story. This investor base has dwindled, driven by caution, liquidity requirements, regulatory change and lack of returns, creating a much poorer funding environment for smaller companies.
At its 2007 peak, AIM boasted 1,694 businesses; now there are just 753 – a 20-year low. Access to capital has also dropped: last year, £1.5bn was raised, the lowest level since 2003. That’s an average of just £2.1m per AIM listed company. While the liquidity, contrary to reputation, has been improving since the market was founded, the distribution of liquidity has not. The majority is focused on a small number of the largest businesses, while the larger number of smaller companies trade less frequently and struggle to raise the funds they need to grow.
This is compounded by the broader shift in UK market ownership over the last 25 years. Insurance companies and pension funds have been withdrawing from UK small- and mid-cap equities, largely replaced by overseas ownership (from 31% in 1998 to 56% in 2020 – and no doubt higher today). But market cap and liquidity constraints mean that overseas investors mostly go for larger companies. Individual ownership, too, has decreased (from 17% in 1998 to 12% in 2020), moving into other assets and global portfolios. The shift in the high net worth threshold – from £100k to £170k – will only diminish it further. And even if they do hold UK equities, they can inadvertently contribute to the problem. While the rise of retail investing has undoubtedly been a good thing for democratising access to previously inaccessible assets, retail investors typically buy and hold, further stifling liquidity. If they do trade, these small volumes have the tendency to disproportionately move a small cap’s share price (usually down) when there is a perceived window to trade – typically on the back of an announcement, regardless of whether it's good or bad news.
Even tracker funds that appear to support UK small companies increasingly do not. Take the L&G UK Smaller Companies Index Fund, which tracks the FTSE SmallCap. Nine of its top 10 holdings are funds, not companies, of which only one invests in UK companies as its principal strategy – and even that fund is heavily weighted to the FTSE 100.
This all results in a shrinking capital pool for smaller companies, encouraging a doom loop where limited investment hampers growth – and the chance to gain future investment. The cost of raising capital in the UK is now about 23% higher than overseas, pushing companies towards international listings or acquisition by foreign investors.
Listing, and remaining listed, on an alternative exchange like AIM used to make sense for small, growing businesses, and still very much does for those with a decent market cap. The investors and liquidity were there, but right now, the cost of listing, and the ongoing costs of regulatory compliance and advice, simply outweighs the benefits for many of the smaller companies. An IPO costs a minimum of £500,000, and listing maintenance costs tend to be at least £200,000 a year, not to mention the management time spent on compliance and reporting. Yet, if they’re on the smaller side of the spectrum, companies simply can’t attract the investors they need.
Part of the solution will fall to macro and regulatory changes, such as incentivising UK pension schemes to invest in domestic listed companies, introducing an ISA allowance dedicated to investing directly in UK small- and mid-cap companies, and reducing the governance and cost burden for listed companies…but these are long-term changes.
Private exchanges like Asset Match offer a cost-efficient and less burdensome alternative for companies that might otherwise consider going public. We provide a platform for trading private company shares through intermittent auctions, enabling growth and liquidity without the substantial costs and compliance burdens of AIM and other public markets. We also serve as a testing ground for smaller companies who may want to go public later on, allowing companies to familiarise themselves with shareholder reporting and good governance practices – or act as a stepping stone to other exit strategies.
So as we wait for the long-term reforms needed to turn around the outflow of capital from UK small- and micro-cap businesses, Asset Match presents a cost-efficient option for growth companies, especially those for whom AIM no longer offers a suitable or financially viable platform.