Did you know that 80% of public companies in the US have market capitalizations lower than $500 million? Many of those seek financing to expand their operation every year. Without a strong cash flow statement and predictable future income, nor lots of fixed assets to show creditors and investors, they have to count on the equity capital market to get the money. However, to win investors’ money in the equity market, small cap stocks need to stand out. How do they stand out? One sure way is through trading volume.
Trading Volume & Financing Capital for Small-Cap Stocks
The Dodd-Frank legislation that was passed after the Great Recession has made it harder for small-cap companies to access public financing. In order to avoid the liquidity issues that were the main cause of the 2008 financial crisis, institutional limited partners (or LPs, those that invest in hedge funds which then invest in small-cap stocks) have shifted their focus to ensuring liquidity in whatever they invest in. This means that those LPs have instructed the hedge funds (also known as GPs, or General Partners) to choose only highly liquid stocks to put their money into. As a result, the best financing capital is reserved to companies with the most liquid stocks. All else being equal, if your company has a weaker stock than a liquid peer, you’ll get lesser investment capital.
Trading Volume Is Important Even If You Are Not Raising Capital
If you think that after capital has been raised, stock liquidity is no longer your problem, you are sadly mistaken. Even if you don’t need any financing, trading volume can still affect how your business performs in a variety of ways.
Employee Retention
Your employees will be less keen on the company’s stock options if your stock is sparsely traded. They worry they won’t be able to sell the stock whenever they want to if there are not enough buyers on the other side.
Attract Institutional Investment
Institutional investors have to follow certain criteria when picking which stocks to buy. No matter how much they like your company, they wouldn’t be allowed to purchase your shares if there isn’t enough trading volume or if your stock price is too low. For example, if an investment firm decides to invest $2 million into a particular stock, it needs to complete the purchase typically within one month (20 days). It doesn’t want its purchase to drive up the stock price significantly because that would result in its paying more than it intends to. How does the firm do it? By selecting a stock with a sizable daily trading volume and complete the purchase little by little each day. If the purchase is to be completed in 20 days, each day, the firm needs to purchase at least $100,000 worth of stock per day. To avoid driving up the price, its purchase shouldn’t exceed 10-15% of the day’s trading volume. This means the firm needs to seek stocks that have a trading volume of at least $667,000.
Get Recommended By Equity Researchers
Equity research analysts get paid when the stocks they recommend get bought up by institutional investors. Therefore, if your stock doesn’t satisfy the selection criteria by institutional investors as mentioned above, no research analyst will recommend you.
Enjoy More Leverage in M&A
To be able to use the stock as a currency to buy other companies, you need it to be liquid and strong. A liquid stock can be used in an all-stock acquisition offer because the target company can easily monetize it by selling it in the market.
Retail Investors vs. Institutional Investors
For small cap stocks to achieve a desirable volume that makes it attractive to institutional investors, they often have to count on the only source of trading volume: retail investors. Before an illiquid stock can catch the eye of institutional investors, it needs to appear attractive to retail investors first. However, many company CEOs are not aware of this and continue to follow the wrong approach: Instruct their investor relations firms to market exclusively to institutions and completely neglect retail investors. Not only is this a waste of time and money, but it also prevents the company from achieving its goal in the first place.
How to Boost Small-Cap Stocks Trading Volume
Now that you are convinced how important trading volume is to your success, it’s time to look at ways you can increase that volume. Even when two companies have the same financial numbers and similar products, one may have a trading volume of $100,000 while that of the other is one million. Why is there a difference? The answer is storytelling. How you present yourself in front of potential investors makes all the difference. In other words, the latter knows how to sell its shares to interested parties. To be able to capture the attention of sophisticated and beginner investors alike, pay attention to the following:
- Use simple language when explaining your business, what you do, and your values.
- Make your website easily accessible to all.
- Communicate clearly and factually to the right audience.
- Keep investors updated with the latest developments in the business.
- Consistently over-deliver what you promise and let the result speak for itself.
- If you are the CEO, charm investors with your knowledge, wit, and eloquent speeches.
To be able to sustain trading volume, here are some mistakes you should be aware of and stay away from:
- Don’t expect investors to come to you after seeing your results. The small-cap competition is too tough for this attitude to work.
- Don’t mislead investors with false promises and constant hypes. Smart investors are quick to detect which news is material and which isn’t.
- Don’t overdo promotion. It’s fine to set up regular trade shows to meet with investors. However, if you do it too often, the law of diminishing returns will manifest itself.
- Stay wary of promised shortcuts offered by third parties when it comes to trading volume boosting. Your goal is to create a sustainable volume increase, not a spike of volume here and there.