Mr. Steiner is the Chief Operating Officer and Managing Director – Investment Banking at Ladenburg Thalmann & Co. Inc. The views expressed in this posting are Mr. Steiner’s personal views and should not be attributed to Ladenburg Thalmann & Co. Inc., its employees, affiliates or subsidiaries or to Gunster.
While the Jumpstart Our Business Startups Act (the “JOBS Act”) is a well-intentioned effort to assist smaller companies in their ability to raise capital (and ultimately increase hiring), it falls short with respect to one of the most pressing problems facing capital formation. One can not argue with relaxed rules in several areas such as (i) permitting solicitation for certain private placements; (ii) reducing the reporting requirements for Emerging Growth Companies (generally, newly public companies with less than $1 billion in annual revenue); and (iii) improving the largely unused Regulation A; however, while the burdens of becoming publicly traded have been eased for some smaller companies under the JOBS Act legislation, a major issue that was not addressed is the inability of small and micro-capitalization public companies to fully gain the benefits of their publicly traded status. Or more to the point – it might be easier to go public via the IPO process, but why be public in the first place?
Regardless of size, a company’s status as being publicly traded is an asset. The manner in which a company maximizes the value of its public status is by maximizing the liquidity in its traded securities in the public markets. This results in easier, more predictable capital raising, the ability to use its stock as currency for acquisitions and hiring of key personnel, and less opportunity for “game-playing” by the unsavory element of the small cap marketplace. Today, the ability of the small cap public company to gain liquidity is severely hampered by the current trading infrastructure. Additionally, heightened regulation of brokers and the aggressiveness of plaintiff’s attorneys have also not incentivized many to trade in the small cap space.
Moreover, changes to the securities trading market process have also had a negative and disproportionate impact on smaller public companies. In 2001 the U.S. stock markets switched from a quote-based market (fractional trading) where people still had to interact to execute trades to electronic order execution (decimal trading), which resulted in progressively smaller spreads. As a result of these smaller spreads, the economic incentive for market makers to support small cap stocks, which tend to trade at lower volumes, significantly decreased. While decimalization and electronic order execution did not significantly impact large cap stocks, which trade with consistent liquidity and at higher volumes, it has been catastrophic to the small cap market.
The effect of the foregoing on the small cap market has been a reduction in the number of investment banks serving this small cap market and added difficulty in raising capital for these companies. With the apparent reduction in the availability of angel and venture capital financing, the public markets could be viable alternative for smaller companies if the IPO process was better tailored to more fully address the particular needs of smaller companies. The (potential) liquidity as a public company could open up a large group of investors that might not be interested in an early stage private company. This is especially true in the biotechnology sector.
Nonetheless, the JOBS Act has not gone far enough to allow smaller companies to maximize the benefit of being publicly traded. In turn, this has also hampered job creation as there is extensive empirical data demonstrating that well-funded public companies create jobs at a relatively higher rate as compared to similarly financed private companies. A return to fractional trading could be one step that would likely help small cap companies by providing them with better access to capital because of the greater incentives that investment banks would have to serve this market segment.
While the major business news outlets predominantly focus on the large cap world, the vast majority of publicly traded companies are below $500 million in market capitalization. These are the employers that will drive job creation. The U.S. has the most effective capital market system the world has ever known. We just need a few tweaks so it works for everyone. There is however, some hope on the horizon. The Schweikert Amendment, a component of the JOBS Act, required the SEC to study the effects of the transition from fraction trading to decimalization. The study focused on both liquidity and the IPO market for small capitalization companies. The SEC released its report to Congress this past July but did not recommend any immediate rulemaking to increase tick sizes, but indicated that further data is necessary to determine the impact of the decimalization of stock quotations on small public companies, liquidity and the IPO market. Politicians obviously have plenty to deal with currently, but lets hope this key component of capital formation (and ultimately, jobs) is addressed in the near future.