If London's Alternative Investment Market (AIM) were a motion picture, it likely would carry an R rating: for mature audiences only. Not for over-the-top violence or extra skin, mind you, but because the market features high-risk and high-reward investments, and its rules are enforced by the members themselves. One company enjoying the show recently is Houston-based Frontera Resources Corp. Like many small E&P companies, Frontera relied on private capital and project financing to fuel its early growth. Formed in 1996, the company has a 25-year production-sharing agreement with the Republic of Georgia to explore, develop and produce crude oil across a 5,500-square-kilometer area in the eastern part of the country, known as Block 12. By last year, Frontera had outgrown its start-up capital sources. Public-equity markets seemed to offer better opportunities for future growth. And, the company had a good story to tell, a total of 118 million barrels of high-quality reserves, an estimated 1.4 billion barrels of additional prospective resources, processing and transportation infrastructure already in place, and significant potential upside. Given all that, conventional wisdom might have figured that a young, growth-oriented company like Frontera would target U.S. equity markets for its initial public offering. Conventional wisdom would have been wrong. Frontera and Morgan Stanley-its investment banker-passed up Wall Street and instead chose the London Stock Exchange's AIM for an IPO this past March. Frontera sold 31 million shares (a 37% interest), saw its offering oversubscribed by a factor of two, and raised $89 million to fund development and exploration and pay debt. Priced initially at 150 pence, the stock traded in early October at around 120 pence, off its August low of around 115. AIM fills a gap for growth-oriented companies like Frontera, says Steve Nicandros, chairman and chief executive officer, offering a broad spectrum of small companies an "easy way to navigate the capital markets." Since its inception, some 1,300 companies have become members and raised around £11 billion. Last year alone, companies raised nearly £5 billion. Formed to provide small companies with flexible, streamlined access to institutional investors, 10-year-old AIM is turning heads as much for its worldwide investor pool as for its so-far successful reliance on self regulation. Financial advisors, "nominated advisors" (so-called Nomads) and audit houses enforce exchange rules, allowing the exchange to operate without involvement of a Securities and Exchange Commission-like third-party agency, or baneful regulations such as Sarbanes-Oxley. In its 10-year history the exchange has had relatively few scandals. "It works nicely as a self-regulated market," says William Thomas, a former Bankers Trust manager who is now chief executive of London-based Urals Energy Ltd., which went public on AIM in August and whose assets are in the former Soviet Union. "That's the genius of it." Michael Humphries, Washington, D.C.-based senior vice president with investment bank Ferris Baker Watts, says AIM offers access to investors who value high-risk, high-reward international exploration plays, a home to not a few companies with market caps valued in the hundreds of millions of dollars, and has reporting requirements "far less onerous" than U.S. equity markets. The exchange is attracting the attention of oil and gas companies. According to Morgan Stanley, energy firms account for three of the 10 largest capital issuances floated on the exchange to date. Those flotations include Urals Energy ($129 million), Equator Exploration Ltd. ($116 million) and Gulfsands Petroleum Plc ($57 million). Frontera, not far off the pace, ranked as the 13th-largest issuer. "There is a huge breadth and depth of sophisticated investors who are familiar with investing in oil and gas companies," says one London-based investment banker. Hefty IPO values aside, oil, coal, gas and manufacturing firms comprise just 4% of new AIM issuances, Morgan Stanley said. Computer software and investment trust offerings comprise a larger number of total issues. The original idea was that companies would raise $10- to $100 million in equity, grow to between $150- and $250 million in market cap, then migrate to the larger London Stock Exchange. "To our surprise, companies are not doing that," says Steve Busher, Urals chief financial officer. Rather than move to a larger exchange, companies with market caps in excess of $1 billion trade on AIM, he says, not unlike Nasdaq during the go-go 1990s. AIM draws praise for a number of reasons, including no minimum on the number of shares that must be in public hands, no requirement for a previous trading record, no minimum market capitalization and no prior shareholder approval for transactions. Rewards, risks Senior energy executives and their investment advisors point to additional benefits. First, investors are almost entirely comprised of institutions and hedge funds willing, if not eager, to take on substantial risk for substantial reward. But it isn't just about risk and reward, says John Dorrier, chief executive of Gulfsands Petroleum, a Houston-based company with 38 producing assets in the Gulf of Mexico and on the Gulf Coast, and development projects under way in Syria and Iraq. Its onshore U.S. business is run by a subsidiary, Darcy Energy LLC, which commenced production this summer. Gulfsands' outlook is more European than American. By that, Dorrier means that he and his investors see Gulfsands' prospects as an opportunity first. Risk is little more than a business issue that can be managed. U.S. investors considering Gulfsands would tend to see the risk first. "Our asset base is better understood [on AIM]," Dorrier says. The company raised $57 million in an IPO in April that saw its shares priced at 130 pence. In early October, the stock was trading at around 114 pence, having fallen to around 95 pence a share in August. Urals' Thomas says, "This is a grown-up, sophisticated market; it's not a kid's game." The company has proved and probable reserves of 90 million barrels of oil equivalent and current production of around 5,600 barrels of oil per day. Its IPO on AIM was in August, raising $129 million. For the Urals board, the decision was not whether to list on Nasdaq, the Toronto Stock Exchange or AIM, Thomas says. Rather, the debate focused on whether to borrow money or list on AIM. The idea of listing anywhere else was never seriously vetted. AIM offers a "mature way to raise money and have public shareholders," Thomas says. Dorrier says the annual cost just to administer Sarbanes-Oxley requirements would be around $2 million for Gulfsands, which has a market cap of around $220 million. "That was too much for us." Although AIM may not have an SEC-like regulatory cop skulking around, the exchange is far from a free-for-all. Ask Don Reinke. The San Francisco-based corporate finance attorney with the international law firm Reed Smith helped Torrance, Calif.