All Dried Up?
This story appears in the November 2000 issue of Entrepreneur. Subscribe »
Spunky Productions is about as much on the leading edge as a business can get. As a digital media company, the San Francisco firm is producing and syndicating what co-founder Karl Kronenberger, 32, calls one of the largest collections of original Web-based interactive cartoons and live-action programs for children in the world.
Plus, Spunky Productions is at the crossroads of one of the hottest trends in Hollywood: the distribution of entertainment content over the Internet. According to Kronenberger, "Many international media companies who can't own cable or television assets in the United States see the Internet as a viable distribution channel for entering the U.S. market." Moreover, he says, the entertainment industry will be in for another radical redefinition when the next generation of wireless Internet products come to market during the latter half of 2001.
The incredible opportunities that companies like Spunky
Productions are pursuing require more than just creative genius and
an audience, however. They require capital, and lots of it. And
growth capital is getting harder to find, because investors are
getting much more cautious. A sell-off of Internet stocks
notwithstanding, the reasons for this change are more systemic and,
in fact, threaten the longest-running economic expansion in U.S.
history.
David R. Evanson's newest book about raising capital is called Where to Go When the Bank Says No: Alternatives for Financing Your Business (Bloomberg Press). Call (800) 233-4830 for ordering information. Art Beroff, a principal of Beroff Associates in Howard Beach, New York, helps companies raise capital and go public, and is a member of the National Advisory Committee for the SBA.
Market Fissures
Investment banker Kenneth Kamen, co-founder of Princeton, New Jersey-based Princeton Securities Corp. and chair of the trade group Regional Investment Bankers Association (RIBA), suggests the culprit for this ominous prediction is, surprisingly, the stock market itself. Specifically, he says, the markets are evolving and changing in ways that are tremendous for large companies and institutional investors but disastrous for small companies looking for capital, like Spunky Productions.
Based on this evolution, Kamen posits the following scenario as potentially very dangerous to the economic prosperity of the country. More precisely, as the markets get regulated into a posture that emphasizes large companies over small ones, the appetite for IPOs dries up. Venture capital investors and angel investors, seeing their exit strategies disappearing, pull in their horns and dramatically reduce the number and dollar amounts of investments they make in promising entrepreneurial businesses. Suddenly, the volume of venture capital tumbles from 1999's volume of some $50 billion to the $5 billion that the National Venture Capital Association says was more typical in the early '90s.
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 Where
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In many ways, the fissure has already begun. Consider these statistics: RIBA, which consists of investment banking firms that focus on IPOs of $20 million or less, has seen the number of deals completed by its members fall off dramatically as the markets have focused on larger companies. For instance, during 1994, association members completed 190 offerings and raised $2.3 billion. In 1999, the number was 38 offerings for $228 million. But the numbers provided by RIBA aren't the final word. After all, not every investment banker who provides services to small businesses is a member of the association. Yet, as a proxy for overall market activity, the trend they indicate is clear: The stock markets are less receptive to small businesses. Says Kamen, "It's not the investment bankers who are suffering from this decline, it's the companies looking for capital." history.
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.
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| What's behind all this day-trading business? Read
"A
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"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.
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| Tiers For Fears The Over-the-Counter Stock Market is divided into several tiers:
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The Nasdaq National Market.
This is the trading venue for the largest, most liquid stocks.
Among them are Dell Computer, Intel, Microsoft and
Yahoo!.
Contact Sources
- Princeton Securities, (843) 577-2000
- Spunky Productions, k@spunkyproductions.com, www.spunkyproductions.com
