The dearth of small-cap IPOs has long been a popular topic to gripe about in venture circles. Usually the complaints focus on a short list of perceived causes: onerous regulations, too-big-to-care investment banks, nonexistent research coverage, and lackluster investor demand.
David Weild, however, is on a mission to move one more item to the top of the gripe list: trading spreads.
Weild, a former Nasdaq vice chairman, has co-founded an organization called the New Markets Movement, with the stated goal of reviving the market for initial public offerings and aftermarket support for public companies.
It’s a similar goal to that set out by the National Venture Capital Association-supported IPO Task Force. The group published a set of recommendations in October for revitalizing the new issues market and is supporting a Senate bill, the “Reopening American Capital Markets to Emerging Growth Companies Act of 2011,” which incorporates some of its ideas.
But Weild believes the recommendations and bill need to go further. He thinks a solution to the IPO shortfall also would need to address problems caused by decimalization – the switch in trading systems dating back to the late 1990s that eliminated the system of trading stocks in quarters and eighths of a dollar, allowing today’s shares to trade in one-cent increments.
Decimalization, when introduced, was widely hailed as a good thing. It allows shareholders to save on commissions and allows more precise measurement of stock prices. However, while Weild thinks the systems works pretty well for large cap stocks, he argues that decimalization hurts smaller companies, because it makes it unprofitable for trading desks and stock brokers to focus on smaller-cap stocks. A better way, he says, would be to allow small cap companies a say in setting the spread.
At present, it’s unclear who is on board with the idea. Weild says he expects exchanges to be receptive, as well as small cap issuers. Traders, on the other hand, will likely hate the idea.
Following are a few more of Weild’s thoughts on the matter, from a conversation yesterday:
Q: So what is the New Markets Movement? A lobbying organization? An industry group?
A: Right now we’re educating, and we’re going to make a determination later on whether we want to get into lobbying.
Q: What’s the basic set of beliefs for improving the small cap IPO market?
A: We believe that for stock markets to work, three things are needed: transparency of information flow, reasonable cost for issuers, and adequate support once you go public.
Q: So how are we doing in those three areas?
A: I think we’re fine on the information front. You also need to have reasonable cost, and a lot of the recommendations have been to dial back the costs for issuers. But the problem with that is what people use as the whipping boy for cost is Sarbanes Oxley. But if you look at the data, you find the small IPO fell off a cliff in 1998, long before Sarbanes Oxley.
The primary thing the U.S. public markets are failing at right now is support.
Q: It seems easy to come to that conclusion looking at aftermarket performance of recent IPOs. So many are well below their peaks, and often well below their offering prices. Do you think that these stocks are underpriced now?
A: We talk about stocks in our consulting practice as being two categories. There’s demand pull – such as social networking stocks, or a company like Tesla – where the brand drives stocks. That’s about 5% of stocks. They probably get a premium because they are sought after, and a lot of that market is not particularly rational. It will purchase stocks on the basis of name.
The other 95% are what we call supply-push stocks. These are companies in areas like biotech and manufacturing. They need research and analysis. They’re probably trading below their fundamental value if they’re public. But they’re not going public anymore, because we don’t have the marketing engine that’s required to get them priced and supported properly.
Q: You’ve been saying that small cap stocks should have a bigger spread to motivate market makers in their shares. What kinds of spread are we talking about? A nickel a share? Ten cents? A quarter?
A: We don’t think it’s a simple answer. What we think is we need mass customization to determine what spread size should be. Issuers are ultimately determining: What do I need to do for my stock to be interesting?