Too often analysts evaluate small-cap companies the same way they look at large-cap companies.
Glancing at a Company’s technology, researching the CEO and reading his Biography is easy. But what you can’t see often drives the outcome of these investments.
Since most of the companies in the Micro/Small-Cap arena are not profitable and therefore “cash-burning” – the most important thing to consider when making an investment in a young company is that it raises capital in a non-dilutive way.
There are a few factors that determine whether a Company can raise capital in a non-dilutive way (where it doesn’t create a lot of new shares in the capital structure). These factors include:
- Management – Does management own enough of the company to take it personally every time a new share is issued? In my experience, large management ownership stakes create an incentive for management to be stingy with the shares. If management has a tiny stake in the company, they aren’t that careful about creating new shares because the incremental dilution isn’t coming out of their pocket. The new cash coming into the Company is something he/she can then spend.
- Effort – Even if management wants to protect shareholder value, they need to be willing to go through the extra effort required to negotiate the best transaction for the Company. This additional effort requires learning the players in the industry that are positioned to provide the best capital. Analysts, Bankers, Fund Managers, etcetera. Finding long-term fundamental investors is hard work – developing relationships are even harder – and finally providing them the information in the form of due diligence is possibly hardest. I have seen many executives sign “structured” term sheets that are easy to come by, but ultimately damaging to shareholders and capital structure.
- Raising Capital – The ability to raise the appropriate amount of capital in the right way also depends on the overall picture for the Company. How capital intensive is the industry? Industrial Companies will naturally require more capital to grow than a slim software company that doesn’t deliver a physical product. So it is important to look at what the capital needs for a business are in the future years. A Company that doesn’t hit their milestones with an ambitious Cap-Ex schedule is one marked for significant dilution.
The factors above aren’t necessarily communicated front and center when analyzing a company so sometimes a little extra due diligence is needed – check 8-k filings and always be monitoring share issuances to see how the Company is being financed.
Author: Marcus Laun, CEO of Growth Circle, creates short, informative videos for Entrepreneurs and Small Cap Companies that highlight their companies & then we distribute them to our large network. We also have a fully transparent trading and distribution platform and community through Nvestly.com, providing 1000’s of actively engaged traders, users, and investors free tools to increase trading volume and liquidity in the market. Contact: Marcus@growthcircle.com