How David Cameron’s ‘Big Society’ idea can be applied to helping Small Companies to lift the UK Economy

Equity Development are regulated by the Financial Services Authority

SoCo points to smaller companies as the best bet to lift and sustain Britain‘s economic growth - but only if, they can find appropriate finance. SoCo takes its name from David Cameron‘s ‗Big Society‘ idea of decentralisation of services away from the State. It applies that principle to the decentralisation of finance for smaller companies away from the dominating banks that refuse to lend to them and the financial institutions that are too big to embrace them. SoCo‘s findings suggest that, given proper incentives, business angels alone could invest £4 billion in start-up companies – a sum which is greater than any form of assistance that could be expected from the government. It observes that, thanks to the effects of the internet and new media, small companies have a much greater chance of succeeding than ever before. SoCo points to the ever shortening time scales of companies from start-up to global success and suggests that ‗there are embryo companies that we haven‘t heard of today that will be world striding giants in under five years‘. It highlights the resilience of an economy based on small companies: It draws fresh attention to the fact that smaller companies employ more than half the UK workforce and observes that, as they grow, smaller companies take on more employees to cope with increasing sales, whilst large mature companies with limited growth prospects often seek to improve earnings by reducing their labour forces. It records that small companies are drivers of innovation, registering more than 60 per cent of all patents. It points out that small company by and large pay taxes whilst many of the largest companies avoid them. It observes that when large companies fail, they cause national, even global distress; whereas when small companies fail, the effect is minimal and localised. Against that background it calls for a much greater differentiation of regulation between large companies and small. In particular, it calls for a sustained effort to be made to lift from smaller companies the excessive burden of ‗catch-all‘ red tape that is principally designed to monitor and control large companies. effect on small companies. It pleads for a complete rethink of employment law for companies employing, say, less than 20 people. This would take the vast proportion of the UK‘s businesses out of a regulatory nightmare but would have little effect on employment conditions. In this respect, it also draws attention to the greater satisfaction enjoyed by employees of smaller companies who can see that their efforts actually ‗make a difference‘. This burden has a disproportionate


Finally, the report observes that a new atmosphere of trust must be established if individual investors are to be attracted to support companies both small and large. With that in mind, it calls for a removal of the core conflict that has neutered the Financial Services Authority. That conflict sits between the objective of „policing the City ‗and that of „protecting the reputation of the City‟. It reports the views expressed by the former CEO of the FSA Howard Davies, that senior figures at the FSA used that conflict to argue against action to tackle regulatory and market abuse, stating that action would draw attention to the abuse and thus damage the reputation of the City. It points to that conflict as a major cause of the failure of the FSA. SoCo argues that new clear objectives must be established and truly independent officials must be appointed if the Bank of England is not to fall into the same morass as the FSA. It demands tighter policing of the smaller end of the quoted company market so that the ‗usual suspects‘ rogue promoters are denied access to investors who, when robbed of their savings, are deterred from further investment, thus denying the market as a whole an important source of funding and liquidity. It refers to the higher returns available from smaller companies across the board, to the savings to be made by individuals managing a proportion of their own investments and to the time being right to encourage individual investment in small companies low because of the rates of interest available in the market place. It draws attention to the loss of confidence in financial institutions that places the UK near the bottom (101 out of 110 countries) of the recently released Legatum Institutes‘ Prosperity Index. It points out that these factors combined are already driving investors to look for superior returns and account for a substantial increase in business angel investment. It encourages the coalition government to support this trend.




Small businesses are more likely to succeed today than ever before because they now inhabit a ‗multi player‘ world where they can instantly and freely interact with innovators, customers, investors, employees, collaborators and suppliers alike. These new opportunities and freedoms come courtesy of the Internet and New Media. As a result, the potential for growth of many of small businesses has expanded massively whilst the cost of getting off the ground has tumbled. It is certain that new companies we have not heard of today will be world-striding giants in just a few years. Given ready access to development capital, they are now the businesses that are the best bet to achieve the growth needed to lift the U.K. economy. The development rate of companies is accelerating constantly. Microsoft and Apple grew from nothing to world domination in three decades; Amazon, eBay and Google took little more than ten years, Skype achieved a multibillion dollar valuation within a couple of years and now brand new ventures like Facebook, Twitter and YouTube reach many hundreds of millions of people around the world. These new, global businesses are themselves successful but their true global importance lies in their revolutionary ability to help other companies to create wealth. The Internet and New Media enable businesses, small and large, not only to bypass the distribution bottleneck to reach their customers but also to communicate more effectively with suppliers and staff to improve efficiency. Tools such as stock control and point of sale monitoring have developed beyond all imagination, whilst sophisticated accounting and payment programmes are now free as ‗Open Source‘ over the Internet. And the small companies that benefit most are those that either make something from nothing, except sheer brain power, or provide a better product or service. They might be authors, film makers or software businesses, of course, but they are also shoe retailers, sausage makers, machine part distributors, security companies, green energy suppliers, technology providers and any one of a multitude of other businesses. Small companies are the innovators upon which commerce relies. They register more than 64 per cent of all patents and they employ some 13 million people, that is 58 per cent of the workforce at last count. Moreover, unlike large companies, they usually grow organically rather than by acquisition. By and large they don‘t have the opportunity, let alone the will, to take on massive borrowings, so they are less vulnerable to the debt induced collapse that has been a plague in recent years. They pay tax in the UK and, of course, if they collapse, they create localised difficulty not the widespread destruction caused by companies like Woolworths, Marconi, Mayflower, Jarvis and so many others. They are likely to increase rather than decrease employment.


SoCo contends that small companies are good for growth, for employment and for a resilient economy. It draws attention both to the opportunities and to the difficulties facing small companies. In particular it reviews how they might be financed and suggests that‘s where Prime Minister David Cameron‘s ‗Big Society‘ idea should be applied.. The coalition government has promoted the vision of ‗Building the Big Society‘ and has stated its ‗driving ambition: to put more power and opportunity into people‘s hands‘. The concept underlying the Big Society is the diffusion of power away from the centre. This has wide ramifications throughout society in all spheres of human activity. We are concerned with the business implications of that philosophy and, in particular, those relating to smaller companies, whose ambitions and concerns Equity Development has supported for many years. We want the coalition government to make it easier for individuals to play their part in financing these companies. To step in where the banks that dominate the economy have failed and where funds that are driven by imperatives that make it unattractive for them to invest in those very small companies that can become the giants of tomorrow. We suggest a number of initiatives and reforms. As we point out, this will not only help small companies but, by encouraging individual investment, the mechanisms could also help create an appropriate pricing tension in the market that could be helpful when the government gets round to selling off assets like the Tote and to disposing of its dominating stakes in the banking industry. All successful companies are built on small beginnings. Many fail, but many survive, and some mature to replace the dominant companies of the day as they wither away in the completion of their life cycle. They have to be replaced or the economy will die a slow death.


Angel Investors (Page 17):
A target size for angel investment in the U.K. might be 60,000 investors, committing $4 billion a year to 10,000 ventures. A sum of money that would eclipse anything offered by way of Government assistance to small companies.

Employment (Page 8):
After government, small companies are the principal source of growth in employment and even during a world recession small-to medium-sized companies (SMEs) are the most important source of employment.

Policy (Page 21):
The timing for new initiatives to help these companies could not be more urgent.

