In a classic Catch-22, many small-cap directors, who may be inexperienced with capital markets themselves, assume their CEO “has the Street stuff covered.” When neither party feels safe to admit that they need to learn more, those assumptions perpetuate, often at the expense of shareholders.
The overwhelming majority of public companies are small-caps, and many of them are never more than one material capital markets misstep away from disappearing. Board members dramatically increase the odds of the same when they perpetuate an erroneous assumption about small-cap CEOs.
Unlike mid- and large-cap companies, small-cap companies (particularly those with market capitalizations below $500 million, or approximately 80 percent of public companies) often require access to capital markets to fund growth objectives, because they aren’t sufficiently cash flow positive to fund those initiatives from within. Moreover, many of those same companies have comparatively illiquid stocks, aren’t covered by high-quality equity research analysts, and confront a daily barrage of potentially existential risks with diminutive governance resources.
If that continuum weren’t challenging enough, many small-cap CEOs are shepherding public companies for the first time. And for those CEOs – intelligence, great judgment, and successful careers notwithstanding – it’s impossible to make up for experience they don’t have.
There is no getting around the fact that scores of small-cap CEOs (and CFOs) have little or no experience interacting with institutional investors, equity research analysts, investment bankers, and investor relations professionals. Said differently, they are capital markets novices – full stop.
Unfortunately, the preponderance of small-cap board members I’ve interacted with during my tenures as an institutional investor and as an advisor to many small-cap boards either expressly or impliedly assume the exact opposite. Perhaps because many small-cap directors are also inexperienced with capital markets, they wrongfully believe that their CEO “has the Street stuff covered.”
The result is two-fold, and 100 percent bad for shareholders.
Board is off limits. When small-cap BoD members systemically telegraph to present/prospective CEOs that they expect CEOs to be capital markets experts, they are unwittingly guaranteeing that most CEOs will never ask board members for capital markets advice (lest they be construed by BoDs as less-than-fulsome leaders). How can it possibly benefit shareholders to advance that kind of communication dysfunction? Good question.
Management team is… also off limits. In conversations over the years with more than 50 CEOs, I always receive a similar response when I ask CEOs: “if you were uncertain about how to approach capital markets scenario ‘A,’ why didn’t you reach out to some of the folks on your team who have more Street experience than you do?” The repeat answer (in so many words) is: “I needed to project capital markets ‘smarts’ in order to get hired, so I was always leery of asking a question amongst my team which might make it clear that I am not quite the capital markets titan I projected.”
Less Assumption, Less Judgement
Long-tenured, small-cap institutional investors meet 100s of CEOs during their careers. When you get to know them well, many CEOs will confide how lonely the job is, because, among other things, there are few people they feel they can ask for help. The result? Unfortunately for them and their shareholders, small-cap CEOs often end up functionally outsourcing critical capital markets decision making to service providers, who themselves have varying degrees of expertise, and plentiful conflicts of interest.
CEOs are, of course, partly to blame for this systemic communications/educative disconnect. But BoDs play an equal if not greater role in perpetuating the same, because a key BoD responsibility is to hire and fire the CEO. If small-cap BoDs continue to either expressly or impliedly assume that CEOs are all capital markets experts, existing/prospective CEOs are invariably going to be predisposed to project the same – whether it’s entirely accurate or not.
The takeaway for small-cap BoDs is clear: when you assume that all CEOs are capital markets experts, you run a material risk of ensuring… the opposite.
The author, Adam J. Epstein, is a former institutional investor, and now an advisor to CEOs and boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. He speaks monthly at corporate governance and investor conferences and has appeared internationally more than 100 times since 2012. Mr. Epstein is a key contributor to Nasdaq’s new Amplify small-cap content initiative, and a distinguished National Association of Corporate Directors (NACD) Board Leadership Fellow, and faculty member. He is the small-cap contributing editor for Directorship magazine, author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies (New York: McGraw-Hill, 2012), and contributing author to The Handbook of Board Governance: A Comprehensive Guide for Public, Private and Not for Profit Board Members (New Jersey: Wiley, 2016). In June 2017, The Perfect Corporate Board was the #1 ranked corporate governance book on Amazon.com, and, in June 2016, The Handbook of Board Governance was the “#1 New Release” in corporate governance on Amazon.com. Connect with Adam on LinkedIn or learn more at https://adamjepstein.com/.