Are you dreaming of a lucrative sale to venture capitalists or flotation on the London Stock Exchange?

Full marks for ambition. One day your dream may become reality. But for growing businesses, the less celebrated OFEX market represents a more realistic stepping stone towards grander goals.

In 2000 and 2001 the market showed what it could achieve by attracting venture capital trusts and retail investors to prospective companies like bees to honey. However, this attraction proved ephemeral, an ensuing downturn has made companies wake up to the fact that these investors were of the ‘fair weather’ variety.

Although some deal-starved corporate finance advisers will tell you there is no shortage of institutional investors telling you to buy OFEX stocks, the reality is that few will at the moment. OFEX has been a great home for a number of companies but any company considering fundraising now has to brace itself for complete indifference and risk-averse investors.

THE STATE OF THE MARKET

Why the investor apathy towards OFEX at present? Part of the problem is to do with its perception among investors. Although both the Alternative Investment Market and OFEX markets suffer from thin trading, OFEX is the one with the reputation for illiquidity and has lost out as a result.

“In the last 18 months, with new issues scarce, there is evidence that OFEX has been losing out to AIM,” notes David Abbott, a director at Solomon Hare Corporate Finance. Another issue is the lack of regulation. OFEX is an unregulated trading platform for the shares of firms without a listing. And in an ultra cautious investment climate this is not what investors want.

“Institutional investors tend to have a dim view of the market, despite the fact that it’s as regulated as any other,” says Peter Shea, joint managing director of Daniel Stewart, an OFEX broker.

Ironically, in trying to fix this problem, some feel OFEX has gone too much the other way and that too little regulation was perhaps better than too much.

One person who holds this view is Stuart Whistance who oversaw the OFEX listings of Knowledge Management Software as CEO in 1999 and group games manufacturer Elton Games as chairman last year: “In 1999 the rules were more relaxed on OFEX than AIM. But as OFEX has tried to improve its profile, I think that might have changed.”

Added to these factors is the move away from unquoted stocks from investors who lack money to put into smaller riskier ventures.

“Two to three years ago companies were coming to OFEX that were little more than an idea and had little or no sales, and that is definitely not the case now,” says Shea. ‘Small but perfectly formed’ is the basis of investors’ expectations these days, with the emphasis on profitability, good cash flow and a healthy balance sheet, he adds.

STARTING BLOCKS

But OFEX has no shortage of supporters who view it as a place where sophisticated private investors can make a lot of money backing small, fast-growing businesses. And for companies looking to raise cash, OFEX has advantages over rival sources of investment.

“It gives you the opportunity to retain more of the equity than in a venture capital deal,” says Andrew Griffiths, editor of the AIM and OFEX Deal Monitor. “VCs try and grab a lot of the upside; on OFEX you often end up in control of a fairly simple share structure.”

Stuart Whistance is also still a keen supporter. “Venture capitalists look for their rewards when they put the cash in rather than on exit,” he says. “One of the beauties of OFEX is that everyone is rewarded equally.”

And while Jonathan Jenkins, joint-managing director of OFEX, acknowledges activity has been thin on the ground over the last year, there are now signs of life. “Corporate advisers are approaching us and and although the investors may not be flooding back, they are certainly inching back.”

DOES YOUR FACE FIT?

In the last two years OFEX funding has shifted away from start-ups to early-stage businesses. Now £500,000 is seen as the minimum a company must raise due to the cost of fundraising and investor appetite. Jenkins confirms this view and says that if your business is at the post-business angel, pre-AIM, funding stage then you should consider the market.

Like the AIM market, there are few hard and fast rules for joining OFEX. It will not discriminate on the basis of the size or age of your company or the sector in which it operates. Jenkins also says that any firm with a turnover of at least £1m and looking to grow will have a good chance of being accepted.

The market has proved particularly attractive to mining/exploration and biotech businesses in recent times (again in common with AIM), but Jenkins points to an even mix of companies with 23 different industries on the board and no one sector has ever accounted for more than 15% of total market capitalisation.

However any company considering a move to OFEX should think carefully about how this changes a business and whether you are ready for the pressures to come. For a start, you may be convinced that your management team are the right people to run your business but can you persuasively convince others? And are you prepared to change the team to get the money you need?

Then there is the strength of your business proposition. Any commercial claims you make will have to stand up to close scrutiny from investors.

They will want to know the minutiae of your products, their place in the market and their strengths and weaknesses vis-a`-vis the competition. Are you prepared to go through that process?