Private Investors (Page 13) And Appendix 4 (Page 33):
Companies both small and large should take note that there is an enthusiastic wealth management community that is looking for better access to companies. Last year these brokers had £390billion of assets under management and conducted 15 million trades of which 82 per cent were on line. The QCA points out: „far more could be done to facilitate participation by certain categories of private investors. In particular, we believe that web-based technology is sufficiently advanced to allow companies to approach such investors directly‟. The PIPE (private investment in public equity) market has been abused by hedge funds in the U.S. but in 2008 almost 1,000 transactions brought in some $90billions of valuable funding. The scope for such a market in the UK is well worth exploring. It is likely that low denomination debt offerings by companies to their customers and members will emerge. These escape onerous prospectus requirements if the debt is non-transferable. The attraction of debt with a decent coupon is obvious whilst interest rates are so low and ways should be found to make such issues less onerous. One way might be for Government to encourage sophisticated investors to register, either centrally or with recognised distributors, in order to facilitate issues of both debt and equity. Given the effective nationalisation of so much of our banking infrastructure we can expect a pipeline of major IPOs in the next few years apart from the readymade favourites such as the Tote. All would benefit from mechanisms that allowed easier access to private investors.


AIM Green Paper Recommendations (Page 29):
The AIM Green Paper submissions are sensible and affordable. The plea for a phased withdrawal of Stamp Duty from SQCs is a perennial that seems unlikely to flower in the present chilly climate of austerity but it has great merit. Stamp Duty revenues from trading in AIM shares accounts for only 5 per cent or approx £180m of the overall Stamp Duty take. Its withdrawal would increase the total amount of capital investment by up to £7.5 billion a year and bring back into the market much needed liquidity that is currently siphoned off into the murky world of spread betting.

Sqcs As An Asset Class (Page 21):
Given that over a period of some 40 years small caps produced a return that was three times the UK equity market as a whole and micro caps out performed by ten times, it would be beneficial both to investors and the economy if mechanisms could be found to allow investors access to SQCs as a defined asset class.

Scrutiny (Page 22/23):
The catastrophic effect of large company failures justifies the recommendation that government smaller company policy should recognise that large companies must bear a much greater burden of scrutiny than should be applied to smaller companies. A great and sustained effort should be made to lift from smaller companies the excessive burden of ‗catch-all‘ red tape that is principally designed to monitor and control large companies. This burden has a disproportionate effect on small companies because it distracts the wealth creators who have to deal with it themselves.

SQC Corporate Governance (Page 12):
The excellent Quoted Companies Alliance guidelines (see Appendix 1) are accepted by the best companies but ignored by the worst, i.e. those that most need to apply them. Currently there is no easily accessible place for nonexecutive directors and others to express their concerns. This leads to poor governance and often to fraud. There‘s a job here for Vince Cable‘s Department of Business, Innovation and Skills to set up a ‗whistleblowers corner‘ where people can raise legitimate concerns and an easily accessible register ( perhaps a ‗mash up‘ of existing difficult to find information) of people who have transgressed, including bankrupts. Currently, the process of digging out information is far too difficult and time consuming.

European Legislation (Page 24):
The European Prospectus Directive is an attempt to limit the impact of fraud and misallocation of capital, not to prevent that fraud and misallocation itself. It will stifle the growth of the very companies that we most need to lift us out of recession and it is misplaced. 8

The right approach is to police issues more intensively, to establish more accessible ‗whistleblowing‘ facilities for complainants, to make information more readily available on people who have transgressed (including bankruptcy) and, perhaps, to re-equip the financial regulator with the power to ban unsound issues by people who are deemed to be not ‗fit and proper‘.

The FSA (Page 22):
The conflict within the FSA‘s established objectives appalled the founding chief executive Howard Davies and unless they are made more coherent they will drive Bank of England Governor Mervyn King to distraction as well.

Policing (Page 13 And 25):
The small end of the market is often the point at which small investors often enter the market. Once these small investors have been scared off they do not return. It is in the interests of liquidity that the market should be purged of that small number of ‗usual suspects‘ who account for the great majority of all sharp practise and fraudulent activity. The threshold for the investigation of such matters should be lowered to the floor. Any and all wrongdoing should be prosecuted and, in admission of Tomorrow‟s Giants‟ error, a working party should be set up to consider returning regulation of the market to the operators.


Pan European Market (Page 24):
The emergence of pan-European funds should provide a stimulus to the truly panEuropean stock market that is so desperately needed.

Big Company Tax Avoidance (Page 28):
To this end the coalition government might consider slicing through the Gordian knot complexity of big company tax avoidance schemes by adopting the idea of the new Business Secretary Vince Cable‘s „General Avoidance Rule‟. This would deem that tax be applied wherever there is an intention to avoid tax, even if the loophole has not been identified in advance by the Her Majesty‘s Revenue and Customs (HMRC).


This paper is, in part, a sequel to the 1999 paper ‗Tomorrow‘s Giants‘, which the former senior Treasury official, Craig Pickering, and I wrote in that year. Tomorrow‘s Giants was itself a plain man's guide to the ‗Riches Report‘ a Treasury report published alongside the Chancellor's 1998 Pre-Budget Statement. Both advocated policies to benefit smaller companies as a driving force of the economy and, together with the earlier ‗Williams Report‘, they achieved a number of helpful reforms. The Riches Report was produced by a working party that I was asked to bring together by the Treasury in 1997 to look into the importance and funding of Smaller Quoted Companies (SQCs). I invited Derek Riches, then head of retail distribution at Merrill Lynch, to become Chairman. Craig Pickering was the leading Treasury member of that group and he had also led the team that produced the Williams Report on the financing of high technology companies. Together, these reports succeeded in stimulating a number of reforms relating to taxation (in particular Self Invested Pension Plans (SIPPS) and Capital Gains Tax Taper Relief) and to the regulatory role of the Stock Exchange. Other important recommendations, particularly those relating to financial education, regrettably, were not successful. Ten years on I was asked by the Quoted Companies Alliance (QCA) to revisit the smaller company and SQC scene. This paper contains some of my findings and observations. I am grateful to John and Stephen Borgars, Clem Chambers, Sir Ronald Cohen, Andy Edmond, Conor Fahy, Professor Chris Higson, John Pierce, Marcus Stuttard, Helen Jeeves, Claire Dorian, Tim Ward, Punit Mistry, Richard Jenkinson, Derek Riches, Tony Hilton, Ian Watson, Nigel Morris, Guy Rigby, Sara Lee, Andrew Baker and many others for their assistance. Sponsorship from the QCA and Equity Development has also been helpful; however, the views expressed are my own.

Brian Basham, November 2010


At a time when financing for smaller companies is increasingly difficult, „SoCo‟ suggests that the time is right for new measures to promote the decentralisation of funding and investment as a way forward that will provide vital smaller companies with the support they need. It reviews the chain of capital provision via angel funding for start ups, through to easier access for investors to the SQC market and onwards to IPOs, including impending privatisations. It points out that an opening up of the market would be beneficial to companies of all sizes. Angel investors could more readily supply expertise as well as much greater funding to innovative very small companies. Individual equity investors could more easily provide all important greater liquidity to the SQC market as well as important funding via bonds. They could even introduce pricing tension and excitement to the biggest issues, especially with regard to pending privatisations. Most of our observations from 1997 and 1998 remain valid today. In particular, lack of trading volume, or ‗liquidity‘, continues to depress the share prices of many SQC‘s and thus their fund raising ability. It also widens the difference between the buying and selling prices, ‗the spread‘, which is horribly disadvantageous to investors. For many small companies, particularly those that are not quoted, the position regarding the provision of capital is now becoming increasingly desperate. Despite the banks‘ protestations to the contrary, the volume of complaint supports the accusation that they have pretty well shut up shop to small companies. This causes, at least, loss of opportunity and, at worst, will lead to a flood of bankruptcies as interest rates increase. The banks have made claims that they lend to 85 per cent of all applicants but that begs the question, what defines an applicant? By all accounts small companies pretty soon realise that the terms demanded are so onerous and the strings attached so binding that they are scared off before they get round formally to applying. Research conducted in June by the Federation of Small Businesses among 1,300 of its members showed that only 16 per cent of those surveyed had applied for new credit in the last two months, but over a third of these (37 per cent) had been refused. The research also showed that over a quarter of small businesses had been dissatisfied with the support offered by their high street bank in the last 12 months. This was equivalent to 1.2 million small businesses. The results showed that the level of dissatisfaction rose in line with the number of business managers in charge of the account over the previous two years.


