Wall Street Economics is Bad for Innovation
March 23, 2010
By Josh Levine
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The institutionalization of finance has been good for Wall Street power brokers, enabling them to concentrate control and profits. But it has done absolutely nothing to improve the environment for small innovative companies seeking to raise $5 million, $20 million, or $50 million. In fact, it has sucked capital away from emerging growth firms and into a mundane mosaic of investments – everything from securitized mortgages to ETFs of every stripe.
The matra of "bigger is better" means investment bankers, hedge funds, venture capitalists and others can earn bigger fees, but it creates a huge vacuum in the system. Too much risk (and intellectual) capital is being channeled into casino-like trading and a range of investment gimmicks rather than serving growth companies and research and development.
The model for funding small innovative firms has been broken for many years, and the economic and opportunity costs are killing us.
Until a better system emerges, many of the most challenging economic problems faced by the United States, including terminal unemployment, decline in leadership of innovation-driven markets, and shrinking capital markets for emerging growth companies, may never be fully reversed.
One of the most effective ways to improve the situation is by changing the incentive system for financing small technology companies.
As two senior advisors at Grant Thornton -- Edward Kim and David Weild -- correctly point out, markets have become inhospitable to smaller private companies looking to raise less than $50 million.
CFO magazine, reporting on their recent testimony for a U.S. congressional subcommittee, says:
"The main cause, as they see it, is lower trading fees, stemming first from online brokerages and new order-handling rules in the late 1990s, and then from decimalization, Sarbanes-Oxley, and the global research analyst settlement separating research from banking. Given the lower fees, it no longer makes economic sense for investment banks to support small-company IPOs with capital and research. Kim says that small companies 'are not a product anymore; they're just food for Goldman Sachs's real clients'— hedge funds looking for quick gains through IPOs…"
Without a major revision of the economic incentives for funding and supporting small companies, we're stuck with a busted system for financing innovation. And while the passage of the Small Company Capital Formation Act of 2011 (a bill that would increase the amount of money companies can raise in the public markets through Reg A transactions from $5 million to $50 million) would help the situation, it will fall far short of what's really needed.
According to Kim, raising the limit to $50 million "would be a positive step that would reduce some red tape, and one that I think Congress will pass, but it's just one step of many that would be needed. I truly believe that without a completely different market model, we won't fix the problems."
Clearly, there is no simple cure for what ails innovation financing. While a new Reg A limit would at least be a first step towards improving market conditions for the companies that have the potential to transform the U.S. economy, there's much more that can, and should, be done.
In an upcoming entry for Functional Inspiration, I will explore some initiatives that could create better opportunities for smaller companies to access capital and accelerate the development of emerging technologies into the marketplace.
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MicroCap Investor delves deep into the world of small stocks to identify big winners. Levine targets innovative companies on the path of the new and revolutionary, developing technologies that disrupt entrenched markets to create tremendous value.
About Josh Levine and Levine's MicroCap Investorwww.levinesmicrocapinvestor.com
Josh Levine has 25 years of senior-level experience in analyzing technology trends and investing in top-performing micro- and small-cap stocks. He excels at assessing management teams and evaluating new innovations and their impact on corporate valuations.
In 2002 he joined independent investment-research boutique ChangeWave Research, where he was editor of ChangeWave MicroCap Investor since 2004, becoming Levine's MicroCap Investor in 2010. He has been editor of the flagship ChangeWave Investing since 2007.
Levine is also senior analyst for ChangeWave Research. Through its survey network comprised of 25,000 members, ChangeWave tracks the rate of change in corporate and consumer demand trends and provides the results through an institutional research subscription service. Its macroeconomic research is among the best on Wall Street.
More on Levine's bio: http://www.levinesmicrocapinvestor.com/aboutus/
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