It’s an unfortunate, but verifiable truth that many a micro-cap deal began with nefarious intent. True also is the fact that many such deals could have been legitimately executed with a bit more foresight, effort and sophistication. It’s the nature of the micro-cap beast to include a bit more volatility and risk, but that doesn’t mean every small cap transaction necessitates a ride on the investment roller coaster. Improving market support for reverse mergers and other alternative public offerings requires insight into all the various stages of the investment value chain. Ensuring such transactions occur smoothly and above board is a combination of nailing everything from public float and investor relations to analyst coverage and deal quality filtering.
Improving Public Float
Perhaps one of the greatest hindrances to winning market support in alternative public offerings is implementing strategies that advance a more active market for a company’s stock. A better market typically includes existing institutional and retail awareness. Companies with large existing customer bases, resellers or a large network of partners can likely raise more money and maintain a public float large enough to have on-going support after a deal is complete. Otherwise companies will be born and die as a penny stock.
Analyst Coverage & Investor Relations
A key component to creating such a market for OTC and NASDAQ alternative offerings involves improving analyst and investor relations coverage. Incenting analysts to cover micro-cap stocks is difficult at best. This is due, at least, in part to the lack of real money flowing to and from such stocks. Activity and coverage of small cap stocks typically occurs because money is flowing. Improving the money flow, analyst coverage and investor relations is a bit of a chicken and egg circular argument. You can’t have one without the other, etc.
Money flowing to “investor relations” firms can help create a market, but it’s often done in a fashion I would typically consider “smoke and mirrors.” It may be a misguided stereotype, but many IR firms have been the cause and perpetrators of some of the most raucous and rank pump-and-dump schemes on the market. It’s the SEC’s job to filter for dealmaker quality. It’s the consultants, attorneys and brokers’ jobs to filter for deal quality.
Filtering for Deal Quality
In a world where traditional IPOs themselves struggle in obtaining ample market support, other alternative methods often require an even greater focus on business longevity and sustainability. In most cases, the best way to improve market support for small cap deals is to improve the quality of the companies being offered on a public exchange.
I’ve heard sharp criticism of micro-cap deals in the past citing studies that nine of ten small cap deals never last longer than a year. This is likely due to at least one of several reasons. First, such firms may not have sustainable revenues. In other words, they may be start-ups seeking capital through a public offering. And, just like their angel-backed contemporaries, the natural way of 90% of the world’s start-ups is the graveyard. Second, smaller deals often include less sophisticated operators. More sophisticated company operators are able to more easily source capital from places other than the public markets. Such management also generally avoids public offerings until the timing is right.
Filtering through the quality deals is often considered to be the market’s job and not the consultants, brokers or attorneys. I disagree. Consulting firms that are simply too small or who may have little to no business in the public arena will help to improve legitimacy, create more money flow into such deals and ultimately bolster the market for micro-cap firms. In reality, this is more easily performed in theory than in practice, but RTO and DPO operators can help to bolster an ecosystem out of the existing quagmire of sleaze. There are those we applaud for doing so, but much work remains.