Dissatisfaction ratings for those who had one (13 per cent) or two (27 per cent) business managers was low but the rating increased significantly for those firms which had three or more managers, with three at 52 per cent, four at 53 per cent and five at 70 per cent dissatisfaction. Despite 26 per cent of firms saying that having a good working relationship with their bank manager was one of the most important factors in their choice of high street bank, almost half (46 per cent) of respondents‘ bank managers were not based locally. The FSB is calls for the establishment of a Post Bank utilising the Post Office network. This, the FSB suggests, would provide a local and trusted option for the UKs small businesses as well as providing more competition in the banking sector. It warns: ‗It is vital the Government looks at new ways to change behaviour in the credit market for small firms, as the economy cannot return to business as usual with current lending conditions‟. Many small companies that are lucky enough to have existing lines of credit are managing to survive because of artificially low interest rates but we can expect the number of liquidations to soar as interest rates rise. This is dangerous for the economy not only because smaller companies are already important as the biggest employers, the drivers of growth and the founts of innovation but because they are about to become more important than ever before. And, as John Walker, National Chairman, Federation of Small Businesses, has observed: “Demand for finance is at its highest as the economy enters recovery. If the Government truly believes that the private sector is going to help avoid a doubledip recession, it needs to consider alternative sources of finance.


„Send me a Bill that creates or saves four million jobs.‟
President Obama's first White House press conference, February 9, 2009

„Our greatest primary task is to put people to work. This is no unsolvable problem if we face it wisely and courageously.‟
Franklin D. Roosevelt, Inaugural Address, March 4, 1933

After government, small companies are the principal source of growth in employment and even during a world recession small-to medium-sized companies (SMEs) are an important source of employment. Research into micro-companies following the 1989-93 crash, when corporate confidence last collapsed, found that survivors increased employment by 50 per cent whilst larger companies were reducing it by 6 per cent.

 There are now circa 5.0 million small businesses in the UK.  Small firms employ more than 58 per cent of the private sector workforce,
that‘s 13.5 million people.

 Small firms contribute more than 50 per cent of the UK turnover  64 per cent of commercial innovations come from small firms as measured by
patents registered

 More than 500,000 people start up their own business every year  Almost all small companies (97 per cent) employ fewer than 20 people  Small firms collect and pay Tax, NICs, VAT and other dues which help pay for
public services. The evidence is clear that small companies promote growth and innovation. Moreover an economy with smaller companies at its core is more resilient because although, individually, small companies are more likely to go broke than large companies, when they do so they cause relatively little damage either to the economy or to investors at large. For example when Marconi went broke, just 5 per cent of the loss from its peak capitalisation was equivalent to the whole capitalisation of the sub 250 SQC market. When Woolworths failed it cost 27,000 jobs. When these giant companies merely hiccup, the market shudders so that BP‘s recent dividend strike accounted for some 8 per cent of the total dividends paid by all quoted companies.


Unlike large companies, small also pay their taxes. A Guardian newspaper investigated corporate tax avoidance in depth. It found that a third of FTSE 100 companies paid no tax in 2005-2006, and another third paid a minute proportion of their operating profits. Her Majesty's Revenue & Customs (HMRC) does not know how much tax companies avoid, but its estimates rise as high as £13.7 billion. It says that 12 of the UK's largest firms ‘extinguished all liabilities in 2005-2006’ through avoidance mechanisms. And small companies take on more people as they grow, unlike so many large companies, which are under constant pressure to cut their workforces and thereby boost the earnings per share upon which management rewards are based. The top ten companies in the FTSE-100, by market capitalisation prior to the crash, comprised three oil companies, three miners, two pharmaceutical companies, one bank and Vodafone. UK employment statistics are not easy to winkle out but it appears that the current top ten employ only 500,000 people in the U.K. with Tesco employing by far the bulk of those. It follows, therefore, that the benefits to the national economy of a robust smaller company sector justify special tax treatment to stimulate the provision of equity capital. In this context, a return of the ten percent capital gains tax taper relief provision would stimulate investment in smaller companies more than any other fiscal measure.

The Power to Transform:
The list of companies that were born in recession is long. It reaches back to the 1870‘s, with General Electric through to Microsoft and Apple in the 1970s, Google, eBay, and Amazon in the 1990s to Skype in 2002. In today‘s environment businesses can accelerate to great size amazingly quickly and transform not only their host economies but also the wider commercial world. When ‘Tomorrow’s Giants’ was published, eBay (founded September 1995), Amazon (July 1995), and Google (January 1996) and Yahoo (January 1994) were in their infancy. Two years ago, before the recent stock market collapses, the smallest of them, Amazon, had a market capitalisation of $37 billion, Google stood at $216 billion, eBay at $50 billion and Yahoo was $42 billion. The phenomenon that is Skype grew from a standing start in September 2002 to be sold for $2 billion to eBay in October 2005. At the end of last year it had 405 million open accounts, more than 30 million people were using it each day and they consumed more than 20 billion Skype-to-Skype minutes. New media is now allowing very small companies to grow at amazing rates by helping them to crash through the steeple-high obstacles that have historically impeded these tiny businesses. Barriers of distribution, marketing, communications, recruitment and the management of both external and internal information are tumbling down.


The Internet, Skype, Facebook, YouTube, Twitter, mobile phones apps and free Open Source software all enable companies to sell goods, to spread the word, to recruit, to manage and to communicate with their colleagues and customers in ways that were never before possible. The Internet remains the most important facility but Britain is already far behind in developing its potential. For example, Korea is committed to a total spending of $24.6 billion over the next five years and the project is expected to create 120,000 jobs. The most remarkable change is that high-speed Internet and wireless broadband services will be upgraded to 1 Gbps broadband--meaning their speed will be at least 10 times faster compared to the U.K. This infrastructure failure by the UK will prevent small companies from bringing forward the „bright ideas that make a difference‟. A recent government study has claimed that there is not enough demand from the public for increased broadband speed but that is to miss the point entirely. A digital highway is like a real highway and as the inventor of the internet, Sir Tim Berners Lee, has said of Government data, „put it out there and people will turn it into something useful‟.

Renewable Energy:
And now there is a new wave of business developing in the renewable energy sector. President Obama has made this the third of his five pillars of U.S. recovery, and in the U.K. alone the sector could give birth to many new jobs. The potential is vast and the rewards can also come in terms of security of energy supply, as an important buffer of strategic independence from Russia and the Middle East.

Capital provision demands a respected and efficient stock market for smaller company shares, one that is transparent, well policed and as lightly regulated as is consistent with the market achieving investor respect. The London Stock Exchange‘s Alternative Investment Market (AIM) AIM is the most successful growth market in the world. Since its launch in 1995, over 3,000 companies from across the globe have chosen to join AIM. Secondary issues have raised a bit more than primary over the years, especially in the last three and a half years. Clearly AIM is providing a much needed source of funds for its existing client companies in these straightened times. However, more than one company a day delisted from AIM throughout last year, many of them to save the relatively high cost of maintaining a listing and the number of companies quoted on AIM is now 1,276 compared with more than 1,600 three years ago.


