The City is stitching up penny share investors

Shareholders in small-cap companies are missing out on some of the best deals around while favoured City insiders line their own pockets, says Tom Bulford.

As penny share investors, we're after one thing: big returns from investing in the most exciting companies on the stock market.

But what's galling is that small companies looking to raise fresh capital often offer new shares at knock-down prices to carefully selected City institutions. That means we're missing out on some of the best deals around. It happens a lot and I know lots of Penny Sleuth readers are spitting about it.

I think that's why I provoked such a response in my 21 February article on the subject of share placings: Mystery and misinformation in the world of penny shares.

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Intelligent private investors know that if they are not to end up in some decrepit care home, they must live frugally and invest wisely. They know that they will never get rich by entrusting their money to the fund management industry and its hefty charges. So they make their own investment decisions.

The government exhorts us to save and take care of our finances. But yet, right under its nose, these share placings give worthy private investors a regular kick in the teeth.

OK, so we know that share placings favour some investors to the detriment of others. That is undeniable. But let me present the case for the defence.

Could an open invitation to all shareholders work?

Firstly, if all shareholders are to be invited to subscribe for new shares, it may be legally necessary to produce expensive documentation so that they know exactly what they are being offered. This would not only take up a considerable amount of management time but these costs would have to be incurred by shareholders.

Then there is the logistical matter of contacting all shareholders, posting documents to them, giving them a fair chance to respond and then dealing with their replies. This all takes time, during which market conditions may change for the worse. That means it may be necessary to underwrite the issue, a form of insurance that further bumps up the costs of the exercise.

By contrast, a share placing is quick and cheap and the company generally gets the money it needs. This is worth more to small shareholders than a strict but expensive adherence to fairness. What is more, the defence would argue, investors who buy AIM-listed shares know the rules of the game, so have no cause to complain!

Here's the way I see things

When a company is raising a small amount of money and is able to do so at aslim discount to the market price, I think that this defence case is quite valid. Indeed I believe that the AIM rules were originally drawn up with this in mind.

Why small investors should have been allowed in on these

But today companies use placings to the exclusion of all other means of raising equity capital. The recent issues of Falkland Oil & Gas and Sirius Minerals both involved raising around £50m. Both were conducted at a wide discount to the market price to the detriment of small shareholders who saw the value of their holdings diluted. In these two cases, I do not accept the case for the defence.

Let's take the matter of costs. Even if it was necessary to underwrite these issues, I cannot believe that the total costs would, or should, exceed £2m. This is a hefty sum but it is only 4% of the money raised and I think that small shareholders would happily bear their proportion of these costs in return for a chance to subscribe for new shares at a discount.

Now let's take the matter of logistics. The problem, AIM companies would argue, is that they do not know exactly who the shareholders are. That's mainly because so many private shareholdings are held in broker nominee accounts. So they could not contact all shareholders even if they wanted to.

But the name of each shareholder must be held by the broker, and in this day and age it surely cannot be too difficult to link databases and supply all known shareholder names to the company.

Do companies need to spend so much on a prospectus?

What could then happen is this. The company could electronically contact all the shareholders on the database giving them, say, 48 hours to subscribe for new shares at a fixed price.

Of course, some shareholders may not be online, they may be on holiday or they may not be able to make the payment in time. So, this process may not be absolutely fair. But it would be a great deal fairer than the current system that excludes all but a favoured few (including, of course, the company's own directors).

I do not see why any form of prospectus is necessary. After all these shares are being offered to existing shareholders who are presumably already familiar with the business. And investors are free to buy whatever sharesthey like, with no form of prior warning or protection.

The more I think about this, the crosser I become. The present system seems nothing more than a City stitch-up for the favoured few.

And there is one more thing that bugs me. The London Stock Exchange loves to trumpet the fact that AIM enables small companies to easily raise the funds they need for expansion. But if that is achieved simply by handing guaranteed profits to some shareholders at the expense of others, then it is hardly something to be proud of.

What do you think? Am I being unreasonable? Leave your comments below.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.

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