Then there is the listing itself. You will have to invest a significant chunk of management time in talking to advisers, doing the legwork for the listing documents and then pitching to investors.

This toll on management time continues once you are a public company. You have to accept the obligations of the market in terms of providing information to your investors in the form of regular trading updates and financial results.

In short, any business which may be thinking about going public should think long and hard about the decision.

GOING PUBLIC

The two main ways of getting your company onto OFEX are via a cash-raising offer for shares or an introduction.

Listings do not happen overnight however. A fund-raising will take at least three months and possibly six to pull off. An introduction where you raise no money, the timescale is three to six weeks. Jenkins suggests planning a year ahead and says OFEX ideally likes to make contact with candidates two years before going public.

Gary Morley, a director at WJB Chiltern Corporate Finance cautions that when you are calculating how much you want to raise you must be realistic what you target – particularly from institutions – and understand the way most fundraisings work.

“A lot of fundraising on OFEX is an illusion,” he cautions. “Most companies valued at less than £5m get virtually nothing from the public, the majority of it is already placed by the company with family and friends.”

But OFEX is not just there for companies wanting to raise cash. Introductions to the list are a good way of providing a trading facility for shareholders or employees with shares. This is why large – effectively private – companies like Shepherd Neame and Weetabix have moved to the list, allowing family members to sell their shares. OFEX’s rules help this as it does not stipulate that a minimum percentage of a company’s shares must be in public hands – unlike the London Stock Exchange’s Official List where at least 25% ownership must be relinquished.

Companies with a track record on the list can find it easier to raise funds further down the line. Whichever way you join, OFEX also allows companies to use their tradable shares as paper for acquisitions, this is particularly handy for small businesses lacking a significant cash resource. But WLB Chiltern’s Morley says that alone is not a good enough reason to join OFEX.

“It only works if someone is prepared to take the shares and most people would struggle to see two million OFEX shares as the equivalent of £2m. I know people who wouldn’t even take AIM shares, never mind OFEX.”

NEXT STOP OFEX

The path to a listing is quite straightforward. The first thing to do is appoint a corporate adviser, who will make the application to OFEX on your behalf. This will then be scrutinised by a specialist within the organisation as well as an independent panel of professionals including investment bankers and lawyers. If necessary, they will go back to the company requesting additional information, with one frequent area of clarification being evidence of trading contracts. “The documentation is not too demanding,” insists Jenkins.

Once accepted, you must ask yourself if you will raise cash, and if so, how much. The largest IPOs can deliver as much as £7m, with secondary fundraisings often worth considerably more. Although £100,000 is cited as the smallest amount, economics mean that £500,000 is realistically the least you would be looking to raise.

An average fundraising of around £1.5m would cost about £120,000, with £10,000 representing the OFEX fee (£5,000 for your application and a £5,000 annual fee). The balance of £110,000 is advisory, charges are split roughly 50/50 between legal/ accountancy costs and corporate finance fees.

Griffiths says you should check whether an adviser is an active OFEX adviser and carefully examine their recent track record to see whether they specialise in your type of business. He adds: “You’ve got to be comfortable with the people and the fee. Don’t be afraid to negotiate – everything’s a movable feast.” He advises shopping around and getting at least two quotes for fees – the difference in commission charged could be several per cent.

Like any service you buy, cheapest is not necessarily best. Netalogue Technologies, a software developer, joined OFEX in 2001 with the aim of making a statement that it was a serious player in its market. It went for a blue-chip adviser in the form of PricewaterhouseCoopers. “OFEX was and continues to be a massive expense, as we have surrounded ourselves with an executive counsel, including PwC, who are there to do a long-term job for us,” says managing director Richard Condon. “Cost is certainly a major factor, but I wouldn’t say that cheapness should be your reason for joining OFEX.”

MANAGING THE MOVE

When appointing an adviser, make sure you have a strict timetable you can both adhere to. Jenkins says a lot of companies expect the adviser to drive the whole process including taking a back seat: think again, because you will be very much involved. Not least, bear in mind that you will need to draw up a prospectus. Jenkins says OFEX needed 13 or 14 drafts when it floated on AIM. Do not expect things to be any different for you – every word will be scrutinised and may be challenged.

“However long you think the process will take, it will always take longer,” warns Jenkins. Once on the market, remember the extra responsibilities that will be imposed. “You are governed in the same way that you would be on more senior markets and heavily audited,” says Condon. “You need to develop a whole new skills set and that could be seen by some as a disadvantage. But if you are thinking big, those skills could become the foundation of your company.”