AIM did well to raise £5.5 billion last year but that was just a third of the 2007 total with £620m of the total raised by one company, Songbird Estates, owner of London's Canary Wharf office complex. Despite AIM share prices soaring by 66 per cent last year, outperforming the main stock market, just 36 companies joined AIM – the lowest annual total since the small-firms exchange was launched in 1995 and just 8 per cent of the 462 companies that joined in 2006. Moreover, only half those companies were ‗new‘, the other 18 were transfers from the main market. It was a creditable performance that circa £760m of the new money raised was for new issues although £557m of that was for seven issues for companies in the £250m market cap bracket. The smaller end looked like this:

Market Cap £1m-£5m £5m-£10m £10m-£50m £50m-£100m Source:AIM

Total raised (£m) 8.8 7.9 44.1 122

Number of Transactions 7 3 13 6

Average Value of Transaction (£m) 1.3 2.6 3.4 20.4

Of course, AIM is dependent upon investor confidence and in the wake of the crash that has been lacking but it could do more to increase confidence by lobbying Vince Cable‘s Department of Business, Innovation and Skills to help it improve corporate governance. AIM operates on the basis of a series of contracts between the market and those market members who are nominated advisors (Nomads). The Nomads, in turn, have a contractual relationship with their clients, the quoted companies. AIM uses this trail to maximum effect, often working behind the scenes, winkling out bad Nomads and giving a nudge here and there. But, thanks in part to Tomorrow‟s Giants, which (mea culpa) recommended giving the FSA the task of policing the market, AIM has limited powers and, rightly, is loath to impose ever more rules. It took a great leap forward when it introduced Rule 26, that makes it obligatory for a company to publish a web site upon which it records its corporate government policies and, for those sophisticated enough to look and understand, that‘s a good facility. The great gap in the protection wall is that there is nowhere obvious for a complainant to go with concerns about either the corporate governance or the general conduct of a company – AIM or otherwise. Nor is there any readily available source of information on people who have been found wanting either as bankrupts, barred directors, even convicted fraudsters. As a result, the same people come round time and again. They file for bankruptcy or get struck off as directors and set up again with a false front. They are struck off as solicitors and reappear as advisors. They even get convicted and a few


years later, when memories have faded, pop up sponsoring deals with plausible stories. The damage these people do is immense and reaches far beyond the money they steal. They target investors through unprincipled distribution houses. Once bitten these investors are naturally twice shy, so the market as a whole is denied an important source of funding. Even worse, they spook the regulators, in particular the European Union, who respond by bringing in draconian ‗catch all‘ measures that have the disastrous effect of making it much more difficult for good companies to raise money. The answer lies partly in using new technologies to enable informants to inform, complainants to complain and most importantly, enquirers to enquire. Most importantly it also lies in reconnecting the market with the task of policing. Currently there is no easily accessible place for non-executive directors and others to express their concerns. This leads to poor governance and often to fraud. There’s a job here for Vince Cable’s Department of Business, Innovation and Skills to set up a ‘whistleblowers corner’ where people can raise legitimate concerns and an easily accessible register (perhaps a ‘mash up’ of existing difficult to find information) of people who have transgressed, including bankrupts. The great strength and the great handicap of the members owned Stock Exchange was the Stock Exchange Council. This inhibited the development of the Exchange because the members could hardly ever agree on anything but they were all old City hands who knew every wrinkle. A visit to the 23 rd floor, where the Disciplinary Committee sat, was dreaded by all but the most hardened cases and those were winkled out over time. As we have found out the hard way, self regulation does not work but there must be a way to bring back the insights and experience of the old Disciplinary Committee to take forward the work that has already begun to clean up the market. At the same time AIM should make a point of strongly encouraging the Nomads to persuade their client companies to adopt the most important aspects of the Quoted Companies Alliance‘s corporate governance guidelines. These excellent guidelines (see Appendix 1) are accepted by the best companies but ignored by the worst, i.e. those that most need to apply them. The guidelines are not onerous but their active promotion by AIM would allow non executive directors to protect themselves from being regarded by some executive directors as mere ornaments on the corporate Christmas tree. The Code identifies certain best practice corporate governance processes and states that the independence of a board member should be defined according to the individual‘s ability to behave appropriately, rather than an absence of connections. It suggests that a company should have at least two independent non-executive directors and should not be dominated by one person or a group of people. 18

As a minimum, this paper suggests that it should be:

 mandatory for a remuneration committee to report to shareholders outlining
the company‘s remuneration practices

 an audit committee to report the major tasks undertaken and demonstrating
independent oversight of management and the external auditors


Retail Shareholders:
Retail shareholders are better served than ever before to take informed investment decisions. Internet sites such as ADVFN (managed by Equity Development‘s parent) are inexpensive, even, in some cases, free of charge and provide up to the minute information that rivals Bloomberg. Moreover, The Companies Act 2006 represented a major overhaul and

consolidation of existing company law and new law regarding paperless communications between companies and their members came into effect on 20 January 2007. For a company with an existing wide shareholder base, paperless communications can be expected to become the norm but, more than that, it allows companies that would welcome a wider shareholder base to equip itself to deal with those shareholders efficiently and economically. The advantages attached to a wider shareholder base are many. When Equity Development carried out a private shareholder exercise for BP some time ago, BP told us that it had researched its peer oil companies and discovered that those with a wide base showed much greater price resilience. Sadly, most companies are overawed by their investment bankers who know that they can make more money for themselves by going the institutional route, so dissuade companies from considering retail investors. But this is to ignore the aftermarket, the advantages in terms of profile and public relations that attach to a company with a large retail presence on its share register and the important pricing tension that is introduced by moving beyond the institutional market. And, as Aer Lingus found, going for a quick and easy placing of underpriced stock with hedge funds which have no loyalty can prove potentially fatal if a competitor then pops up with an opportunistic bid. Companies both small and large should take note that there is an enthusiastic retail stock broking community that is looking for better access when they launch an IPO. Last year wealth managers had £390billion of assets under management and private client stockbrokers conducted 15 million trades of which 82 per cent were on line. When it comes to IPOs, the advantages of retail distribution really begin to pile on. For a start, commissions are lower. They are likely to cost the equivalent of 0.2 percent to 0.5 percent whereas brokers start at 0.5 percent and go upwards. There are also likely to be advertising and public relations costs but even adding those back, retail still substantially undercuts the brokers and bankers and, of course, advertising also creates brand and customer awareness. Given the effective nationalisation of so much of our banking

infrastructure we can expect a pipeline of major IPOs in the next few years apart from the readymade favourites such as the Tote. However, if the Government and big companies want to penetrate this market they need to get their ducks in a row now because it does take some initial organisation and something of a new approach to understanding the imperatives.


With email, the internet and the growth in discretionary management a launch can take place at minimal notice. Road shows or special presentations are not required, so it‘s a process that is less intrusive on management time; however, companies can decide to meet retail brokers and that can be helpful. And a retail IPO can fit in very comfortably with an institutional offer over, for example, a two week marketing period and a five to seven day offer period. So, the retail market really does compare in every possible way favourably with an institutional IPO. There is the same withdrawal right, price range can be there are companies that offer announced as little as five days before the close of the retail offer, shares can be held in brokers' nominee accounts and applications, terms and conditions and other documents ready to go. Following its merger with Borsa Italiana in 2007, London Stock Exchange Group is now taking a broader view of mechanisms to encourage individual investors. In Italy individuals make up around 30 per cent of the value traded in the market compared with two percent of the London market, One of the reasons for this is that Italian private investors are allowed direct access to the market, known as Direct Market Access (DMA). DMA allows the investor to buy or sell securities directly to the exchange or market where it is listed and traded. As a result investors can see what is going on in the market, perhaps to obtain better prices and certainly to make more informed decisions. DMA also allows investors to participate with LSE member firms in pre-market and post-market auctions. This type of trading occurs in the morning hours before the Stock Exchange officially opens for regular trading and immediately after it had closed. While the majority of trades take place during traditional hours, pre and post-market trading can offer some opportunities to investors. DMA is a benchmark by which all trading platforms are judged and it is good to learn that the London Stock Exchange is working with its member firms to extend the number of participants that offer the service. Corporate bonds are another possible source of financing. While US companies have long favoured bond market funding, small and mid-sized European companies have relied more heavily on bank debt, which was private and relatively cheap. But markets made sports headlines when Manchester United launched a £500m issue and that drew attention to a growing appetite in the bond markets for smaller issues. Dealogic provides a platform for investment banking and capital markets professionals globally to help improve strategy, competitiveness, and execution. The company reports that during the past year, the average size of UK bond issues has halved from the peak in 2007 as midmarket companies have enter the market. In the UK, the record amounts of debt that companies issued in the boom years in the loan market are close to maturing. About £350bn of investment-grade


loans mature between 2011 and 2014 and the refinancing peak comes as soon as 2012. There is a deep pool of debt liquidity available from US institutions to US corporates, but the equivalent UK market is underdeveloped. However, there are signs of progress. Earlier this year the London Stock Exchange launched an electronic order book for bonds. The new initiative is modelled on Borsa Italiana‘s highly successful MOT bond market which, with €230 billion worth of trading in 2009, is Europe‘s largest retail fixed income market. It is to be hoped that the initiative will increase distribution for bonds by opening up new capital for issuers seeking access to large pools of retail liquidity and this could stimulate increased retail size issuance of corporate bonds. A UK company, for example, could issue a bond tradable in units of £1,000, or even £100 and private investors would be able to buy this bond in the electronic market as continuous two-way tradable prices would be provided by a dedicated market maker.