-based Enova Systems Inc., a maker of digital power-management systems, go public earlier this year. He was pleasantly surprised with the AIM experience, he says. Despite having to prepare a 150-page due diligence report, which his firm then had to endorse in writing, and having to hire duplicate sets of auditors and lawyers in the U.S. and U.K., Enova raised $20 million, but wound up spending 25% to 40% less on professional fees than it would have for an identical U.S. securities listing. Reinke shared his experience in testimony before the SEC's advisory committee on smaller public companies in September. The committee has been looking this year at how Sarbanes-Oxley and other regulations affect small companies' ability to raise capital. A third advantage AIM offers is the substantially compressed time to market compared with U.S. markets. One reason is that the IPO is set by the participants rather than by a third-party agency like the SEC. Reinke says Enova's IPO required four months from start to finish. Ditto for Urals and Frontera. On Nasdaq, by comparison, six to nine months is more often the norm. Urals' Thomas says, "The speed at which we can raise additional capital and the minimum filing requirements for the company are such that there is not a comparable market in the world." But before you book the next red-eye to London, consider these cautionary points. If your company is based in Houston, for example, and has assets largely in, say, the Midcontinent, you'll need a good explanation of why you aren't raising money in Houston or New York. More than one source says skepticism exists in London when it comes to deals originating from the U.S. for primarily U.S.-based assets. Executives must be able to answer the question, "If Houston won't fund it and New York won't fund it, why should London?" Frontera's Nicandros cautions, "The AIM Exchange is not a place to raise money for a half-baked business plan." Helping to make the pitch fly is if the listing-seeking company focuses on an emerging market, has geographically diverse assets or its U.S. assets are prospects. Having a London presence is also important for a company listing on AIM, especially since many investors in AIM-listed stocks have offices in London. A third consideration is that U.S. securities regulations prevent U.S. investors from buying foreign-listed stocks for up to a year after their initial listing. The law may have been intended to protect U.S. investors, says Nicandros. But as chairman and CEO of an AIM-listed company, even he is barred from buying stock in his own company for now. "The rule maybe wasn't thought through enough," he says. Going dark That's not the only rule that may need to be revisited and revised, sources suggest. The SEC's small public company advisory committee is looking at how securities regulation reform may help these firms regain access to U.S. equity markets. Last June, the advisory committee heard testimony from John P. O'Shea, president of New York City-based brokerage house Westminster Securities Corp. He cited two trends that are having a negative effect on capital formation for small companies: first, the rules are leading many issuers to terminate their securities registration, or "go dark;" second, an increasing number of issuers are choosing to go public in markets outside the U.S. He pointed in particular to AIM's rising popularity. In 2004, the number of international companies listed on AIM was 116, nearly double from a year earlier, O'Shea noted. Through May 2005, another 33 foreign companies had joined AIM. By contrast, Nasdaq Small-Cap issuers declined by 63 during 2004, while OTC Bulletin Board issuers remained essentially even. The American Stock Exchange gained 63 issuers, but O'Shea said, "this still nets to zero gains across the three markets." O'Shea's investment-banking clients, including Chinese, Eastern European and U.S. issuers, have asked his firm to consider AIM as an alternative to U.S. exchanges. And investors in small-cap stocks are expressing interest in securities traded in non-U.S. markets, he said. Another development is the formation of new stock markets that emulate AIM rather than Nasdaq. The Irish Stock Exchange recently launched the Irish Enterprise Exchange and the European Euronext market launched Alternext. Both are focused on small-cap companies. "As these alternatives become increasingly available and credible, issuers-both U.S. and international-will have less incentive to face the complexities and costs of trading on comparable U.S. markets," O'Shea testified. A major innovation is AIM's use of an entity known as a "nominated advisor" or Nomad. Typically an investment-banking house, the Nomad is responsible for ensuring the exchange rules are followed. In essence, it assumes the oversight role of an SEC. Not only is the bank's reputation on the line in enforcing compliance, but it also is legally liable for its clients' adherence to the rules. What's more, listing companies' boards of directors also must personally attest to the truthfulness of their company's prospectus, Reinke says. And companies may not be listed without a "competent person's report," which independently supports valuation claims. "The competent person's report is the basis for valuation," says Humphries of Ferris Baker Watts. He helped London-based Equator Exploration Ltd. raise $100 million in an IPO last December. When Equator securities were floated, it essentially was a shell company with no assets but with joint-venture access to 2-D and 3-D seismic in the Gulf of Guinea offshore West Africa. Investors active in AIM like to take risks with exploration companies, Humphries says. These are "institutional guys" who invest in a company for the "long haul" and have expectations that they may see a four- or five-time return on their initial investment. Such risk-taking in nascent companies can lead to market volatility, which happened earlier this year when several oil and gas companies reported disappointing results. Energy stocks fell for between four and six weeks, but have been showing signs of recovery since then. "AIM took a momentary stumble, but people got over it," Ural's Thomas says. "These are big boys that take a bet on high-risk companies." Not every oil and gas company will be a good fit for AIM. Certainly, the London versus Houston versus New York story needs to be clear. And, says Thomas, a company's management and directors need to fully understand their assets and who their natural investor base is likely to be. At Frontera, Nicandros' goal is not so different from that of many other executives who manage small-cap oil and gas companies: "to turn into the next large independent and the next huge independent." Among natural resource companies looking to tap a sophisticated investor base, AIM seems to be enjoying some rave reviews.