If you’re thinking of going public, you can’t afford to ignore the cash shell route – a quicker and often cheaper way of floating. Following a boom of late, there are now 69 shells on AIM, all searching for the right business. And they’ve got £77 million to spend.

Shell companies used to be considered corporate curiosities, peculiar business beasts led by unconventional entrepreneurs, advised by enlightened brokers and backed by contrary investors. Now, however, they are an important and entirely normal part of the financial landscape.

The proof of this is in the counting. When Business XL last investigated this area (in 2002), there were 25 such vehicles. But our recent research, conducted with the assistance of leading legal advisers Pinsents, unearthed no less than 69. Between them they have around £77 million to spend.

The allure of the shell
For the uninitiated, a shell is simply a company that boasts a stock market quotation and cash in the bank, but no actual operating business. They are usually led by a well known City player, have a ready-made list of eager shareholders and are basically looking around for a suitable business to buy for the cash they hold or one with which to conduct a reverse takeover.

If you’re an entrepreneur looking to float your business, ‘reversing’ into an existing shell company offers several distinct advantages over a more traditional listing.

According to Chris Akers, an entrepreneur who currently heads two shells and has been associated with several successes in the past, 'the main attraction of shells is that they represent a guaranteed route to market which may not have been available to certain businesses due to either market conditions or management’s lack of contacts with the City.’

For Liam Murray, a corporate financier at CFA Capital, another attraction is that they offer a ‘fast track’ route to joining a public market. Says Murray, ‘a conventional flotation will take at least three months and usually around six. But if you reverse into a shell you can actually complete in a month – provided, of course, everything falls into place.’ This is a crucial advantage as it means that a chief executive will have to spend less time with advisers and more time doing what he is paid to do, namely, driving his company forward.

Cash, personalities and more cash
Perhaps more importantly, moving into a shell can allow you to grow at a much more rapid rate.

The most obvious reason for this is that they possess cash resources, which can be utilised for expansion. Then, of course, there is the incumbent serial entrepreneur. As mentioned, many of these are experienced, financially savvy professionals whose knowledge and contacts could prove invaluable.

Should you require more cash, the shell’s ready-made list of existing shareholders may also prove very willing (depending on the shell) to invest further sums if the business plan demands it.

Last, but by no means least, the costs associated with the transaction may (though do not always) work out a little cheaper as a result of the reduced time frame involved.

Some initial risks
Unfortunately, not every shell will be able to deliver all the benefits listed above. The value placed on the shell can prove problematic (of which more later).

Then there is the fact that certain shells are headed by City players who are more opportunistic than entrepreneurial. They may be more interested in making a financial return than sticking around to grow your business. Says one City insider, ‘there are some horrible scams around. In some cases the shells are set up on AIM by one guy, who then puts his chums in, loads up with cash and sits there for months waiting for an unsuspecting company to come along – like an elephant trap.‘ Once the deal is done – often at a price favourable to the incumbent entrepreneur – they sell their shares and move on.

You may also have a hard job raising extra cash from the existing shareholder base you inherit, particularly if you reverse into a ‘dirty shell’ whose previous business has already failed.

Choices aplenty
The description ‘dirty’ in this context basically means a shell that has been forged from the remnants of a failed business and is seeking a shot at reinvention. These vehicles stand in contrast to ‘clean shells’, purpose built companies floated on the market to find a company to buy.

There are 29 ‘clean’ shells on AIM and 40 who sport a ‘dirty’ label and the differences between the two camps are marked. The current crop of clean shells has over £45 million in cash and £46 million of assets. Despite there being 11 more of them, the dirty shells have just £32.2 million of cash and £29.1 million of assets (after liabilities) at their disposal.

Market valuations attributed to clean and dirty shells also show great disparity. At £3.5 million, the mean market cap for purpose built entities is around £2 million greater than it is for dirty shells. This is in spite of the fact that the former group have, on average, just £800,000 more cash to their name.

Basic attractions
A clean shell’s most appealing asset – apart from its cash resources – is the fact that, as it’s a new company, it has no historical baggage and it should prove to be an uncomplicated transaction for an incoming business.

With dirty shells, historical revenue losses can be offset against profits if the incoming company is in the same line of business, while accumulated capital losses can be used for anything.

Amberley, for instance, has some £13 million of capital losses to its name at present, whilst Illuminator has in the region of £4 million waiting to be exploited.

