Are they worth the risk?

This is a question of facts and circumstances. Sometimes an acquisition is the right strategic choice, and other times this would be the wrong move. Chapter 9 of this book, on postmerger integration, discusses postmerger returns, based on the latest research.

To begin with, let’s consider the clearly positive case of one small company buying another in an emerging industry. Few would criticize Alteryx’s 2021 decision to acquire Lore as a kind of “acqui-hire” in its rollup of companies in the cloud-centric engineering space.

This said, it is notable that acquisitions are particularly risky for small-cap firms in public markets because of the chain of events that may occur if shareholders do not agree with the deal. Whereas companies with a vast number of holders can weather a shareholder revolt over an unpopular deal, a small-cap company cannot.

• First, if investors sell the company’s stock, short it, or simply don’t trade it at all, stock price and/or volume might suffer, making any attempts to access the equity capital markets more dilutive. In the worst-case scenario, it could all but foreclose access to the equity markets.
   
• Second, if trading volume dries up, the company also won’t be able to use its stock as acquisition currency; that is, high-quality companies won’t want illiquid stock as purchase consideration.
   
• Third, high-quality, sell-side research firms have seen the same small-cap M&A “movies” that fund managers have, so the chance of getting impactful research is going to be diminished.
   
• And, fourth, but certainly not least important, many small-cap officers and directors underestimate how much a pressured/languishing stock can impact employee recruitment, retention, and morale.