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Buying into a company a few months before it floats is an easy way to double your money, say market experts. However, only a privileged few are invited to play this game and they are buying shares well below prices private investors are offered. Robert Tyerman investigates.

Sophisticated investors with deep pockets and those institutions allowed to dabble in unlisted securities are increasingly taking a chance with pre-float fundraisings. Brokers say buying shares in companies a few months before they float on a public market can enable you to double your money, or more, in a short space of time – even if the eventual public float subscribers may feel it is at their expense.

Aussie investment duo Clive Trist and Ken Frey hope to tap London investors for Van Diemen Mines, which wants to buy options on promising alluvial tin and sapphire-bearing properties in Tasmania. To pull this off at a time when the mining market has gone off the boil, they have chosen what their adviser Ambrian reckons is a smart way of attracting initial investment backing before taking the plunge for an AIM float later this year.

Richard Chase of Ambrian, a young LSE member firm which handled Algy Cluff's recent £600,000 pre-float funding for Cluff Gold at 20p, says Van Diemen is first seeking to raise £1.9 million through the private placing of a convertible loan. To tempt in 'seed capital', the loan will be convertible within a month into Van Diemen shares at a price equivalent to half the AIM issue price fixed for the shares.

The AIM price has not been set, but Chase says the float will seek to value the company at between £12 million and £14 million.

The attractions to the entrepreneurs and seed capitalists are clear. Offered the possibility of doubling their money in a matter of weeks, punters are more likely to put at least £1.9 million into this speculative venture than they otherwise would in today's markets.

Whatever happens to the shares after their AIM flotation, unless they halve, the seed capitalists will be sitting on a useful profit after a month. Whether investors invited to back the AIM float will be equally satisfied with these terms is another matter.

They need good reason to think the shares will rise. If a big chunk of the equity is held by people and institutions that have already doubled their money in such a short time, they may fear there will be less urgency about promoting their interests.

Naturally, that Van Diemen and its directors wish to grow the company as much as possible is in everyone's interest. But the question of pre-float funding is coming increasingly to the fore in what Bill Brown of the ISIS investment group calls 'the blurring of the lines between venture capital and public share markets'.

When former Ogilvy & Mather adman Simon Crisp brought high-tech sandwich board venture Adwalker to OFEX recently through an introduction at 8p, punters saw the price soar to 20p before settling back to 8.75p. But investors who had been asked to put in pre-float funds at a variety of prices ranging from 1.25p to 7p a few months before the float were better insulated from this volatility than those buying after the OFEX launch.

A queue of deals

John East, the ambitious small company broker whose corporate finance side is now spearheaded by City heavy hitter and former Kleinwort Benson luminary Johnny Townsend, is lining up a string of fundings for companies it plans to bring to market soon at much higher prices. Madwaves, boasting software enabling mobile phone users to change their ring tones 'in real time' until they find one they like, is seeking 'at least' £2.5 million.

This will value the company at £20 million and, says Townsend, will be followed by a public float later this year valuing the company 'at many times that'. John East, which not so long ago raised £1.6 million of pre-float funding for equine veterinary MRI scanner company Hallmarq, is also seeking to raise a pre-float £1 million for Holiday FM, which wants to provide holidaymakers in Europe and on cruises with Capital Radio programmes.

That would value the company at between £3 million and £4 million and East hopes to achieve 'a multiple of that valuation' with a public float a few months later. With ex-Warner Bros luminary Tim Foster as managing director and a team including Capital Radio founder Paul Robinson and presenter John Sachs, Holiday FM projects £1.25 million pre-tax profits in the year to October 2005.

Brown, who runs the AIM Trust for ISIS and is helping to float two companies which have had prior financing, argues the key test is whether these deals are necessary to pay for steps to be taken to make the companies involved floatable at all. 'AIM requires companies to state they have enough working capital for 12 months and pre-funding may be necessary for that,' he adds.

John East maintains raising funds from friendly institutions and private investors at a discount ahead of flotations will become an increasing trend. Venture capital funds often demand it.

Punters subscribing 50p a share to internet legal reporting specialist Law///Alert's £1.5 million Enterprise Scheme issue naturally hope its planned AIM float in 12 to 15 months time will command a significantly higher price. By then, with help from the EIS issue, the company hopes it will have achieved profitability.

Who gets the deals?

Investing in a private company, especially a newly created one, inevitably carries more risk than backing an already quoted concern, even if it is only a few months away from flotation and offers the possibility of a hefty short-term capital gain. Therefore these deals tend to be presented to sophisticated high-rolling individuals, well versed in the markets, such as Australian small company backer Bruce Rowan, and more entrepreneurial institutions.

One such is Phillip Richards' recently quoted RAB Capital. Hailed as an often crucial early-stage supporter of young companies, RAB has taken many pre-float stakes, for example backing Bangladesh coal play Asia Energy at 15p last November and later at 70p ahead of its April AIM float at 75p. (The November purchase in particular cushions some of the recent post-float slide to 67p.)

Ambrian's Richard Chase says investors who are showing good profits from recent stock market dealings but are wary of present market trends will still have a go at pre-float deals, where fast returns are potentially still available. At John East, Townsend says pre-float backers are 'a mixture of institutions and private equity investors, who,' he insists, 'are in for the long run and not there to make a turn on the float.'

Beware after-market risks

'Young companies require serial investments,' argues Brown, who agrees that pre-float deals, often involving venture capital groups, 'will become more of a feature. We would not find funding 12 months ahead of a flotation unusual.

'But,' he warns, 'if I was faced with an Initial Public Offering which had had money very recently put in, I would ask why, if at all, we should be asked to pay a significantly different price.'

Pre-float funding can have a depressing affect on the market for a company's shares after flotation, possibly inhibiting future corporate moves. Early backers of Russian gold producer Highland Gold Mining, including the merchant banking Fleming family and entrepreneur Ivan Koulakov, bought 40 per cent of the company ahead of its late 2002 float at a mere fraction of what others paid for 20 per cent of the company in that float.

That has helped prevent the shares from performing as some had hoped, despite the quality of the company's projects and the fact that it has been making money. (North American giant Barrick Gold was also able to buy a hefty stake at a discounted 235p, which has not helped the price.)

Another mining company with potentially attractive Russian prospects, Trans-Siberian Gold, raised

£16 million last November with an AIM float at 150p. However, it had previously raised £4.5 million in

two pre-float fundings at 58p and 125p and profit taking from these was blamed for the shares' subsequent fall to 115p.

A long-term route

Investors outside the charmed circle of pre-float regulars can still gain indirect exposure to young companies aiming for eventual flotation through a company such as AIM-quoted IP2IPO, set up under chess grand master David Norwood to commercialise intellectual property acquired by university research. IP2IPO, which cut its loss from £1.6 million to £583,000 last year, has long-term agreements enabling it to buy into ventures spun out by Oxford University, King's College London, and Southampton and York Universities.

There are no built-in short-term profits here. But shares in IP2IPO, which recently realised £1 million on the flotation of Offshore Hydrocarbon Mapping, have risen nearly 75 per cent from last year's 275p float price to 474p.

That is not quite the order of gain that direct pre-float punters expect. But it is not bad for mere outsiders.