Chances are you’ve never heard of bendamustine, let alone know how to pronounce it (ben-da-MUST-een). It’s used to treat leukemia and lymphomas and the company that makes it, Eagle Pharmaceuticals (ticker: EGRX), has just 35 employees — enough to fit into a coat closet at Eli Lilly & Co (LLY).
So Eagle is a no-brainer: a small company with small potential, right? Guess again — stock in this tiny New Jersey outfit has shot up more than five times in 2015, with bullish analysts at Piper Jaffray setting a lofty price target of $120.
In the informal parlance of the trading pits, this stock is red hot.
For starters, Eagle entered into an exclusive licensing agreement in February with Teva Pharmaceutical Industries (TEVA) for its injectable drug. And even if demand levels off, there’s more to come. “Eagle is not just a one-drug company,” says Tim Lugo, an analyst with William Blair & Co. in Chicago. “They will have significant launches in 2016 that should drive pretty meaningful earnings.”
So small companies, it turns out, can be big money machines for investors — even if the task of locating winners equates to finding a golden needle in a mountain-sized haystack. “Investing in small businesses takes courage and is not for the faint of heart,” says Ben Walter, CEO of Hiscox USA, a specialist insurance firm in New York. That said, Walter says that a Hiscox survey of entrepreneurs showed 72 percent of small businesses surveyed reported revenue growth in the past year. “Small businesses are an untapped opportunity for most investors.”
And the JOBS Act (an acronym for Jumpstart Our Business Startups) that was signed into law in 2012 creates an attractive avenue for investors to back such ventures via crowdfunding — but with the same potential volatility. “The JOBS Act should open new investment opportunities for everyday Americans,” says Candace Klein, chief strategy officer at Dealstruck, an online direct lender. “But underwriting and risk assessment will be extremely important, as the typical crowd investor will lack the expertise to understand the risk associated with their investments.”
To some extent, investors will find protection with new Securities and Exchange Commission rules that govern online investment. Meanwhile, small businesses going public can attract investors who fall outside the “accredited” realm. To be accredited — that is, having special status under financial regulation laws — an investor must earn $200,000 a year and have a net worth of at least $1 million.
“It’s exciting news, in part because small businesses are likely to further increase access for investors that were previously prohibited because they didn’t have the income or assets,” says Blaine McLaughlin, vice president of business development and sales at Folio Institutional in McLean, Virginia. “This is a great time for investors and growing companies to more easily find each other and work together.”
The entrepreneurial spirit. On the entrepreneurial side, the investment paradigm often gets turned on its head so far as Wall Street is concerned — with some people emptying their portfolios rather than padding them.
David Nilssen, CEO and co-founder of Guidant Financial, a small business financing company in Bellevue, Washington, relates how Eric Schneider grew tired of the corporate world of commercial insurance, where he held nose to the grindstone for 25 years. His wife was equally restless, and so they opened Headrush Roasters Coffee & Tea, headquartered in Kansas City, Missouri.
“The couple used a rollover process to fund the business — and business is booming.” Nilssen says. The cash is rolling in, but there’s another return that’s even more important. “They couldn’t be happier working for themselves.”
And sometimes the returns are off the charts. “Many of our biggest companies today were started out of a garage, dorm room or basement,” says Kevin O’Neill, a financial professional with the MetLife Premier Client Group. Think Wall Street giants Apple (AAPL) or Hewlett-Packard Co. (HPQ), for example.
Look for new sectors. While you can find strong contenders in any sector, the search often boils down to new sectors where the growth has astronomical potential.
One such example is the cannabis industry, poised to take off as more states legalize recreational marijuana use. “The legal cannabis industry provides an unprecedented opportunity for both entrepreneurs and investors,” says Leslie Bocskor, an investment banker in the marijuana trade. It’s also largely absent of king-sized competitors due to its complex regulatory framework. “Many traditional companies, such as those found in the tobacco, alcohol, retail, big agriculture and other traditional industries, are hesitant to enter.”
And this condition often proves the litmus test by which small businesses sink or swim — one that traditional investors too often miss. “Good small companies can fail because they are unable to scale, they’re more vulnerable to economic changes or can get squashed by bigger companies that move into the sector,” says Phillip Rooke, CEO of Spreadshirt, an e-commerce platform.
Rooke should know: Spreadshirt scaled from a small business in 2009 to mid-sized by filling a niche that the mighty Amazon.com (AMZN) has yet to pursue: on-demand printing of clothing and accessories. But he’d also be the first to tell you “investing is betting, you can win or lose.”
“As with any investment, there are always risks,” Nilssen says. “We finance small businesses all over the country and it’s not uncommon for people to underestimate their costs and overestimate their projections. That will dictate their capital request, which can then hamstring their ability to succeed long-term.”
That raises a crucial point for investors: So much as the potential return on investment, market capitalization or quarterly earnings, the one variable that can really drive a small business is human capital.
“Typically, when investing in a small business, an investor is really betting on a person or small team of people as much or more than anything else,” says Dr. Bruce Irwin of Birmingham, Alabama. Irwin invested in a small business — the Doctors Express urgent care franchise — in April 2013. Irwin now has 87 small business owners, the franchisees, working under him.
“When you’re dealing with a smaller team, you can interact with people on a one-to-one basis,” he says. “Not only does this give the investor greater ability to understand the business on a day-to-day basis, but that kind of access also means you can make a real difference by providing valuable input that can help the business grow.”
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Think Small for Big Returns From the Stock Market originally appeared on usnews.com
