Small IPOs Buck Trends In An Otherwise Cold Market

By Tom Zanki

Law360 (August 24, 2022, 6:38 PM EDT) — While the initial public offerings market remains largely frozen for big-name companies, a steady supply of smaller IPOs are defying the doldrums this summer, generating work for capital markets lawyers who specialize in so-called micro-cap offerings.

The term micro-cap IPO generally applies to companies with market capitalizations of $50 million to $300 million. According to research firm Renaissance Capital, 34 micro-cap offerings have been completed in 2022, representing 64% of all IPOs.

Experts note that several factors are enabling such deals to get done despite an otherwise harsh market. One is simplicity. Most micro-cap IPOs raise no more than $20 million, a less-daunting task than a typical IPO that nets at least $100 million — or sometimes more than $1 billion — from a larger investor base. And smaller offerings may include investor-friendly terms, such as warrants, that help get them across the finish line.

“This is definitely a phenomenon,” said Olshan Frome Wolosky LLP partner Spencer Feldman, whose firm is representing the underwriters of a planned $10 million IPO for Shuttle Pharmaceuticals Holdings Inc., an early stage company developing drugs to improve radiation therapy. “We are getting a lot of work doing smaller deals.”

Sichenzia Ross Ference LLP partner Greg Sichenzia said it’s been a busy summer as well for his firm, which steered underwriters for electric boat developer Forza X1 Inc.’s $15 million IPO. A brief summer stock market rally may have helped spur momentum for offerings, Sichenzia said, plus many investors have cash ready to deploy.

“There’s a lot of money on the sidelines,” Sichenzia said. “And some of the terms are a little more investor-friendly than you’ll get in the big-cap space.”

Smaller issuers also tend to have urgent funding needs, especially pre-revenue biotechnology startups that are developing new medicines. Feldman added that smaller companies often conduct pre-IPO bridge financings, or interim financing arrangements that are predicated on going public, and want to tap public markets sooner rather than later.

“With time and expense invested to date, and the fact that public companies get a premium in value to private companies, they are still pushing ahead,” Feldman said.

Feldman also pointed out that these offerings are often underwritten by smaller investment banks that are eager for business and less deterred by market volatility.

Bigger companies and the well-known investment banks that underwrite large offerings have been quiet thanks to choppy market conditions in 2022, contributing to an 80% drop in total IPOs year to date, according to Renaissance Capital. Among 15 IPOs completed since July 1, only one raised more than $40 million.

Matthew Kennedy, a senior strategist at Renaissance Capital, noted that large businesses often can afford to wait longer before going public because they can turn to venture capital or private equity backers for funding.

“Smaller companies often do not have that option,” said Kennedy, whose firm provides pre-IPO research and manages IPO-focused exchange-traded funds.

While companies that pursue small IPOs may satisfy their immediate funding needs, investors don’t always fare well, as evidenced by wild price swings that followed several recent IPOs, some of which debuted strongly only to plunge afterward.

Shares of eight companies that went public since July 1 have fallen by margins of 10% to 50% from their IPO price, according to Renaissance Capital. Kennedy noted that offerings with a relatively low number of shares are susceptible to “momentum trading,” such that the average first-day gains for micro-cap IPOs is 236% in 2022.

On Tuesday, Malaysian payment app Starbox Group Holdings Ltd. saw shares soar 285% to close at $15.40, up from a $4 offer price, in debut trading following its $20 million IPO. Yet shares of Starbox fell more than 30% to $10.70 on Wednesday.

University of Florida professor Jay Ritter, who studies initial public offerings, noted that micro-cap IPOs attract higher percentages of individual investors compared with large IPOs, which cater to fund managers and other professionals.

By Ritter’s estimation, the number of micro-cap IPOs is about the same as last year, but represents a bigger percentage of IPOs since larger offerings have collapsed. He doesn’t see much relationship between micro-cap offerings and the wider IPO market.

“The willingness of unsophisticated retail investors to overpay for these micro-cap IPOs has little relevance for the institutional investors that buy larger IPOs, which are typically underwritten by the major underwriters,” Ritter said.

To ease investor concerns, some small issuers offer warrants in their IPOs. Warrants are essentially sweeteners that provide investors the right to purchase additional shares at a fixed price within a given time, usually at or near the IPO price. This option can appeal to investors if the company’s actual stock price soars above the warrant price.

The exercise of warrants raises additional capital for the company since new shares are created. But warrants also dilute a company’s equity and are typically not included in larger IPOs, which often attract enough demand that such incentives are unnecessary.

While the prospects for a broader IPO recovery are unclear — total filings are down 71% this year compared with 2021 — it appears that more small companies are lining up for public listings. Sichenzia’s firm is also representing Australian distiller Innovation Beverage Group Ltd., which filed for a $20 million U.S. IPO last week.

“And it feels like there is more in the hopper,” Sichenzia said.

–Editing by Kelly Duncan and Emily Kokoll.


Tom Zanki

Senior Reporter, Capital Markets