All Dried Up?

Shifts Affecting Small Businesses

According to Kamen, some of the more fundamental shifts that have worked against small businesses include:

The emergence of ECNs. Electronic Communications Networks (ECNs) represent a new, more efficient way for institutional investors to access and trade in the market. And groups like Institnet, Island and Archipelago have captured a substantial portion of the trading that used to be conducted through brokerage firms. The problem with this trend, suggests Kamen, is that ECNs haven't fully reached into the lower tiers of the market, namely the OTC Bulletin Board. "The great technological advancements haven't been implemented in the lower-tier markets," says Kamen. "Therefore, when the only way traders and investors can access these companies is through technology that's totally archaic, they'll cease to support and invest in these small companies."

Tightening of listing standards. Kamen says the tightening of initial and continued listing standards, which was implemented in 1998 for the Nasdaq SmallCap market, has undermined the cause of small issuers. "Increased listing standards for the Small-Cap market had two unfortunate side effects," he says. "First, it meant that many companies could no longer go public, because they wouldn't be large enough to meet the new listing requirements. Second, many companies that were once trading on the SmallCap market got delisted for failing to meet the new standards." There are informed investors who are willing to accept the risks involved with these stocks, but the latter occurence, says Kamen, "was a tragic event for many companies because they were thrown onto the OTC Bulletin Board, a marketplace that reduced their access to a broad base of brokers and institutional investors."

The emergence of for-profit stock markets. This past April, members of the National Association of Securities Dealers (NASD), which owns Nasdaq, voted to spin off the stock market as a for-profit entity. "The idea of a for-profit stock market is a good one," says Kamen, but "how will [it be regulated]? Will the cost of regulation be so high that it drives the brokerage firms which support and fund small companies out of business?" In addition, Kamen says the prospectus detailing the spinoff of the stock market makes the future of the Bulletin Board unclear. "There was only one paragraph that even referred to the Bulletin Board," he says, "which does not bode well for the businesses that are trading there."

The trend toward late trading. Brokerage firms that trade and make markets in Microsoft or Intel can profitably do so 24 hours per day, because the average daily volume is in excess of 30 million shares. But for firms that concentrate on smaller issues, trading perhaps just 50,000 to 100,000 shares per day, or less, a longer trading day means just one thing: longer business hours waiting for business that is unlikely to come. Says Kamen, "The effect of across-the-board longer trading hours will cause the firms which have traditionally supported small business to focus on larger companies, further exacerbating the large company focus in the marketplace."

Efforts to narrow trading spreads. A trading spread is the difference between the bid price of a stock-what buyers are willing to pay-and the ask price-what sellers want for their stock. Large spreads are detrimental to investors because they result in higher prices. Kamen says the securities regulators, such as NASD and the Securities and Exchange Commission, have worked to narrow these spreads through the adoption of new order-handling rules in 1996, and, more recently, with the approval of trading in decimals rather than fractions to allow smaller increments of the spread.

What's behind all this day-trading business? Read "A Trade A Day" to find out what the hype's all about.

"Narrowing spreads is a completely noble motive by securities regulators to protect investors and to make the markets more attractive to capital," says Kamen. "But the trend toward a one-size-fits-all market is a critical error. A company like Oracle with a market capitalization of $240 billion has significantly different trading characteristics than a stock with a market cap of just $35 million." Specifically, Kamen says, if spreads are tightened too much, there's little profit motive for brokerage firms to support and invest in smaller companies. "If you can't make money trading or underwriting small companies, 'Why work with them at all?' has been the attitude adopted by many securities firms," says Kamen.

For companies like Spunky Productions, there's a real risk of getting caught up in the vortex of the changing marketplace. The diminished likelihood of an IPO results in diminished opportunities for private capital. "Unfortunately," says Kronenberger, "we can't control the market or the appetite for investment in companies like ours. It's scary to have a large part of your destiny outside of your control." And although the search for capital continues, there's no sense of urgency just yet.

Still, the forces shaping the market are much larger than any of its constituents. The real force is that if current trends continue, small businesses, the engines of job growth and innovation, will have nowhere to go.

Tiers For Fears

The Over-the-Counter Stock Market is divided into several tiers:

The Nasdaq National Market. This is the trading venue for the largest, most liquid stocks. Among them are Dell Computer, Intel, Microsoft and Yahoo!.

Nasdaq Smallcap market. This market hosts up-and-coming companies, but there are few, if any, household names. Both this and the National Market offer wide distribution of quotes, news and company information. In addition, they offer traders and institutional investors efficient electronic access to companies.

The OTC Bulletin Board. While the Bulletin Board offers electronic distribution of quotes, many investors consider it a lower-tier venue. Many securities professionals, venture capitalists and entrepreneurs feel that the Bulletin Board should be beefed up with the latest technology to provide a state-of-the-art incubator stock market.

The Pink Sheets. At the lowest level of the OTC market are so-called Pink Sheet stocks, so named for the color of the one daily publication that tracks the prices of companies that trade here. There's a limited distribution of electronic quotes, and companies that trade here don't necessarily file financial information with the FCC.

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This article was originally published in the November 2000 print edition of Entrepreneur with the headline: All Dried Up?.

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