Angel Groups:
SoCo suggests that angel groups, in particular, should be given tax breaks to encourage small company investment and that these tax breaks could also be used as mechanisms for regional development, as has been demonstrated so successfully in America. A good first step would be to reform EIS relief which, currently, excludes debt. Michael Weaver, chief executive of Beer & Partners, the UK‘s biggest angel investor group, tells us that he has seen an increasing flow of funds from angel investors but observes: ‗There is a growing trend amongst US business angels to offer start-up companies convertible loans instead of providing first-round equity funding. That this trend is less pronounced in the UK is largely a result of the EIS scheme, which encourages UK business angels to provide equity finance rather than offer a convertible loan. UK business angels are faced with a predicament. Convertible loans can offer more harmonious negotiation process with the deferral of a valuation, but they do not reward the investor with the benefits of the tax reliefs offered by EIS. EIS has been the most imaginative measure taken to encourage investment in business but is now in need of an update. As part of the consultation on the business finance green paper “Financing a private sector recovery” we hope that the government will consider simplification of EIS and include relief for loan capital as well as equity.‟ If business angels were to be given greater incentive, important small new companies would have greater access not only to the capital they need but also to the help that would come with that capital, as the many „Hidden Experts‟, with which society abounds, would find it easier to step forward and engage both their savings and their abundant skills in guiding them forward. 22

The time is right, not only because of the fresh political climate but because the mood of investors is conducive to such a move. Followers of The Archers, which puts great effort into keeping its finger on the pulse of rural society, will have picked up a flavour of this when Grandma Woolley said 'It's so difficult to find a home for your money these days' as she agreed to fund her grandson‘s Tom Archer‘s pork sausage business. And no wonder she was disenchanted; household name institutions have either gone broke or been bailed out, fund managers have delivered disastrous returns and ‗safe‘ investments are showing miniscule returns. By contrast to the other options available to Grannie W, Tom‘s sausage business becomes a reasonable bet. She can understand it, see it, know the manager, keep an eye on it and, if necessary, influence it. In her own way she is a Hidden Expert: she understands catering, has played her part in running a business and can give Tom sound guidance. If savers like Grannie W spread their smaller company investments they are likely to do at least as well as they would by investing through pooled funds, especially given the recent records of these funds and taking into account the exorbitantly high attendant costs. In compiling their gigantic and seminal work, ‘Triumph of the Optimists', London Business School Professors, Elroy Dimson, Paul Marsh and Mike Staunton recreated indices for 16 main markets of the world, from publications and public records going back to 1900. They recorded that over half a century small cap companies, taken together, have performed three times better than the market as a whole and that the tiniest companies performed circa ten times better.]]]]]]]]]]]]]]]]]]]]]]]]]]]]]]]]] (ii) '£1 invested in the UK equity market at the start of 1955 would, with

dividends reinvested, have grown to a nominal value of £592 at the beginning of 2001, an annualized return of 14.9 percent. An identical investment in smallcaps (the HGSC) would have grown to £1,676, almost three times as much, giving an annualised return of 17.5 percent. Micro-caps performed even better with their annualized return of 20.8 percent producing a terminal value of £5,961, three and a half times as much as the HGSC (Hoare Govett Smaller Cos).' There is strong evidence that private investors are ahead of the game. Richard Jenkinson of the share register analysts, Junction RDS, tells us that during the recession, private investors have been putting increasing money into smaller companies. The Office for National Statistics (ONS) estimates 10 per cent as the average proportion of private shareholders on a share register but in SQCs it is probably nearer double that. ONS defined a private individual as any named individual and this only includes private individuals directly owning the shares and company directors and since the last ONS survey in 1997 most analysts have relied on that. However, Junction RDS believes that they have failed to take into account the change in the structure of ownership and market direction. More and more people

are holding their shares through Private Client Brokers (PCBs) and if these are included in the definition then the percentage of private shareholders is higher.

PCBs Jan ‘07 Jun ‘10 Source: ED 4% 7%

FTSE 100 5% 12.5%

FTSE 350 8% 12%

AIM 13% 19%

Junction RDs research suggest that during the recession private shareholders have actually been increasing their holdings not just by being loyal, or even apathetic, and not selling but that they have been buying whilst institutions have been selling. As a half-way house between single private investors and institutions of one kind or another, this paper suggests that a strategy for Angel Groups should be considered. Angel Groups take many forms but they have in common the characteristic that people with money gather together to pool their collective knowledge. Many of these are what may be called „Hidden Experts‟ and they pop up in the most unexpected places. I was at an Angel meeting recently when the chap sitting next to me began to grill the ceo of the presenting company, demonstrating, in the process an expertise that made the ceo squirm. The presentation concerned a retail opportunity and my neighbour turned out to be the former deputy chairman of one of a major supermarket chain. Commonly, Angel Groups include entrepreneurs, accountants, lawyers and business managers both retired and still working. With interest rates and trust at an all time low, these people are looking for sound propositions that they can understand and, perhaps help with both money and expertise. The biggest issue for small company funding is due diligence. Angel Groups can sometimes manage this within their membership but, however it is managed, due diligence tends to be costly. At Equity Development we have been attempting to devise an approach to due diligence that allows a progressive approach so that the cost is low for small sums and rises in pace with the sums of money raised. We will report on progress in due course. Overall angel statistics are difficult to come by because angel investment tends to be wrapped up in venture capital statistics but it is probable that Beer & Partners accounts for about 15 percent of the market. Last year they raised more than £12 million and over the past ten years have raised some £108 million for around 330 transactions. Beer is successful in raising funds for about half the companies it endorses. If the circa 15 percent figure is correct, it may imply that angel groups as a whole have raised perhaps £720 million for small companies, many of them start ups, over the past ten years and that there are some 10,000 investors. In the U.S., the angel investor market is much more developed. The number of active investors in 2008 was 260,500 individuals according to the Center for 24

