It seems like the perfect situation: a less expensive way to achieve a public listing, a wide range of shareholders and a large cash pile ripe for immediate investment.

For all the positives, though, reversing into a cash shell remains unknown and uncharted territory for many, but if done well, the process can achieve most, if not all, of a business’s listing goals.

Extensive research, compiled by Business XL, finds there are 59 cash shells currently on London’s main, AIM and PLUS stock markets with a total of £229.25 million in the bank.

The research, now in it its eighth year, which for first the first time includes analysis of cash shells on all three London markets, highlights the difficulty of raising money in the first quarter of this year.

New issues have raised £77 million in the period, but three times that amount of money remains in the balance sheets of cash shells.

The average market cap of shells is £5.8 million, while the AIM-listed ones have the most cash in the bank, the research finds. The average size of a cash shell on the junior market is £9.8 million and the average cash in the bank stands at £6.6 million.

PLUS-quoted shells have an average market value of £1.1 million, while the average cash they hold is £300,000.

The benefits of reversing into a cash shell

‘The main benefit of reversing into a cash shell is that you know the cash is there,’ explains Jon Isaacs, corporate finance director at Alfred Henry.

‘Whereas a lot of businesses will go through the listing process and a fundraising at the same time, and not really know if they are going to raise the money or what sort of shareholders they are going to have, with cash shells, the money is sitting in a bank account and the shareholder list is there for everyone to see. The other benefit is that you go from a private business of maybe one or two shareholders, to all of sudden having a nice wide shareholder base, which will help with liquidity.’

Increasing the shareholder base can have some added benefits. Gavin Burnell, corporate finance director at Northland Capital Partners, who remains one of the most active directors with two directorships, explains.

‘Reversing into a shell can provide forward thinking and management because there is an existing board in place and a board director in many cases. These are people who are already on the board of a quoted company and can be very useful for the vendor in providing feedback, knowledge and experience.’

Injecting fresh thinking and new blood was one of the reasons mapping firm 1Spatial wanted a public listing. However, the business had been burned in the past after a failed initial public offer in 2007-08.

Chief executive Nic Snape says he had never heard of reversing into a cash shell as a route to market until a non-executive director suggested the avenue.

A little over a month later, Snape and the senior management team decided to start dealing with IQ Holdings. The deal initially proceeded swiftly, but after the terms of agreement were signed in May, the transaction ‘went into a bit of a hiatus’.

‘This was because of the emotional connections of the current IQ shareholders who were getting in the way,’ Snape recalls. ‘You have to be human about the business, and although it was a distraction at the time, I went to meet the IQ board, and that was a really important moment, because it was a face to face discussion about what was happening.’

Snape explains that an independent person was then appointed as chairman of IQ – a decision that greatly sped up the process. The new group joined AIM on 19 October last year.

‘Overall, we have been pleased with the outcome. We gave them [IQ] 10 per cent of the company. When we were going to do an IPO years ago, we had to give up 35 to 40 per cent, so that was better – we had to give less of the company up.’

Snape adds, ‘My advice to anyone taking the process, in addition to getting your finances in order and being a well run company, is that while the deal has to be done unemotionally, you have to realise there is a human component. Someone is giving their baby up and you have to be respectful of that.’

This attachment is one of the main challenges to a reversal. Burnell says that as an adviser he has seen many ‘opportunities missed’ because of a failure in chemistry between the shell manager and the vendor of a business.

‘You tend to find the people who are managing the shell take their time,’ Burnell continues. ‘They are quite protective over their vehicles and sometimes they want to wait to find the right deal. This varies from shell to shell though.

‘Another issue is you want to make sure that you don’t have a shareholder who is out of favour.

‘Also, the process can actually be more costly than an IPO – that is because to reverse into a cash shell, you will probably have two sets of lawyers, accountants, advisers – one for the shell and one for the vendors – so sometimes costs can be slightly higher.’

Isaacs agrees, saying, ‘Most people do think that going to a shell is a shortcut to listing, and it’s not.’ But for the right company and right shell, he argues, a reversal can achieve beneficial outcomes for all involved.

