Life Cycles of Companies...Young Growth Companies (Micro Caps)

Life Cycles of Companies...Young Growth Companies (Micro Caps)

Young growth companies usually range from start-up companies with little revenue and no earnings that are testing out the market for their products and second-stage companies that are moving on to profitability.

Most young growth companies tend to be privately owned and funded by their founder/owner who are usually backed by venture capitalists.

When these companies go public, they offer investors great profits if their potential is realized, but in turn present great risks as there is little operating history to go by. Expenses are associated with getting the business established, rather than generating revenues so they are usually operating at a loss. Many don’t make it and fail but the chance of  establishing a position early provides potential for great profit if the company takes off. An additional problem is the trading illiquidity of their stock as there is usually few number of shares traded (small float).

Further uncertainties revolve around lack of revenue growth, missing target margins and the risk of key people leaving.  

To offset these risks investors should insist upon the following characteristics...

The company should be aiming for a large and growing  market to absorb their projected revenue growth. 

Profit margin targets should be met so that expenses can be contained. 

Access to capital is critical for these young firms so they should have large cash balances as well as some institutional sponsorship. 

Since key individuals and founders are critical to the success of the firm, there should be a solid bench to back up key personnel.

Finally the enterprise should have products that are difficult to replicate wheather that be through technology, patents or brand name marketing



Resources

The Little Book of Valuation

Aswath Damodaran