Venture Research at the University of New Hampshire. Total investments in 2008 were $19.2 billion and 55,480 entrepreneurial ventures received funding in 2008. By any number of measures the U.S. is between circa five and seven times the size of the U.K. Its population is 300 million v 61 million, its GDP $14 trillion v $2.13 trillion and The World Wealth Report 2010 (Capgemini) tells us that in 2009 the UK had 448,000 dollar millionaires against 2.866m in the USA. It follows that a target size for angel investment in the U.K. might be deemed to be, say, 60,000 investors, committing $4 billion a year to 10,000 ventures. A sum of money that would eclipse anything offered by way of Government assistance to small companies. There may be lessons for the U.K. in this in terms not only of small company finance but also in terms of regional development. The U.S. angel movement is driven to a significant extent by localised State-byState tax breaks. According to Jeffrey Williams of Belmont University, who published his paper Tax Credits and Government Incentives for Angel Investing in Various States in July, 2008, in the past decade, more than 20 states have implemented programmes to attract or retain investment capital by way of income tax credits. As state legislatures have the latitude to choose the parameters for any policy incentive, no two programmes are identical. For example, one programme offers 100 percent credits for investments while others offer minimal incentives. Some are purely Governmental in structure while others are a public/private hybrid. Some are tax credits, some are seed funds. Some are deferred capital gains credits, some are transferable, non-transferable, carried-forward, capped annually, capped over many years, and more. This would be a nightmare for the U.K.’s wholly centralised tax gathering but there’s no reason why a core relief should not be established with, perhaps, regional incentives so that credits might vary from, say, 50 percent in the prosperous areas to 100 percent in areas to which Government might want to direct investment. In the U.S. tax credits represent a dollar-for-dollar reduction of the investor‘s tax liability. These tax benefits can be structured as refundable credits or nonrefundable credits. Refundable credits have greater potential value to the taxpayer because when the taxpayer has a credit greater than the tax liability, the state will pay the balance to the taxpayer The benefit of angel tax credits is to reduce the risk and cost of angel investing in order to encourage more entrepreneurial activity in high-growth small businesses. The theory is that if successful, these programmes can attract investment dollars, create jobs, and contribute to the economic growth of the region. The National Association of Seed and Venture Funds (NASVF) May 2006 report, ‗Seed and Venture Capital: State Experiences and Options‟ includes an analysis of the qualities that should guide the states‘ capital investment incentive programmes.


According to this report, „successful states should structure programs that have the following characteristics: the credit should be financially fair to the state, sizable enough to be substantially effective, and managed at the discretion of experienced professionals in the private sector. A program‟s strong leaders and champions should be profit-motivated, target the knowledge-based industries, and constantly evaluate the program to the extent possible. Through this targeting, the credit should have a narrow purpose requiring minimum legislation, and the initiative should address a long-term goal‟. A summary of selected US states approaches to angel investing is shown at Appendix 5.


The SQC Market:
Within smaller company policy, SQCs in particular are to be encouraged. As we said in 1998: ‗The SQC market can be viewed as the umbilical cord that connects entrepreneurialism to the body economic‟. Nothing has changed in that respect.

The importance of the SQC market cannot be over emphasised. Its health has an impact right down the finance chain. That is why AIM is so important and why AIM needs jealously to guard its reputation. Sir Ronald Cohen, formerly of Apax, has said that: „When the SQC market is strong, venture capital managers can raise money. When it‟s weak, they can‟t‟. Tom Mackay, former legal director of the Stock Exchange, former legal director of 3i, now partner of the American law firm, Curtis, Mallet-Prevost and both founder and chairman of FISMA, the not-for-profit billboard site for small company business plans says: „Angel and start-up investors are strongly influenced by the state of the SQC market.‟ John Pierce, former chief executive of the QCA, said: „The SQC market is an

important link in the chain of capital that runs from the smallest companies right through to the main market. If it‟s broken, it affects capital provision right across the board.‟

SQCs as an Asset Class:
Given that over a period of some 40 years small caps produced a return that was three times the UK equity market as a whole and micro caps out-performed by ten times, it would be beneficial both to investors and the economy if mechanisms could be found to allow investors access to SQCs as a defined asset class. The success of venture capital was initially due to the successful lobbying by the British Venture Capital Association (BVCA), under the guidance of Sir Ronald Cohen, for venture capital to accepted as a standalone asset class. As a result funds under management of BVCA members increased from a smidgeon of total funds under management by UK institutions to reach something like 7 per cent – a huge sum of money. A similar initiative with regard to smaller companies would allow the all important actuarial advisors to institutional funds to advise their clients to maintain appropriate weighting in the new asset class. Investors would benefit from superior across the board long-term performance in a resilient asset class, SQCs would benefit from more stable investment attitudes, SMEs and all they imply for employment and innovation would benefit from a strong SQC market.


The Banking Strike:
The confusing thing about the financial crisis is that the physical economy is in the same shape as ever; but it can be paralysed if investment money cannot flow from those who have it to those who use it‟. Financial Time‘s Undercover Economist, Tim Halford The former stockbroker analyst, successful entrepreneur, commentator, Chairman of Channel 4 and now Chairman of the Royal Society of Arts, Luke Johnson, writing in the Financial Times, put it succinctly: „With few exceptions, the banking breed has brought capitalism into disrepute and massively compounded a brutal downturn. Their story is a tragedy for those of us who believe in free markets and private enterprise.‟ In the same article he also commented: „Ideally, we should adopt a voluntary spirit of civic decency, and intelligent new forms of incentives that punish as well as reward‟. In the meantime, the support that has been lavished upon banks is a desperate attempt by governments to stop liquidity draining from the world economy. Getting money into the banks is one thing; it is proving to be quite another getting that money out and into the hands of the small companies that need it. And whilst bankers continue to pay themselves astronomical bonuses and salaries, as many as 123,000 small companies are reported by the corporate restructuring specialists, Begbies Traynor, to be „showing significant signs of corporate distress‟. It is to be expected that about one in four of these will go broke if nothing is done to help them raise cash and many more will fail if interest rates increase from their extraordinarily low current levels. The timing for new initiatives to help these companies could not be more urgent. A poll of 1,700 insolvency practitioners by their trade association, R3, came up with a prediction that insolvencies will actually peak this year at 28,000 compared with 22,800 last year, which was, itself, a 16 year high. As the private equity guru Jon Moulton has pointed out that the number of insolvencies is artificially low because ‗in trouble‘ companies are hanging on by their finger tips by courtesy of low interest rates. And the ending of the Government scheme to allow firms to delay their tax payments will cause more bankruptcies. It will leave HM Revenue & Customs (HMRC) with no option but to take action to trigger formal insolvency proceedings. This could lead to a second tidal wave of business failures. The Turnaround Management Association is Chicago-based and has about 9,000 members in the U.S. It has about 250 members in the U.K. Its U.K. President, Tyrone Courtman, warned in the Financial Times that dozens of small companies are being left ―to wither on the vine‖.


Courtman told the FT that TMA members were finding it harder to turn struggling companies around without sufficient support from banks. ‗Many of our members are seeing companies that face financial oblivion,‘ he said. Courtman reported that despite Government assurances that the Enterprise Finance Guarantee would underwrite up to £1.3 billion of loans, the most recent figures indicate that it has only been used to extend a 75 percent guarantee on 2,350 loans worth up to £270 million.

Big Company Governance:
The catastrophic effect of large company failures justifies the recommendation that government smaller company policy should recognise that large companies must bear a much greater burden of scrutiny than should be applied to smaller companies. That scrutiny should extend to monitoring the ethical and prudent management of large companies with reference to the sharp practises, including wide scale tax avoidance that is heavily engineered to defeat the purpose of the tax. Such avoidance is damaging to small companies that cannot afford the expensive hired help from the Big Four accountancy firms and others that dream up the avoidance schemes. To this end the coalition government might consider slicing through the Gordian knot complexity of big company tax avoidance schemes by adopting the idea of the new Business Secretary Vince Cable‘s „General Avoidance Rule‟. This would deem that tax be applied wherever there is an intention to avoid tax, even if the loophole has not been identified in advance by the Her Majesty‘s Revenue and Customs (HMRC).

Reform of the FSA:
Confidence to invest in small companies can only be rebuilt if investors believe that the financial system is being properly policed. Under Conservative Party proposals, the Financial Services Authority (FSA) functions are to be taken over by the Bank of England but the conflict within the FSA‘s established objectives appalled the founding chief executive Howard Davies and unless they are made more coherent they will drive Bank of England Governor Mervyn King to distraction as well. When the original „Tomorrow‟s Giants‟ was being drafted, Howard Davies complained to its authors that the first of its objectives ‗maintaining market confidence‟ was seen by powerful City figures to be in conflict with the third and fourth, „securing the appropriate degree of protection for consumers‟ and „fighting financial crime‟. It is this conflict that lies at the heart of the FSA’s failure to spot and act upon the financial wrongdoing and excessive risk taking that certainly contributed to, and may even have sparked, the global economic crisis.