The flip side of this coin is that many dirty shells possess liabilities, meaning that there can be a considerable amount of problems to clean out. In addition, it can be difficult to shrug of the reputation of former failed businesses when meeting investors and journalists.

The price of a deal
The most important consideration when engaging with a shell though is the price at which you conduct a deal.

Among the clean shells, Fitzwilliam Capital, for instance, has a mere £500,000 in cash but boasts a market value of £5 million. Conival, led by Richard Thompson, meanwhile, has cash reserves of £400,000 and a market value of £2.5 million.

Of the dirty shells, Greenchip Investments is valued at the greatest premium to cash, while Matisse’s cash of £15,000 is deemed to be worth £740,000 by investors.

The premium afforded to all of these entities is basically a reflection of the hope and optimism the market has in the ability of the entrepreneur leading them to engineer an earnings-enhancing deal.

But owners of private businesses need to seriously question these valuations. Says Adam Hart from leading City broker KBC Peel Hunt, ‘it is essential to ask what you, as the incoming firm, are receiving in exchange for the deal. If you are paying £2 for what is essentially £1 of cash, what are you getting for this premium.' he opines.

In short, reversing into a shell trading at an unrealistic premium to its assets is likely to prove very expensive to the incoming business owner. Unless you bargain hard and take the proper financial advice, your ownership of the new vehicle will be diluted out of all proportion to the assets you have actually injected.

Behind the shells
As already alluded to, the entrepreneur behind the cash shell should represent a key consideration for any growth firm considering a reversal as a route to market. Their contacts, expertise and ongoing commitment are vital to future success.

When it comes to cash shells, certain City figures are extremely active and, just like the shells themselves, the specialities of these figures vary greatly.

Some, the likes of Leo Knifton, Nigel Weller, Peter Redmond and Richard Armstrong, specialise in cleaning out failed businesses and preparing the empty shells for reversal. Others such as Haresh Kanabar and Chris Akers create new shells and act as mentors to bridge the gap between businesses and the City.

Convincing these entrepreneurs that your business is the right one to back is not a simple process. Richard Armstrong, who currently sits on the board of four AIM shells, says, ‘when you embark on this route your are in the shop window. It is a bit less arduous than having to go through the whole flotation roadshow, but it’s not an easy option. We're just as, if not more, rigorous than brokers. We are, after all, putting all our monetary eggs in one basket.’

Against this, it’s worth noting that striking a deal with these entrepreneurs is a two-way street and you have to be just as rigorous in your own due diligence. 'We've been embarrassed by the paperwork put out by some shells,' Chris Akers, chairman of Ardent and TMT confesses. 'The ratio of founder investment to placing investment is particularly important to look at. Shell creators can't be allowed to load themselves up with discounted founder shares and take a free ride.'

Most professional advisers counsel that it is wise to thoroughly investigate the founder’s shares, warrants, options and other incentivisation tools. And make sure those behind the shell are ‘locked in’ (that is, are not able to sell their shares) for a least a year to guarantee they remain committed to providing guidance and assistance to the new business’s growth plans.

Case Study — How SSI found a home in Chelford

When supply chain software solutions business SSI decided to launch onto AIM in mid-2000, it opted to do so via a reverse takeover rather than flotation – a decision that, chief executive Trevor Lewis explains, owed much to the circumstances of the time.

SSI's dilemma was that it was looking to come to market just as technology stocks were losing favour. 'The float window was beginning to close,' recalls Lewis, 'but fortunately one of our board had a contact with [acclaimed shellmeister] Mike Edelson.' For SSI, Chelford (the shell in question) solved the problem because it had 'the cash and the credibility', however, he admits that while the deal 'has worked well for us' there have still been a few issues to overcome.

'Clearly what we have is a significant retail shareholder base but we do now need to bring in some institutions,' Lewis concedes and 'some people also held a bit of a stigma against us as we are a penny share. This is something we are also looking to address.'

For those considering following in his footsteps in future Lewis simply advises that businesses 'make sure the shell is absolutely clean, that the people involved have credibility and that they have something to offer following the deal’s completion'.

Buy the full report
This document is part of a larger, more extensive report entitled ‘Cash Shells’ compiled by Business XL. The report is available in PDF format priced £195 + VAT. To order a copy, call 020-7430 9777 or email info@businessxl.co.uk.