Small cap hell is where you end up in about six months after your IPO, when all the high fives and champagne have receded into a distant memory. Unless your company is big enough. How big is big enough? According to Investopedia, small cap refers to companies with "a market capitalization of between $300 million and $2 billion."
That's right, to escape small cap hell you need to have a market cap over $2 billion.
To put that in perspective, that describes one out of 14 publicly traded SaaS companies (Salesforce.com). So 13 out of 14 are in small cap hell. Actually, two out of the 14 are micro cap, i.e. below $300 million in market cap. This matters to all of us. A healthy public market for Web tech ventures ripples all the way down to seed level investing and drives the innovation economy.
What Does It Feel Like To Be In Small Cap Hell?
Lonely. Nobody cares about your little venture. To the team that endured blood, sweat, toil and tears to get to $50 million in revenues, and then go through all the SEC gyrations to become a public company, that is tough to accept. Here is what you can do.
- Hire a strong investors relations team and send out lots of press releases, be accessible to the press, go on road shows and speak at conferences for investors. Your IR team can take care of the mechanics, but this is also a big time-suck for the CEO and CFO. (And you cannot say, "Sorry we missed our numbers we were too busy schmoozing folks like you.") The result is a lot of work and you have to do it - but the payoff is small. Every other small cap is doing the same thing.
- Buy back your own shares. That tells even the most dimwitted investor that you think the stock is undervalued, and as you run the company you probably know. This is fine if you personally are vastly wealthy or you have massive amounts of cash laying idle on the company balance sheet. In other words it is not an option for most companies
Social Media IR Rides To The Rescue?
Agoracom is a modern IR firm. They use online methods to tell your story. That may not sound like a big deal, but IR is a pretty conservative business, so just using a few tools like Twitter intelligently is a big step forward.
Agoracom's pitch is that they can "tell your story". For a while there will be an opportunity to use modern methods while your competitors are stuck with their buggy whips. But that advantage will erode really fast. So this is where the new Finance 2.0 sites like Seeking Alpha, Stocktwits, Kaching and Covestor may have the key.
I decided to test this on the 14 publicly traded SaaS companies.
Finance 2.0 For Small Cap: It is Too Early To Tell
Select a classic small cap stock in the SaaS Index. For example: RightNow Technologies (RNOW). At time of writing, they have a market cap of $525 million. It is a cool company that is growing fast and delivering good results for customers. So how much coverage do they get on these new sites? In my test I looked at RNOW for the period Jan. 1 to March 1.
StockTwits: There were nine tweets about RNOW, and many of them mentioned RNOW among a list of other stocks. Some are not very helpful, such as: "Does anyone know the future of $rnow ?"
SeekingAlpha: This has two posts that were specific to RNOW and they seemed high quality. That is better than nine tweets that don't say much.
Covestor: This is interesting to play around in. You can see the last 10 trades done by Covestor members in RNOW. But you cannot drill from that to any rationale into RNOW. The system is set up to do that, but there is just nothing there yet.
Kaching: This gave good news aggregation on RNOW. It looked better than YahooFinance (still the starting point for lots of investors) but seemed to lack depth. Nor did it have any fundamental new information.
So, from the limited perspective of one small cap, these sites are at this time not the answer.
What about "ye olde stock forum" on Yahoo Finance? Their message board for RNOW for the same period of time has 28 posts, not including the threaded replies. That puts them way ahead of the newcomers.What about quality you ask? What is the use of a lot of noise from anonymous posters pushing the stocks they own (or panning the ones they short)? That seems to be the problem with all these sources.
Wanted: Patient, Long-Term Investors
Found: Momentum-chasing day traders.
You want investors who will buy into the quality of your technology, understand your value proposition, like the market you are in and think you are doing a reasonable job managing the business. In other words, you want Warren Buffett.
That is not what these new sites are delivering. They do not seem to be the key to escape from small cap hell.
Let Your Story Surface
The evolution seems to be:
1.0 Tell Your Story. This is standard investor relations. The updated version of IR is to be present where investors hang out, which today means online. But it is still the old broadcast model.
2.0 Let The Crowd Tell Your Story. This is classic social media - and it suffers from classic social media problems. You might trust a user-generated review on Yelp before going to a diner, but you are likely to be a bit more nervous before investing your kid's college fund in a company.
What we need is something that reverses the flow, that lets investors discover you, that lets your story surface. This is where XBRL may help. (For a basic intro to XBRL read our earlier coverage.)
The Current XBRL Disconnect For Small Cap Is Temporary
XBRL was not any help when I was compiling the data for the 14 companies in the SaaS Index for the Saas Insights Report (a paid report for investors available from CapitalMarkets.com. Disclosure: The guest author wrote this report). The reason is simple. Only one out of 14 reported to the SEC in XBRL format. That company is Salesforce.com (CRM). The reason for that is also simple: The SEC currently mandates that companies with a market cap higher than $ billion report using XBRL. That is what creates the disconnect:
1. XBRL will enable the good investments from small cap companies to surface, but,
2. Only big cap companies report using XBRL (and they have no trouble reaching investors).
The good news is that disconnect is temporary. The second wave of new XBRL filers in 2010 is estimated to include 1,500 - 2,000 reporting companies, and the final wave in 2011 is for about 10,000 additional companies.
Imagine the Information Discovery Tools
When I go to my local wine store, the owner asks me what I want and we have fun with my standard reply that I want something "incredibly delicious and ridiculously cheap". Investors want the same. Warren Buffett got to be one of the richest men in the world by finding a few of those.
When all companies file in XBRL (and some geeks have created some neat tools to help sip more effectively from that firehose), ordinary investors will be able to create really powerful filters to find those "incredibly valuable and ridiculously cheap" companies.
They won't find them among the big cap companies. They will find them among the thousands of small cap, micro cap (and yes, even nano cap) companies. When the value surfaces, they can reach out to IR who can them tell their story.
Of course, when all this pans out, the opportunity to find the bargains will disappear. That is the price of an efficient market.
But the value to all the companies trapped in small cap hell will be immense. They can focus on building value knowing that the value they create will surface.
And that will have a great impact on the innovation economy.
Photo credit: Chris Whiteside