The FSA has four objectives under the Financial Services and Markets Act 2000. Those are:

 maintaining market confidence;  promoting public understanding of the financial system;  securing the appropriate degree of protection for consumers;  fighting financial crime.

Influential City figures and, more importantly, senior directors of the FSA argued that objective one is in conflict with three and four. Making a fuss and even arresting senior people, they said would shatter market confidence. We now know they were wrong and that the best way to have encouraged confidence would have been to have come down hard not only on clear-cut wrongdoing but also upon the sort of wild risk taking that occurred when banks such as HBOS lent aggressively to homebuyers who were unable to repay their mortgages. We shall never really know whether or not the FSA was inhibited by the fact that Sir James Crosby (former chief executive of HBOS) was Deputy Chairman but it is a fair guess that confidence will not be rebuilt whilst, echoing Max Mosley‘s criticism of the Press Complaints Commission, „the Mafia is in charge of the local police force‟. The City is a damaged brand and it is clear that new regulation is needed to control the banking and securities sectors and to rebuild trust. Government should lay a light hand on regulation, spend much more on policing and apply lower levels of red tape to small companies than large. A ‗one broken window‘ policy on market manipulation and other fraudulent activity should be instituted to improve the reputation of the SQC market in particular. The threshold for the investigation of such matters should be lowered to the floor. Any and all wrongdoing should be prosecuted. The small end of the market is a kindergarten to the University of Corporate Crime. It damages the reputation of the market as a whole and is the point at which small investors often enter the market - sometimes by way of ‗boiler house‘ promotions. Once these small investors have been scared off by a combination of chicanery and the degrading effect of dealing costs on their savings, they do not return.


European Regulation:
Britain and the US have suffered from a lack of regulation to control bankers, mega companies and a stifling flood of regulation aimed at protecting the financial consumer. Following a round of intensive lobbying, the London market, with AIM to the fore, has managed to contain the worst excesses of the European Prospectus Directive so that the threshold for the distribution of a full (and vastly expensive) full prospectus has been lifted from 100 to a still paltry 150 people. This is an attempt to limit the impact of fraud and misallocation of capital, not to prevent that fraud and misallocation itself. It will stifle the growth of the very companies that we most need to lift us out of recession and it is misplaced. The right approach is to police issues more intensively, to establish more accessible ‗whistleblowing‘ facilities for complainants, to make information more readily available on people who have transgressed (including bankruptcy) and, perhaps, to re-equip the regulator with the power to transgressions. At least important concessions have now been wrung out of Europe, largely by the QCA, so that all SMEs and issues of under E100million will now be able to issue a so called ‗Proportionate Prospectus‘. Given that the cost of getting a company to market via a full prospectus has been estimated to be around E500,000 this concession is long overdue. However, it remains a truth that long documents verified by expensive solicitors would be shorter and cheaper if there was less danger of fraud and that‘s a matter for effective policing. ban unsound issues by people who are deemed to be not ‗fit and proper‘ because of previous

A Pan-European Market:
Recently, European parliamentarians voted in favour of a ‗management company passport‘ provision reforming rules covering the €7 trillion European market for investment funds. This passport will allow asset managers to sell funds across the EU from a central base, without having to establish full administrative functions in each jurisdiction. The issue has been extremely contentious because officials were concerned that investor protection could be compromised. Since then, however, the Committee of European Securities Regulators (Cesr) has said that the plans would be workable and consistent with a high level of protection. This advance proves that pan-European co-operation on investment is possible and the existence of pan-European funds should provide a stimulus to create the truly pan-European stock market that is so desperately needed.


QCA Summary of Corporate Governance SQC Guidelines:
The Quoted Companies Alliance (QCA) has published new "Corporate Governance Guidelines for Smaller Quoted Companies" (QCA Code). Since the UK Corporate Governance Code only applies to companies with a premium listing of equity shares, the QCA Code is aimed at all UK smaller quoted companies, including standard listed, AIM or PLUS-quoted companies. The QCA Code explores the meaning of good corporate governance and argues that the chairman‘s responsibility for corporate governance and teamwork on boards are key elements of effective corporate governance. The QCA Code states that the independence of a board member should be defined according to the individual‘s approach to the role and his/her ability to behave independently and appropriately, rather than an absence of connections. The QCA identifies 12 essential good practice Guidelines to achieve the flexible and efficient framework it believes is key to securing long term growth in shareholder value:

Flexible, Efficient and Effective Management
 Structure and process - companies need to implement the most appropriate
governance complexity. structures based on corporate culture, size and business

 Responsibility and accountability - allocation of responsibility for the
management of the company and for the achievement of key tasks should be clear. The roles of chairman and chief executive should not be occupied by the same person.

 Board balance and size - a board should not be so large as to prevent it
operating efficiently. A company should have at least two independent nonexecutive directors (one of whom may be the chairman if he/she was deemed independent when appointed) and should not be dominated by one person or a group of people.

 Board skills and capabilities - boards need an appropriate balance of
functional and sector skills and experience to be able to make key decisions and plan for the future. Boards should be supported by audit, remuneration and nomination committees with the necessary character, skills and knowledge to enable them to work effectively.

 Performance and development - there should be periodic reviews of the
performance of the board, board committees and individual board members. Induction, evaluation and succession plans should be updated as a result. Ineffective directors (executive and non-executive) should be helped to become more effective or be replaced and membership of the board should be periodically refreshed.

 Information and support - the board and board committees need the best
possible information (accurate, sufficient, timely and clear) to enable them to


constructively challenge recommendations put before them. Non-executive directors need access to external advice when necessary.

 Cost-effective and value-added service - shareholders need to understand
how efficient and effective governance has added value. This will normally involve publishing key performance indicators which align with strategy and feedback through regular meetings between shareholders and directors.

Entrepreneurial Management
 Vision and strategy - there needs to be a shared vision of what the company
is seeking to achieve over what period and an understanding of what is required to achieve this. This vision and direction must be communicated internally and externally.

 Risk management and internal control - the board needs to be able to
define and communicate the company‘s risk appetite and how it manages its key risks, while maintaining an appropriate balance between risk management and entrepreneurship. Remuneration policy should assist with this.

Delivering Growth in Shareholder Value over the Longer Term
 Shareholders’ needs and objectives - there needs to be effective
communication between shareholders and the board so the board understands shareholders‘ needs and objectives and their views on the company‘s performance.

 Investor relations and communications - an effective communication
reporting framework between the board and all shareholders needs to be in place so that shareholders‘ views can be communicated to the board and shareholders can understand the circumstances of and constraints on the company.

 Stakeholder and social responsibilities - companies should have a
proactive corporate social responsibility (CSR) policy as this can help create long-term value and reduce risk for shareholders and other stakeholders.

The QCA Code includes a section on demonstrating good corporate governance, particularly in relation to clear disclosures. Companies are advised to publish a corporate governance statement that describes how they achieve good governance annually. This should be published in their annual report and accounts or, failing that, on the company‘s website and so that the annual report and any separate governance related documents can be easily located, an investors‘ section of the website is also recommended. The QCA Code also prescribes minimum disclosure requirements for annual reports:

 The chairman‘s report should detail how the QCA Guidelines are being applied
to enable long-term success;


 The number of meetings of the board and board committees and individual
directors‘ attendance at them;

 A statement outlining how the board operates to set, develop and execute the
company‘s strategy and an explanation of the types of decision taken by the board and those delegated to management;

 The identity of all directors, their roles and membership of board committees;  The identity of directors deemed independent, together with an explanation as
to why they are deemed independent notwithstanding factors which may appear to impair that status;

 The skills and experience of the non-executive and executive directors so that
shareholders can make an informed decision as to the balance of the board and the appointment and reappointment of board members;

 A description of the role of each board committee;  A description of board performance evaluation procedures that the board
applies, focusing on its objectives and outcomes and including a summary of how evaluation procedures have evolved from the previous year, the results of the evaluation and action taken or planned as a result;

 A business review detailing the company‘s strategy and how this is
communicated to all areas of the business;

 An audit committee report explaining the major tasks undertaken and
demonstrating independent oversight of management and the external auditors;

 A summary of risk management and internal control systems and activities,
and an explanation of how these relate to strategy and link into key performance indicators, remuneration policies and CSR activities;

 An explanation to shareholders of how auditor objectivity and independence is
ensured, particularly where the auditor provides significant non-audit services; and

 A remuneration committee report outlining how the company‘s remuneration
practices align the interests of senior management and shareholders.

