Escaping the small cap liquidity trap

By John Paul Murphy, Imprima
Increased global competition, limited investor appetite for small cap companies and a slower than forecast economic recovery means that the London small cap market risks seeing an exodus of stronger companies to other markets.  Commentators have suggested that tax breaks, a further shake-out of the weaker listed companies and a stricter admissions policy would help to strengthen the small cap sector.
Small cap companies can get frustrated by their inability to attract institutional investment and grow the value of their ventures as shares are tracked and traded.  While most people believe that the small cap sector will recover in line with the rest of the capital markets, many think that more radical action needs to be taken.  Our view is that there is plenty that small caps can do today to improve their visibility and the understanding of their proposition.
For example, many small caps fall into the liquidity trap because they are not doing enough to differentiate themselves from the competition.  Attracting investors relies on making your company stand out from the crowd.  Potential investors need to understand your proposition, what makes you different, what milestones you have reached already and where you are heading next.  What proof points do you have about your performance to date – customers, partnerships, future sales pipeline?  
It’s also important to set realistic goals, so under-promising and over-delivering is the name of the game.  It’s vital to keep on telling and updating your story – while remaining honest with yourself about what can actually be achieved.
Because nature abhors a vacuum, business planning should include a pipeline of announcements for the next 12 months, with news or communications being sent to your investor base at least once a month.  By the time you’ve factored in results announcements, road show dates, new hires, product updates and contract wins there should be more than enough to talk about.  These should be included on your website in a news section and issued via Twitter or LinkedIn in a timely and integrated way. You can also use Investor Relations Apps to keep your stakeholders up to date with information on the go via their iPhone, iPad or other mobile device.
Research undertaken by Imprima with small cap owners and investors reveals that the three most important sources of information for learning about small cap stocks are company websites, independent research and online annual reports, the latter being more popular than the hard copy format.  Other sources of information include specialist investment media, professional advisers and national media.
According to our survey, there’s a growing interest amongst small cap investors and advisers in accessing company information from their mobile devices: press releases and share prices are the most popular types of information, registering 81% and 78% respectively followed by daily company updates (52%) and investor presentations (48%).
Remote access to annual reports is also becoming increasingly important.  Small cap market participants are particularly attracted by annual reports that can deliver information in multiple formats, including video and audio.  Small cap experts were also attracted to the cost savings generated by sending out fewer hard copies.
Many small cap companies have multiple retail investors who, compared with institutional investors can be difficult to manage.  But some companies have addressed this issue in a positive and effective way simply by getting to know their retail investors and finding ways to involve them in the business.  
For example, it’s possible to establish a ‘fan club’ of retail investors who have access to experts within the company and receive relevant information about updates to products or services.  This process can include regular meetings with retail investors during which experts are made available and demonstrations carried out.  
Institutional investors are a different challenge: they are notoriously short of time and inundated by requests for investment.  As well as getting your story straight and succinct, remember that they will prefer a short, paper-based presentation rather than a complicated Powerpoint.  Another issue to bear in mind is that potential small cap investors are looking at all sorts of propositions, from mining to biotech, and from financial services to technology.  Avoid the jargon associated with your sector and describe what you do in ‘man on the street’ language that everyone can understand.
It’s tempting to rush into an AIM listing as quickly as possible in order to take value from a business that has been built up over the years.  The problem is that so many AIM-listed companies float on a high valuation then fail to keep up momentum.  Investors become disenchanted with the performance of the stock and move onto new opportunities and the company fails to build liquidity and growth in its value.  Institutional investors tend not to be interested in a company until it reaches the £100 million market cap mark, so it can be difficult to climb out of the liquidity trap.  The solution is therefore to build more value into the business before it is floated on AIM and ensure that the share price is not over-inflated.
One of the gripes that investors have about small cap companies is that some founding directors seek third party investment but are reluctant to put their own money into the business.  Another is that directors pay themselves inflated salary and benefit packages, or award themselves high numbers of shares.  A third is that they sell their shares for profit on the quiet or in a seemingly fragmented way.  All in all, investors like to see that directors are in the business for the longer-term and not just for short-term personal profit.
Your annual report is the longest and most complex communication you will have with your investors and the chance to tell the story about where you have been and where you are heading.  There are statutory facts and figures that you have to include in the report, but the best reports go beyond that to give a real flavour of the personalities behind the business, the passion that the people within the business have for their company and the ecosystem of clients and partners that will help to sustain it in the future.  Also, consider how you present your performance: the focus has been on growth but investors will be looking at other factors as well, such as risk and quality.
Finally, as a rule of thumb it takes around three years to correct a poor valuation of a company.  Be patient, set realistic milestones with a clear roadmap and points at which you can communicate news.  If genuine value exists, it will emerge in the end. 
As Warren Buffet would say: if a business does well the stock eventually follows.
 

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