Is a small-cap funding revival coming? Retail investors could be the key

There have been some positive rumblings on the small-cap secondary market of late.

Though the annus horribilus that was 2022 has extended well into 2023, green shoots have begun to emerge from the infertile ground of the London Stock Exchange.

Among these green shoots was Videndum PLC (LSE:VID)’s £125 million share placing in mid-November. An eye-catching sum in of itself, but the real story was how the film and TV supplies company did so at a mere 3% discount.

At the lower end of the spectrum, Great Southern Copper PLC (LSE:GSCU) recently tapped the market for £905,000 at a 10% discount.

Then we saw CleanTech Lithium PLC (AIM:CTL, OTCQX:CTLHF) overshoot its £6 million capital raising target by a third, successfully raising £8 million, albeit at a slightly higher 15% discount.

Fair enough, these are still discounted offers, but when certain doomsayers are calling curtains on the international competitiveness of the Square Mile, it’s hard not to feel some optimism for Britain’s growth companies, even if their funding terms aren’t exactly what they would like to see.

Besides, we’ve also even seen some premium placings, not least XP Power Ltd (LSE:XPP)’s £43.9 million round at an 11% premium.

Keeping a close eye on what discount or premium the market places on these secondary offerings is important, as it determines the level of risk investors are willing to take on a company.

Steeper discounts are a surefire sign that demand is low for a stock; they are also portent of greater equity dilution for existing shareholders. This is great for bargain hunters and not so great for everyone else.

But are the days of 70%-plus discounted offerings behind us? Is the tide turning on the small-cap funding drought, just as interest rates have (hopefully) peaked?

Or are we simply drawing unsubstantiated parallels, when in reality the same problems plaguing the London Stock Exchange persist? 

The numbers don’t lie

There is no beating around the bush: Trading volumes on the London secondary market are down significantly, even in comparison to the letdown that was 2022.

Official London Stock Exchange Group PLC (LSE:LSEG) data shows that year-to-date trading volumes up to October 2023 were down -22%, with the number of trades down -37%. 

AIM-listed securities fared worse than the average, with total traded values down -42%. In comparison, main market-listed securities’ total values were down -22%.

Basically, we could end this article here, but there is a more nuanced discussion to be had about the prospects of the market going forward.

The power of retail

As a retail investor technology platform, PrimaryBid has a unique perspective on the buy-side appetite of the junior market.

Retail investors – i.e. the segment of the buy-side market comprising (usually wealthier) individuals as opposed to institutional buyers – are more prevalent in the lower end of the capital markets.

PrimaryBid estimates around 30% of AIM-listed company stock is owned by retail investors, while the lead index is less than 10%, thanks to the prominence of institutionally run passive tracker funds.

This has good and bad connotations. Without the financial heft of these tracker funds, small companies need a strong narrative if they want to get buyers on their side. Doubly so in a bear market.

“What we’re seeing in capital-raising is that for companies that have a strong investor following, market conditions are reasonably good,” said Nick Smith, a Managing Director in PrimaryBid’s capital markets team. “It’s the names where there’s not a really compelling story or where they’re trying to do something unusual where the deals have struggled.”

Selling into the retail market is particularly difficult, since, well, a retail investor doesn’t always need to buy into a placing to get the volume they want; they can simply tap the open market.

Nonetheless, Smith is observing more retail demand coming into deals, which has steadily increased during the year. But he also reiterated that companies without a good story will continue to struggle.

It’s a passive market

Meanwhile, Smith observed that institutional investors trying to beat the market “have not been punished for missing deals”.

In regular times, investing in a capital-raising exercise should lead to active investors outperforming passive index funds.

“But what's happened is that, because the performance of the market has not been stellar, people sitting on the sidelines have not missed out - yet,” Smith explained

Smith’s comments reflect a wider acknowledgement that UK investors are simply more conservative than their US counterparts.

They’re less willing to take on risk, and less willing to invest in the long term.

This has been especially prevalent in the biotechnology sector, where many great British innovators have fled across the pond to chase higher valuations and more excitable investors in New York.

Regulation is also a bone of contention for Britain’s investor class.

To the limit

‘Build a good story and they will come’ seemed to be Smith’s advice. But, as any budding young novelist will attest, sometimes you need a good support network to help you thrive.

Unfortunately, British listing rules aren’t always supportive.

The UK is still beholden to a European Union regulatory overhang that caps retail share offers without a prospectus at eight million euros (That’s less than £7 million at the latest exchange rate).

Though there are plans underway to scrap this Eurocratic imposition, it is still proving to be somewhat of a bottleneck in the market.

“Since the summer, we’re again having deals that reach the retail cap for transactions where there is no published prospectus. So that means we’re generating more than eight million euros of demand from retail investors,” said Smith. “We went through a stretch earlier this year where that cap wasn’t being reached on deals, and we welcome the steady increase in engagement from retail investors since the Summer.”

Removing the cap is part of a wider plan of deregulating, or at least re-regulating, the London Stock Exchange, whether that be through reforms to pension investments or a friendlier tax system.

So, to bring it all back to the question at hand: Is the small-cap funding drought starting to turn? Not really, it’s just that the market is favouring those companies with a good story to tell. 

Perhaps that isn’t a bad thing. The market was due for a shakeout after all.