Orphan Microcaps and the Next Boom
By Josh Levine -- May 12, 2011
It hasn't been easy operating a small business for last few years. In particular, companies with less than 100 employees have struggled against a tide of obstacles from tight credit to rising costs -- all in the midst a difficult economic environment.
In the world of finance, small firms have also faced an uphill battle as alternatives to raise equity capital, practically the only avenue for funding tech-driven micros, have narrowed significantly since the technology bubble burst in early 2000.
Still, the barrier to entry for small companies becoming publicly-traded isn't very high, thanks to the broad acceptance of the reverse merger. The big difference during the past decade, however, is that sponsorship from venture capital firms and investment banks nearly vanished at the $200-million market cap threshold and below.
Changing Times
During the 1980s, sparked by the IPOs of Apple and Genentech (now part of Roche), venture-capital-driven deals evolved into IPOs for established investment banks, which helped to create active markets and tremendous buzz for emerging technologies.
The 1990s climaxed with the dot-com explosion, which helped lay the groundwork for today's Internet. The pace of creation and destruction has never happened so fast, as the half-life for hundreds of newly publicly-traded companies was only a year or two.
Following the dot-com burst, the emergence of new businesses in nanotechnology and cleantech served as catalysts for short periods in the microcap world. But it wasn't enough to create a complete ecosystem for funding and supporting emerging tech firms -- from start-up to IPO and beyond.
Small technology firms that want to go the public route can manage this through reverse mergers, as well as direct public offerings in which a company sells its shares directly to its own "friends and family." Yet today a sponsorship vacuum remains in the microsphere.
As virtual orphans -- without the influence of venture capital groups or investment banks who have become highly institutionalized in the way they do business (i.e., they get paid more money for the same amount of work on bigger deals) -- microcaps are challenged to engage sponsors who will fill the roles once played by these financiers.
By definition, a sponsor in this context is one who assumes responsibility for the microcap, using their influence to create demand for the shares. Many investors assess microcaps based on the depth of sponsorship, believing that the endorsement of established investment firms is even better than the "Good Housekeeping Seal of Approval."
Venture firms, which invest in a gaggle of young firms with the hope of hitting just one or two huge winners, depend on windfalls from IPOs to overcome failed investments and to deliver healthy investor returns. But, except for a couple of years, the IPO market has been mostly dormant this decade.
Angel investors -- wealthy individuals with industry experience and contacts -- have filled a part of the role for VCs, but they typically lack the organization and the breadth of contacts and influence among the broader investment community.
As a result, many companies with the potential to go public through high-visibility IPOs choose to be acquired by the Googles and the Ciscos of the world.
There's an upside to all of this.
First of all, this tepid investment phase will pass and there will be a resurgence in early-stage funding and IPOs -- in one form or another. The current transition occurring from Wall Street to Silicon Valley will evolve into something that fills the current void in venture financing. The current fervor for IPOs of social networking firms and other technology outfits is the latest sign of the coming shift towards more aggressive growth investing.
Here's better news: During periods like this (think the 1950s or 1970s), when funding and sponsorship was tough to access, it's "the tough that get going," as they say. The smartest and most talented in technology focus on what counts the most and innovations flourish -- and this will inevitably lead us to the next revolution and the next explosive phase in tech stocks.
Venture Profits for Us
Meanwhile, we've already got entrée to several immense investment opportunities currently in the MicroCap Investor portfolio.
Several of the companies I've recommended -- developing everything from solutions for the $100 billion problem of fraud in financial services to innovative cancer treatments -- are capable of delivering venture-type returns, i.e., 500%, 1,000%, and more. (In fact, I captured a 400% profit just a couple weeks ago in a biotech play by selling half of the position). Importantly, unlike VC investments these shares are already publicly-traded with liquid markets.
Without the bright-lights of neon sponsorship, it may seem that the microsphere is in the dark. On the contrary, there are bigger and brighter opportunities, and values, than I've seen in a very long time. To gain an advantage, investors can serve themselves well by focusing on these stocks now -- before markets awaken to the fantastic prospects.