In addition, the QCA Code specifies certain additional information that should be available to shareholders on the company‘s website and it provides practical examples of governance structures and the reporting of corporate governance, linked to the 12 Guidelines. Finally, it considers the significance of the QCA Code for the whole board, the chairman, a non-executive director, the senior independent director, an audit committee member, a remuneration committee member, a nomination committee member, a company secretary and shareholders. Copies of the QCA Code can be obtained from the QCA at


Appendix 4: Summary: QCA Proposals
Investor enablement: Participation in primary market activity is currently restricted almost entirely to institutional investors. While this is a direct result of the regulatory landscape, we believe that far more could be done to facilitate participation by certain categories of private investors. In particular, we believe that web-based technology is sufficiently advanced to allow companies to approach such investors directly, thus utilizing all the regulatory exemptions available to them. We set out more about this proposal later in this response. Improving access to non-bank finance: It is clear from our members that there is significant interest in further exploring the idea of a corporate bond market for small and mid-cap issuers. In particular members have pointed out that a market for such instruments and other forms of ―quasi equity‖, such as preference shares, existed in the 1970s and early 1980s. We are also aware of the greater sophistication of the PIPES market (private investment in public equity) in the USA with debt and ―quasi equity‖ in smaller listed companies being far more common there. Greater transparency: The effect of the current regulatory system is that those who need the most information get the least. In the absence of reliable information, many investors do not remain inert, but base investment decisions on supposition and conjecture. In particular the changes in the rules on the distribution of investment research following the implementation of MiFID in November 2007 have led to a dearth of independent research on small and midcap companies. We believe that a systematic approach to independent research which is available to all - is needed. Incentivising investors and stakeholders: We would like to see a

comprehensive review of the UK‟s approach to encouraging entrepreneurial behaviour. In particular we would like to see the EIS and VCT schemes remodeled with a specific purpose in mind – the creation of jobs. We would like to see the schemes widened. We believe that discouraging investee companies from taking on employees because they would break an arbitrary limit on employee numbers is currently counterproductive. In addition we believe that the sectoral scope of the schemes should ensure that jobs in hospitality, leisure and service industries are every bit as valuable as jobs in hi-tech and bio-tech.

Appendix 5: The Approach of Selected US States to Angel Investing:
Hawaii has the most generous tax credit that grants a 100 percent of the investment made, with a $2 million cap per business per year and no total cap. Wisconsin was noted in the NGA report, as it has a „particularly good method for attracting, vetting, and selecting applicants‟. A brief examination of local motivations is revealing:


Traditionally, tourism, real estate, and agriculture have driven the Hawaiian economy, and Hawaii‘s leaders were interested in diversifying. Hawaii‘s remote location and high cost of living create a difficult climate to attract new business. At the turn of the millennium, Hawaii‘s state leaders began taking steps to attract new knowledge-based industries and began passing economic incentive acts. The Tax Director at the time, Ray Kamikawa, has been a driving force and could be a source of expertise in managing the pitfalls for the U.K. Treasury. From 1999 to 2005, tax credits claimed totalled $195.6 million, whilst related investments received totalled $821.6 million, a significant injection to the Hawaiian economy. Hawaii is a unique state, and this bold state incentive takes into account Hawaii‘s remoteness. There might be lessons in this for comparable areas of the U.K. – remote, tourist dependant and economically deprived Cornwall springs to mind. Kansas is generally seen as a ―flyover state.‖ However, through the leadership of the Kansas Technology Enterprise Corporation (KTEC), Kansas is increasingly a home for promoting technology-based economic development, particularly in biotechnology. As a private entity, KTEC directs its energies towards all high technology start ups, which allows it to cross many boundaries. It is able to partner with four universities and the two major angel networks in Kansas. As a public entity, KTEC receives funding from the state lottery and has a responsibility to approve businesses and investors for the Kansas Angel Investor Tax Act passed in 2004. The Angel Investor Tax Credit began in January of 2005. In just the first 45 days of the tax credit, the state awarded the entire $2 million appropriated by the legislature. After this whirlwind of activity, KTEC soon realised that it would need to adjust the process Subsequently, the programme‘s processes have evolved so that the government has given KTEC the authority to evaluate projects on a more rigorous and detailed basis. Today, KTEC examines the business plan and financials, scores the deals, and then reserves tax credits, following a two-week evaluation cycle. Like many other state angel tax credits, it is targeted to high-growth, hightechnological business plans. The annual credit limit has also been raised twice since the 2005 debut, finally rising to a total of $6 million for 2008, which is projected to stay constant until 2016. One other change that took effect was that investors can carry the credit forward indefinitely. Since 2005, entrepreneurial projects have raised twelve times the capital that was granted in tax credits. One of Kansas‘ programme strengths is that it works in conjunction with all of the angel organisations in the state. The angel groups share due diligence with the others, sending deals back and forth across the state. Not only does this help KTEC know what deals are being presented, it is easier for the entrepreneur to access capital and to communicate with more potentially interested parties. In this respect, angel networks are not competing with each other for projects, and


it does not matter who talked to the entrepreneur first, because eventually he or she will be referred to everybody. Plus, due diligence only has to be done once. KTEC believes that this system of communication and transparency is a big part of why companies are able to raise capital in Kansas. One wonders how such a programme would affect similar by-passed and deprived areas of the U.K., say, Lincolnshire? The Wisconsin experience may have particular resonance for the U.K. as a whole. When Governor Jim Doyle took office in 2003, he focused on an economic development plan under the banner ‗Grow Wisconsin.‘ But in attempting to balance the budget, Wisconsin did not have the latitude to commit huge dollars. The leadership agreed, therefore, to a $3 million annual limit in angel tax credits, based on a 25 percent credit of the individual investment made. As with most investment incentive programmes, these credits target businesses that are in the high growth, high-tech and bioscience fields. There are two major organisations involved in the programme. The public entity is the Department of Commerce, which approves the businesses that qualify for the tax credit and administers the tax credit to the investors. The private entity is the Wisconsin Angel Network (WAN), under the Wisconsin Technology Council, a non-profit entity which is not a part of government. The WAN mission is to provide educational opportunities for angel investors, to enhance the deal-flow pipeline, to provide aid to forming angel networks, to measure results, to communicate, and to provide any other support in the service of angel networks. WAN does not have money of its own to invest; rather, it focuses on arranging conferences and networking opportunities on many levels. The programme is designed so that the public and private sectors work in harmony. An entrepreneur first comes to the Department of Commerce to sign the application in order to obtain approval and certification. After successful certification, the entrepreneur can upload a business plan to WAN. Communication and connections are critical for success. One important aspect of the initial success was media coverage. Positive press helped create a positive angel investing environment—one that promotes the idea of risktakers. In 2005, WAN held four ―Power of Angel Investing‖ seminars. Today WAN still holds conferences that offer such workshops, continuing these important communications. When it comes to evaluating how many jobs were created, it was difficult for WAN to know if it had accurate data. To help with this problem, WAN used NorthStar Economics, based in Madison, Wisconsin to investigate and cross-reference the data to ensure there was no overlap. The Wisconsin process is clear and streamlined, but more importantly, it is visible.


Wisconsin reported in June, 2008 that angel investments had grown by 43 percent over a year ago. The state has documented angel investments of $147 million in the last year.


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Analyst Contacts
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