Microcap Stocks Struggle to Get Funding
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Anyone who has followed micro-cap stocks, also known as penny stocks, for at least a few years has many have noticed that funding significant changes to funding terms for many of these companies. The ability of companies to get capital, and the terms of those deals, plays a vital role in the success of those companies. Lack of funding can result in bankruptcy (when a company has debt), cessation of business activity (when a company has no debt), an inability to conduct necessary research and development, or insufficient funds to grow the business.
In the past, when the stock market was booming, funding was relatively easy to get since investors expediate continued increases in shares prices. As an example, a company might have a private placement of shares at the recent ten-day average stock price and add one half of a warrant per share purchased in the private placement. Funding terms like those in this example generally did not have a negative effect on the current share price. Everyone was happy: The private placement buyers received a free one-half share warrant, the company got cash to fund their business, and existing shareholders were happy that the company had sufficient funds to carry out its business plans.
In the current market we are seeing funding terms that are dramatically different than in the recent past. A typical deal now might offer a 15% discount from the current price and add a full warrant per share. The result is a much higher cost of capital for the company and a negative perception in the market place. Deals like this can have an immediate negative effect on the share price, often driving it below the offering price. I have also noticed that some prices have tanked before the offering is announced (and priced), resulting in total price declines of up to 50%. There is also a lot of speculation about manipulation by firms and investors participating in these private placements, which creates this price dip. But that is a topic for another day.
While some retail investors blame the company leaders for these poor funding terms, it is important to remember that they may have no choice. If they could get better terms they would certainly do so. And raising capital is one of the most important aspects of executive roles in micro-cap companies. Retail investors need to keep a close eye on the dilution created by these deals, warrant prices and execution dates, and the total number of outstanding shares as that number changes over time. While the fundamentals and business outlook for a company may remain strong, the investment quality and potential for share price growth could be less attractive.
These issues with funding are a part of ever-changing market conditions. Beyond the analyses of companies as potential investments, investors must also understand the macro environment in which all companies operate. Only then can investment decisions (buy/sell/hold) be made with confidence.
