How SMEs can access financing through the stock market to scale up is a constant challenge. We look at the state of play and ask one of the market leaders in listed SMA investment strategy, Recall Capital, about their new investment algorithm.
Everyone knows that the stock exchange has been an effective way for SMEs to raise money both to scale up and remain profitable. Access to global capital has been good for this sector, where expectations and confidence in the company’s business concept, offer and market were the most persuasive arguments for buying shares. Recently, management and the board have become an increasingly important part of the investment case too.
The number of listed companies is growing. In Europe alone, the number of companies has risen by 11% in the last 18 months. In individual countries, this figure is around 20%. So there is still good faith that the stock exchange is the best solution regarding equity supply over time. However, companies with a market capitalisation of less than 110m Euro represent less than 1% of Europe’s total market capitalisation and only 0.5% of the trading volume – and it is these smaller companies amount to almost half of the number of listed companies.
Times are changing, and it’s no longer just a company’s business model, product and possible market that control investors’ choice of investment. It’s also about management’s ability to perform and get things done, as well as the board’s ability to transform management work at the right shareholder value.
Change on the way
Why this shift of focus? Through the development of SME companies on the stock market in recent years, the market is also becoming increasingly mature. A natural consequence of this maturity is that investors have also started reviewing the companies more and not just relying on good presentations based on theoretical outcomes. Management and the board are often crucial to the investor and indeed the size of the investment. Quite simply, there is increased competition for the investors’ money, and it is easier to invest in a company where you feel secure in the management and board. It’s all about people.
The concern now beginning to emerge on the SMEs stock market is that stock trading is falling and that it is happening as the number of companies grows steadily. Total trade fell by 12% (Euro 1.7 billion) in the first quarter this year compared to the first quarter in 2017. During the second quarter trade fell even more – by 27% or around Euro 3.5 billion.
Looking at trade measured per company, trade in the first half of the year has decreased by a full 24%, making Europe the world’s worst performing area.
These figures are naturally alarming for companies that, through reduced trading volumes, also lose value, which affects the company’s ability to use its own shares in acquisitions, for example. The value per company in Europe decreased on average by 6% in the first quarter and by 12% in the second.
Why is trading volume so important for SME companies? Because there is a statistical and secure relationship between stock trading and the value of a share. This applies regardless of the company’s earnings ability, which is generally constant regardless of the value of the share.
Another challenge is that too many SMEs have too low a market capitalisation to be listed at all. In Europe, the share of companies with a market capitalisation of less than EUR 5 million is about 40%, and more than half of all listed SME companies have a market capitalisation below EUR 10 million. This situation naturally causes some caution from investors, which also affects the increasingly weaker interest in buying shares in SME companies.
Companies with an excessively low market capitalisation imply higher risk because relatively small amounts of money can significantly change the price of the share and stock can easily be manipulated. Terms that usually constitute a measure of risk are volatility. But for these illiquid companies, the measure is simply not useful and instead, other measurements should be used, such as the value of the trade value versus the value of the company. This becomes particularly clear if we also take into account that SME companies with a market capitalisation of less than 10 million Euro have lost 65% of their trading value in the first six months of the year compared to the same period of the previous year.
These two factors cause the stock to remain fixed until a fair market value is established. It may seem like a Catch 22 situation, but it is more about conscious and methodical work from the board to create value for its shareholders – something that was an utterly unthinkable task 10-15 years ago.
Buyers and sellers of shares in SME companies are often local actors in their own country. Some countries have a more mature trade than other countries, but primarily their population limits how much can be traded in SMEs.
Europe represents 17% of the global market capitalisation of SMEs and 19% of the number of listed companies but only 4% of the trading of shares. This imbalance is because Asia accounts for 46% of the companies and 88% of global equity trading. Perhaps it is time for companies to change their perspectives and start thinking about how is it possible for Asia to have eight times more stock trading in SMEs than Europe? What is it you can get from this region that allows for greater trade and investment?
An essential part of being on the stock exchange is capital procurement. The fundamental principle has been that, in the first place, existing shareholders should be asked if they want to invest more money at a small discount. Today, this process has almost disappeared in several countries, and instead, companies target emissions against certain owners. This practice is defended because of speed, fewer costs and reduced value losses for shareholders. In line with the competition for money, these preferential issues tend to guarantee high repayment requirements and, to avoid investing, they also demand low emission rates. Not surprisingly, therefore, this model of raising money in many countries has mostly disappeared.
New creative solutions which have challenged the old structures and which gives the companies themselves better control and planning of their liquidity situation and needs.
That means a model which provides the company with precisely the amount of money it needs month by month. So, for example, if you know you have a significant investment upcoming, you can start planning for this in good time. It sounds like a traditional banking solution, but as we all know, banks do not work with these companies because they do not fit the bank’s templates. As usual, when you need the money, there is none, and when you do not need any, you will be offered regular credits.
Recall Capital, a Swedish finance firm which helps SMEs find investments on the stock market, has developed a new model which puts companies on control of their current withdrawals and work with the stock market to stimulate more trade.
Björn Wallin of Recall, says: “Given the new challenges of SMEs and thus opportunities for those who meet that challenge, one’s death will be the bread of others. Companies that do not work continuously with the stock market will be replaced by other companies that take the matter seriously.
“There are tools on the market that can be used as support for trade, but real trade arises if the technical trading parameters are also appealing – especially important if you are looking for trade from other countries. The probability that someone in another country translates a report and takes a stand for investment decisions is not very big. However, anyone who deals on a regular basis can look at trade patterns, behaviours and so on, and on the well-wise decision to buy and sell shares primarily with a short and/or medium-term horizon.”
What’s innovative about Recall Capital is that it has built an algorithm generator that continually operates in the market. However, only the companies that subscribe to the algorithm can access it. The purpose is to make appropriate trading parameters attractive and thus attract new traders who both buy and sell shares on a regular basis. This practice will statistically over time lead to increased rates. Ultimately, it will strengthen the company’s ability to use the stock as a tool for continued growth towards its vision.
In the twenty-first century, the field has been cast open. Innovations around investment that Recall offer will lead to significant opportunities for SMEs to scale up.