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Cash shells are a unique feature of AIM. But proposed revisions to the rules surrounding these vehicles could suffocate this high-risk area, which can provide very high returns.

Some of the best returns investors can make involve exploiting market inefficiencies. Entrepreneurs do this by picking up businesses in which they see potential on the cheap, transforming them and watching their share prices soar. By hitching a ride to such higher risk propositions, investors can share in this good fortune.

Cash shells allow such clever operators to pounce quickly on targets and build businesses of significance at a rapid pace. This is because shells give the entrepreneur more control when identifying possible acquisitions, rather than having to go through an investment committee and inordinately lengthy due diligence.

Top performers

Last year two of the top 20 best share price rises came from shells that leapt after a go-ahead business reversed into them. Online brand adviser IBNet jumped 239 per cent after it became profitable marketing group Deal Group Media.

And holders of shares in failed mobile internet business OverNet Data enjoyed a 271 per cent rise after transgenic plant developer FuturaGene reversed into the group.

Popular Sectors

Overall, there were 41 reverse takeovers on AIM during 2004, worth £586.1 million in all. This is where a quoted company buys a business larger than itself, generally by issuing more shares than it currently has in issue to the target.

The two most popular sectors for reverse takeovers were media and finance, with nine deals apiece. Notable media transactions included World Television's £18.1 million reversal into Virtue Broadcasting and in-store music provider Imagesound's £15.1 million takeover of Advance Capital Invest. On the financial front, a deal of note was the reversal of Andrew Regan's Everdene investment vehicle into Corvus Capital for £22.5 million.

In all these instances, these deals involved shells that had been on AIM for sometime. For example both Corvus and Advance Capital Invest joined AIM in 2000 to hunt for technology-related businesses.

Unwelcome rules

The new AIM rules would stamp on such endeavours and force them to leave the market and return the initial cash raised to shareholders, if they had failed to announce a deal within a year of flotation and conclude it after 18 months. In addition such shells would have to raise at least £3 million.

The apparent thinking behind this is that the dealmakers behind purpose-built shells will effectively have to have a firm plan before joining AIM and in addition receive backing from institutional investors who can keep them in check and ensure they meet these objectives.

However, the very nature of shells is that they are unpredictable. Take Melrose, set up by Christopher Miller and other former directors of respected industrial concern Wassall. The group raised £12 million with backing from a raft of institutions on joining AIM in October 2003 but has yet to complete a deal, having had its attempts to buy troubled bus maker Mayflower and building materials group Novar rebuffed.

Under the new rules this would mean Melrose would be shown the door by the AIM authorities. Another example is Hugh Osmond's Capital Management & Investment, which only finally managed to complete a transaction last September, over a year after its audacious bid for FTSE 100 leisure giant Six Continents, and seven years after joining AIM!

Over half of the 30 or so purpose-built cash shells that have floated on AIM over the past year have already concluded deals. The largest ones have been Urban Dining's purchase of hamburger chain Tootsies for £30.6 million and the £106 million acquisition of Atlantic Waste and Zero Waste by former Waste Recycling chairman David Williams' entity Augean.

Impose artificial rules and AIM could wash away some promising opportunities along with those more speculative ones that are undeniably wasting shareholder's money.