Despite the fact that the overwhelming majority of public companies in the United States have market capitalizations below $1 billion, the structure and regulation of capital markets in the U.S. have always been one size (i.e., large) fits all. The result has been that while capital markets function seamlessly for mid- and large-cap companies, small-cap companies face unique challenges that negatively impact shareholder value, job creation, and innovation.
Capital formation. According to Sagient Research, small-cap companies raised approximately $21 billion in growth capital in 2016. If that sounds like a big number, it is (according to Renaissance Capital, the IPO market in 2016 was $18.8 billion). Not only has capital raising become more uncertain and time consuming for small-cap issuers since 2008, but financing terms have become inextricably linked with trading volume (or widespread lack thereof). When you compare the comparatively free flow of capital to late stage private companies to the conspicuous capital formation challenges in the small-cap ecosystem, it’s not a surprise that the number of public companies continues to shrink.
Volatility. While efficient markets require volatility, comparatively modest order flow increasingly creates dramatic price swings in many thinly-traded small-cap stocks. Excessive price movement can: (a) make financings more challenging to price (and more dilutive); (b) distract existing/potential investors from company fundamentals; and (3) induce the flow of capital towards larger, more liquid issuers.
Equity research coverage. Due to a confluence of factors, the number of small-cap Nasdaq issuers without sell-side equity research coverage continues to grow. According to Reuters, for example, the number of companies in the Russell 2000 that have no research coverage has jumped 30 percent in just the last 3 years. While some fund managers view the lack of research coverage as an opportunity to roll up their sleeves and unearth value, many investors simply invest elsewhere.
Though there is no magic elixir regarding these complex challenges, one thing is certain: inaction is not a realistic option for small-cap companies and their stakeholders.
Towards that end, Nasdaq unveiled its Revitalize blueprint in May 2017 to strengthen the markets for smaller companies while creating a favorable environment for investors. There are a number of aspects to the blueprint, including proposed proxy, tax, litigation, disclosure, and market structure reforms.
One particularly interesting aspect of Nasdaq’s proposed market structure reform in the blueprint involves the potential for issuers to choose to enhance liquidity by trading in a more consolidated environment that is exempt from the Unlisted Trading Privileges (UTP) obligations.
Ultimately, Nasdaq’s proposals are just that – proposals. In order to effectuate change and succeed in right sizing the capital markets for the benefit of their stakeholders, small-cap issuers should first make sure they understand the various aspects of Revitalize, and then actively engage in the dialogue.
Adam J. Epstein advises the boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. Prior to founding Third Creek, Epstein co-founded Enable Capital Management, LLC; Enable’s special situation hedge funds invested in more than 500 small-cap financings. Epstein speaks monthly at corporate governance and investor conferences, he writes the “Entrepreneurial Governance” column for Directorship magazine, and he’s the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (McGraw Hill, 2012).
The views and opinions expressed herein are the views and opinions of the author at the time of publication and may not be updated. They do not necessarily reflect those of Nasdaq, Inc. The content does not attempt to examine all the facts and circumstances which may be relevant to any particular company, industry or security mentioned herein and nothing contained herein should be construed as legal advice.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
