Why Your Company's Valuation Doesn't Matter Without Liquidity

As an Investor that gets pitched multiple times a day, the main mistake I see is public companies trying to raise capital at a valuation that has no liquidity to accompany it.

Almost everyday, I speak with at least one publicly traded company that is attempting to raise equity capital at a valuation based off their current market capitalization with almost little to no liquidity in their stock price. A company’s valuation can not be properly utilized unless there is an active market of buyers and sellers to determine how the public views the company and its underlying fundamentals. Going out to market and using your illiquid valuation as a tool to raise capital will dissuade investors from allocating their capital to your equity round.

From an investor’s point of view, the biggest hesitation I would have with investing in a company who’s stock price is illiquid would be the inability to enter at the proper valuation relative to the financials and business model. Alongside that, I'll constantly be worried that I won't be able to liquidate out of my position when needed at an execution price that makes sense. For example, if a company has a $60 million market cap, stock price of $1.00, average daily trading volume of $10,000, a $.30 wide bid-ask spread, and is looking to raise $5 million in a private placement at a $50 million valuation, I along with most other investors would completely ignore the proposed valuation due to the company's lack of volume and rather base it off the financials in order find a true valuation that can be stomached. Growth companies that are pre-revenue or don’t have substantial financials are even worse off in this situation as most investors don’t have anything to value the company off of besides their stock price and current market cap.

Along with that, most institutional investors that buy in the open market usually won’t be interested in your stock unless there is volume. As a public company, you want to put yourself in the best situation for institutional investors to consider buying in the open market as that is reflected as a positive sign to current and future shareholders. That, however, can’t be done unless there is enough liquidity.

As you can see, liquidity for a public company is extremely important when going out to raise capital from investors. But one main question still stands: how do you bring liquidity to your company’s stock?

Here are 2 ways to increase the liquidity and volume in your company’s public market:

  1. Investor Relations (IR) Program: Having a dedicated IR team or program will help improve your liquidity by issuing press releases regarding the company's progress, sparking interest amongst retail investors, and showcasing your value at various investor conferences. Some IR firms will also offer or introduce you to other firms that will publish periodic research reports covering your company and will distribute it to other investors. Although this won't fix your problem overnight, it will slowly bring interested buyers and sellers into your market and increase your average daily trading volume.

2. ATM/Equity Line: An ATM (at-the-market offering) is a tool whereby a broker-dealer, acting as an agent, is appointed by the company to sell newly issued registered securities into the trading market at the current prevailing prices. An Equity Line, similar to an ATM, is an agreement between the company and an investor that gives the company the ability to periodically sell newly issued registered securities to the investor at a pre-determined formula that is tied to the prevailing market price at the time of each issuance. While an entire blog post can be dedicated to discussing this form of raising capital and its benefits, the key thing to understand here is that the selling that arises from either the agent or investor can be beneficial to creating volume in your company’s market. This selling will assist in creating an active market that brings in more buyers and sellers. It is important to note that the amount of shares issued under either method should be done so in a responsible manner on the company’s side. For example, if your average daily trading volume is $10,000, it is much smarter to issue $50,000 worth of shares rather than $500,000 as you should expect a portion of those shares to be sold into the market over a short period of time.

Overall, every public company should keep in mind its liquidity and volume when going out to raise equity capital from investors. Although you might be able to raise small sums of capital here and there, it will be tough to raise substantial capital at a valuation that makes sense if your stock doesn't have the volume to support it.

This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.