Beyond the Knockout Punch: Why Microcaps Struggle with Business Diversification

During their recent episode, Taylor, Carlisle, and Claremon discussed Beyond the Knockout Punch: Why Microcaps Struggle with Business Diversification, here’s an excerpt from the episode:

The other place where companies struggle is what I would call small company problems. What really hurts these companies is things that like single product, like lack of diversity of products, lack of diversity of customers. A lot of these companies have customer concentration. Lack of diversity of end markets or regions. They’re selling regionally or they’re not selling globally.

I always talk about this. small companies have trouble taking punches. So, you’re a public company, things are going to happen to you. Either it’s going to be a COVID, it’s going to be a March of 2009, its somethings going to happen. The problem with small companies, when you have small company problems and customer concentration and market concentration, all of those things, is that a punch can knock you out. A big company like Honeywell, they can take plenty of punches. Honeywell is still going to be around, because it’s got breadth and depth and diversification. Small companies don’t have that. If you have a management team who doesn’t deeply understand capital allocation and has that, like, whatever they take a punch, sometimes it can be the knockout.

And so, I think that ability to grow and diversify your customer base, diversify your revenue base, make sure that you are not too dependent on single lines of businesses, that is where companies often fall down, because the management teams are so consumed with trying to grow what’s there and trying to maintain what’s there, that they don’t have the bandwidth and the time to really think strategically and operationally about how to become more resilient.

Look, bigger companies, when there’s a downturn, guess what they do? They buy up all the little competitors. Small companies that don’t have access to capital when there’s a downturn, even if they’re operating well, they don’t get to go on offense. They always are playing defense. And so, putting one of those companies in the hands of a private equity firm, any private equity firm who has access to capital and who have LPs that want to continue funding this business, just gives you so many more options.

One, the punch you take is probably not a knockout, because you have the capital base to support you. But secondly, when you take that punch, and everyone’s taking a punch in the industry, you might have access to capital to go on offense, whatever. Anything can go right or wrong for companies. But the capital allocation and then just the structural issue of being a small company is really where you, I think, often seek permanent capital impairment in these companies.

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