Microcap companies which raise capital infrequently will likely be surprised to find the financing market less receptive today. It’s unclear how long this environment will last but there are some trends to watch which should give us a clue to timing.
Microcap Companies that Were Fortunate to Raise Capital Early Last Year Found a Friendly Market.
In the latter half of 2014, the financing market for the smaller, less liquid microcap companies is decidedly tougher. In order to raise capital now, smaller, less liquid microcap companies are getting term sheets for variable or “toxic” converts. Larger, more liquid microcaps can raise capital but they’ll find their stock price discounts wider and equity kickers more expensive. This deterioration in the microcap financing environment is likely related to several trends, some cyclical and some perhaps permanent.
Normal Cyclical Capital Flows
Microcap funds compete for capital with several investment categories including large and small cap funds. Market watchers know that the Dow index and large cap companies, in general, are trading at historic highs. It’s not surprising, then, than capital is flowing into large cap funds…and some of that capital is flowing out of microcap funds.
Microcap funds have experienced redemption requests from their investors during the second half of 2014 and fear more redemptions as we move into 2015. These redemption requests typically prompt stock sales to raise cash – which hurts microcap stock prices in general with the smaller, less liquid stocks hurt the most.
It’s no surprise, therefore, that microcap investors, facing the redemptions, have become less aggressive in putting money to work, triggering the weaker microcap financing market.
We know, however, that capital regularly flows between large, small and microcap funds. It’s likely that the flow out of microcap will in time reverse itself as a normal cyclical event.
New Capital Flow
There is another trend at work, however, that is the increasing popularity of exchange traded funds, “ETF”s, which offer investment exposure to sectors such as small cap stocks in a readily tradable diversified fund form. Many ETFs mirror stock indices so their operating costs are lower than the costs of actively managed funds.
In 2014, many microcap investors shifted capital into ETFs and out of managed funds, further pressuring the microcap funds cash flows. This trend too has prompted the selling of microcap stocks. ETFs invest back into the market in stocks which match indices so smaller, less liquid stocks don’t get the benefit of ETF cash inflows. The popularity of ETFs shows no sign of slowing, so the full impact and duration of this trend is yet unknown.
Alternative Capital Strategies
Microcap companies considering raising capital will likely find it more expensive, perhaps prohibitively so, until microcap funds see capital inflows again or, at least, no more outflows.
In the interim, we at Monarch Bay can assist your microcap companies with alternative financing strategies, including:
1. Finding unconventional capital sources such as strategic investors or family offices;
2. Arranging debt, perhaps senior and mezzanine debt;
3. Raising project financing, if applicable;
4. Selling business units to raise capital;
5. Locating a merger partner to increase size and achieve synergies
Microcap companies need capital to grow. If the usual equity market is less receptive, there are often workable alternative sources.
Please contact me to discuss your company’s capital needs.
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