For digital communications agency Fuse 8, negotiations for their reversal into Award International took about four months. Originally a small cash shell listed on PLUS, Award had a draw card in having Maven Capital Partners as a shareholder. It was this backing that Graeme Burns, non-executive director of Fuse 8, points to as the main attraction for the transaction.

Burns says the decision to reverse into a cash shell came down to ‘certain practicalities’ and ‘a bit of serendipity’.

He says that while speaking to a number of advisers, Maven’s name was mentioned, and because he had had some business with the firm in the past, he supported the decision to proceed.

‘We did a very simple transaction with Maven being a lead shareholder,’ he says.
‘We reversed into that in July 2010, which gave Fuse 8 a listing that it sought. It was very cost-effective. There was a six-figure sum in terms of fees, so it is not a cheap process entirely.

‘There is definitely a need to understand the chemistry with long-term investors, and that will increase exponentially depending on the size of the stake that remains. If they come down to 10 per cent then it is less important. If they are going to have 40 per cent, you are really going to be need to be clear on what the company’s strategy is so there won’t be any surprises.’

Clean Shells and Dirty Shells

Listed shells vary enormously from companies that have been around for a decade and have sold or closed operations to newly-minted shells that have never had a trading business. Older shells that still have residual liabilities are known as dirty shells, while ones with no past links are clean. Both the 1Spatial and Fuse 8 deals involved cleaned-up shells.

Other reversals have not been so lucky. MobileWave, which owns the Planet Oi social networking platform, reversed into Fieldbury in August last year.

The shell sold its original Freeplay cleantech business to Indian entrepreneur Devinder Raj Narang in 2008 for a total of $14.5 million, of which $1.5 million was originally deferred until the end of 2009. Narang asked for the final payment of $1.5 million to be delayed and still has not paid the cash.

MobileWave, which was aware of the late payment at the time of the reversal, obtained a judgment against Narang in the UK courts and is trying to enforce it in India. Shareholder and former director Gordon Roddick has lent the company £150,000 to cover its immediate cash needs.

Tim Fussell, corporate tax partner at Baker Tilly, warns, ‘If you are reversing into something that has history, you have to be aware of any potential tax or other nasties that could be hiding away that could come out to bite you.’

Fussell continues, ‘Before you carry out a transaction, you will certainly want to apply for advance tax clearance to ensure that as far as the vendor’s shareholders are concerned they are going to get rollover relief – effectively they are not going to have pay capital gains disposals on the swapping of their shares to the new vehicle.

‘Also, if you have losses in your own group and you are reversing into a cash shell, very likely you’ll end up with a change of ownership and there are anti-avoidance provisions that can then potentially put your losses at risk.’

Fussell adds that other issues including VAT and PAYE registration will also need to be factored in.

‘There is some flexibility [in these areas], but the obligations continue on both sides because the company reversing is effectively putting a new parent company on top.’

Despite the pitfalls that can develop during reversals, Jon Isaacs, who floats clean shells on the PLUS stock market, and has a mixture of clean and dirty shells on the AIM stock market, says there is no real difference when it comes down to whether a business chooses to reverse into one or the other.

‘What comes out at the other end is a business with all its liabilities wiped out, and often [dirty shells] have a nice wide shareholder base that they have built up.’

However, having a long list of shareholders does not mean they will want to remain investors in the group. Even very small investors can hold back a share price by offloading their stake when it rises.

Also, for dirty shells, Isaac says, more often than not they will not have much money, so businesses looking for shells will need to be wary about their fundraising ability.

He continues to explain that the business, rather than the cash shell, will commonly do the pursuing.

‘Businesses will normally come to us asking about a cash shell,’ he says. ‘One of the advantages of having a shell is that people come to you, they know you have £700,000 in the bank, so they will approach you.’

‘Most cash shells are looking for something where you can get decent capital growth,’ he continues. ‘It used to be blue skies. Nowadays people are looking for slightly more established businesses, but still something with significant growth potential.’