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Small Caps

Are you thinking of investing in a small or medium-sized business?

Before you invest, make sure you know all the facts. Take the time to find out about the features, risks and potential return of the company you’re thinking of investing in.

SMBs are generally defined based on annual revenue and number of employees. Companies with up to 500 employees whose annual revenue is less than $50 million are normally considered SMBs.

SMB securities may be listed for trading on a stock exchange.  If that is the case, the SMB will generally be considered a small cap company due to its lower market capitalization (number of outstanding shares multiplied by share price).

Most listings on the TSX Venture Exchange are securities of small cap companies. These companies are often referred to as “emerging” companies. An investment in this type of company is also called a “venture capital” investment.You could earn solid returns with securities listed on the TSX Venture Exchange or with unlisted securities, but there is a greater risk of losing a lot of money, or even your entire investment.

What are the advantages of investing in small and medium-sized companies?

The largest and most prosperous companies were originally SMBs. The growth potential of an emerging company may be greater than that of a mature and well-established company.

Emerging companies are likely to adapt more quickly to new technologies and exploit promising new niches that large companies are not yet interested in.

If you make a well-informed choice, the value of your securities could jump significantly, but there will still be a risk.

Note also that there are tax benefits associated with shares of some small cap companies. For example, shares eligible for the Québec Stock Savings Plan II generate certain tax deductions.

What could be the disadvantages of investing in small and medium-sized companies?

The securities of SMBs are considered high-risk and very volatile investments, as their value could fluctuate considerably. Even if such securities are listed on a stock exchange, they may not be liquid, as the secondary market for such securities is very limited.

Several SMBs do not succeed in marketing their products or services and must therefore rethink or cease their activities. If they become insolvent, they could be compelled to enter into an arrangement with creditors or even go bankrupt.

Plenty of information and analyses are available about large companies. This is not always the case with small cap companies since they generally have less history. Their securities tend to be traded less frequently and are followed less closely by financial analysts. Companies listed on the TSX Venture Exchange must provide financial statements and generally a prospectus when issuing shares for retail investors. However, you will have to spend a lot of time and effort to obtain more information.

The officers and directors of SMBs may have more limited experience than their counterparts at large companies.  The governance mechanisms of emerging companies (how they are managed and controlled) are generally less elaborate.

What is your investor profile?

What is your risk tolerance? If you have little  tolerance for risk, SMB securities are not for you.

Do you have the means to be patient? The marketing of an idea, however good it may be, can take a long time and the road to profitability can be full of detours. If you think you will have to resell your securities in the short term, this type of investment is not suitable for you.

How much time do you have to spend on your investments? If you want to invest in SMBs, you will need to devote time and energy to gathering information.

If you are prepared to take risks and to invest part of your portfolio in an SMB, invest in a company that carries on business in a sector you are familiar with. You will be better able to assess its chances of success.

Before investing ...

Here are some important questions to ask before investing:

  • Does the company have a track record?
  • Did you find reliable information about it?
  • Does the company have any income?
  • Is it profitable?
  • How long has it been in business?
  • What is the profile of the managers of the company?
  • Who are the Board members?
  • What is their background?

You can consult the enterprise register at www.registreentreprises.gouv.qc.ca to find out the names of the directors, officers and principal shareholders of a company that carries on business in Québec. You can also contact the company itself, which can provide you with the name and address of the Board members upon request.

Does the company offer products and services that will be in demand in the coming years? Does it operate in a very competitive sector?

Are the securities you are buying traded on the stock exchange? If not, you may have to keep them for an indefinite period of time. The legal structure of the company could also be more complex. Who are the company’s shareholders? Is there a shareholders’ agreement? What are the features of the issued shares?

How will the company finance its activities? Will it issue other securities? If it does, the value of your investment could be diluted.

Have you read the company’s financial statements? Is it financially sound enough to successfully deliver on its expansion plans? Does it have any cash? Does it have a lot of debts?

If you buy securities without a prospectus, is the distribution exempt from the requirement of preparing a prospectus?

In the case of an arrangement with creditors or in the case of bankruptcy, shareholders’ claims will be paid after the company’s creditors have all been paid. If a company becomes insolvent, it will probably not have enough assets to repay all its creditors so shareholders will very likely lose their entire investment.

 

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