Palm Beach Attorney Laura Anthony Answers the Question What Makes a Company "Small"?

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May 14, 2019, 06:33 ET

WEST PALM BEACH, Florida, May 14, 2019 /PRNewswire/ -- Small is a relative term. In order to accurately categorize a business entity using size as the only standard, it must either be compared to another entity or measured according to a set of well-defined criteria; simple enough.

Comparing companies in the under $300 million market cap class is inevitably an apples to oranges scenario; a dead end. Option two would indeed yield an accurate valuation but the standardized criteria needed does not currently exist.

A public company with less than a $300 million market cap could be considered a micro-cap company, a penny stock, unless their share price is over five dollars, a lower middle market company or even middle market. Investopedia defines "lower middle market" as "the lower end of the middle market segment of the economy, as measured in terms of annual revenue of the firms. Firms with an annual revenue in the range of $5 million to $50 million are grouped under the lower middle market category."

Wikipedia defines "middle market" as "companies larger than small businesses but smaller than big businesses that account for the middle third of the U.S. economy's revenue. Each of these companies earns an annual revenue of between $100 million and $3 billion". In a speech to the Greater Cleveland Middle Market Forum, SEC Commissioner Robert J. Jackson, Jr. defined a middle market company as those with trailing twelve-month sales of $50 million to $1 billion.

Bank of America, and their brokerage, Merrill Lynch, will not transact business in the securities of companies with less than a $300 million market cap and less than a $5.00-per-share stock price. Moreover, even if the stock price is above $5.00, such transactions or requested trades will face increased scrutiny and may not be processed right away. Bank of America clearly thinks that under $300 million is a micro-cap company.

References to market cap and revenue are used and misused, creating even more confusion. For example, the SEC rules define a smaller reporting company or SRC as one with less than a $250 million public float or if the company does not have an ascertainable public float or has a public float of less than $700 million, an SRC will be one with less than $100 million in annual revenues during its most recently completed fiscal year.

Should one initiate a Google search for the terms micro-cap, small-cap, lower middle market and middle market, numerous conflicting definitions are generated, all of which reference a company's revenues and market cap while applying different thresholds to determine which are small and which are not.

Last summer the Investor Responsibility Research Center Institute, or IRRC, published a report titled "Microcap Board Governance" providing some interesting data on public companies with less than $300 million in market capitalization.

Nasdaq and NYSE American

Since most companies with less than $300 million market cap are not included in any major indices nor receive widespread analyst coverage, there is less aggregated information on their board composition and governance practices. A recent IRRC Report examined 160 companies representing approximately 10% of this company class that are traded on U.S. stock exchanges.

Seventy-three percent of those companies trade on the NASDAQ, and the balance are on the NYSE or NYSE American. Of the 160 companies, three-quarters have been public for more than 5 years, illustrating that not all small public companies are early-stage growth companies. Only 14% of the companies were still led by their founder. Although the IRRC report didn't address the reasons or meaning behind these numbers, they seem to hold water in the overall corporate ecosystem.

Very few companies will successfully grow to large-cap entities, nor should they. High-growth models come with great risk and can often lead to a total business failure. For instance, a company that goes public with a $50 million market cap and then grows 10%-20% year over year would still be in the under the $300 million market cap class in five years, but also will likely have strong infrastructure and internal controls and provide steady growth to its investors, rather than a high-risk, faster growing entity.

The majority of the companies are in industry sectors that lend themselves to either slow growth or have seen dramatic industry change over the last decade. Thirty percent of the companies were in the healthcare sector, which notoriously has a very long research and development, pre-revenue lifecycle. Finance companies comprised another 18%, which sector has transformed post-Dodd-Frank, which was enacted in only 2010. Rounding out the industries were consumer goods and services for 15%, energy and utilities with 11%, basic industries and transportation comprise 10%, capital goods 9% and technology 7%.

More than half of the companies went public in the first ten years of their founding. Although private equity has become more readily available for some companies (technology companies in particular), thus postponing a public offering, in my experience, smaller companies have more opportunity to access capital through public markets than private sources.

Considering these facts, a logical case can be made that small companies are particularly suited for the public markets and well-deserving of the corresponding benefits they provide. Small companies tend to be more innovative than their larger counterparts and also account for a substantial percentage of new jobs created every year.

Public markets provide small companies with an opportunity to recoup some or all early-stage investments, incentivize employees through stock options and grants, increase their economic exposure, grow through acquisitions using stock as currency and, of course, provide enhanced access to capital that can be dedicated towards the company's continued growth.

Attorney Laura Anthony

Laura Anthony, Esq. is the founding partner of Anthony, L.G., PLLC, a national corporate, securities and business transactions law firm. For more than two decades Ms. Anthony has focused her law practice on small and mid-cap private and public companies, capital markets, NASDAQ, NYSE American, the OTC markets, going public transactions, mergers and acquisitions, registered public and exempt private offerings and corporate finance transactions. ALG has represented in excess of 200 companies in reverse merger, initial public offering and direct public offering transactions. Palm Beach Attorney Laura Anthony is also the creator and author of SecuritiesLawBlog.com, the host of LawCast™, Corporate Finance in Focus and a contributor to The Huffington Post and Law360.