Is AIM replacing venture capital?

Although AIM is often considered an alternative to traditional sources of growth finance for entrepreneurial companies, it’s also complementary to the work of the venture capital community. Its success has acted as a magnet to London for fund managers, professional advisers and companies seeking capital from all over Europe, a number of whom have established headquarters here as a result. This benefits the whole entrepreneurial ecosystem.

Many entrepreneurs currently prefer to take funds from AIM rather than venture capital, in the belief that that an AIM flotation will offer a higher valuation for their companies than venture capitalists. This happens because pricing on AIM is driven by the supply and demand of money, sector sentiment and by the historically lower return expectations of public market investors. Thus, when money is plentiful and a particular sector is in fashion, companies coming onto AIM attract high valuations – sometimes higher than they merit.

Market whims and wiles
But in a different part of the stock market cycle, companies approaching AIM will either be valued at much lower prices or will not be able to raise money at all. And those already on the market may find their valuations plummeting through no fault of their own. The public markets can be a brutal place and it’s important to remember that pricing is based as much on the availability of capital and market sentiment as on the quality of the company.

Furthermore, when money supply is tight, companies on AIM may find themselves left high and dry, unable to obtain further finance. All companies raising finance after the early rounds anticipate the new round seeing them through to profitability. But this often doesn’t happen for a variety of reasons, not necessarily related to unrealistic forecasts. If a company has gone to AIM too soon in its development, it may fail simply because it cannot raise further funds, not because the business proposition isn’t viable. Venture funding is nearly always a better option for loss-making, early-stage companies.
Companies that are profitable cannot stand still; they too need to raise capital for further growth. This must carry them through market cycles until they attract a sufficient following of customers and investors. Many fail as a result of being under-capitalised, rather than because they have a poor product or business model. These companies can benefit from the greater access to finance that public markets offer, but they have to sell their story hard to maintain profile.

Picking the right path
So, when is AIM the right choice for entrepreneurs? Generally, we regard an AIM listing as a viable alternative to a fourth (Series D) or fifth (Series E) round of institutional finance. By then, the company should have reasonably predictable revenues and may well be close to profitability. Strategy and management should be proven, sound and stable and the company will have predictable organic growth as well as the potential to make acquisitions. The flotation will be a means to achieve expansion, generating funds for capital investment, a potential for acquisition currency for small companies with large ambitions, an incentive currency for management and employees as well as wider visibility and credibility.

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