Small cap private equity firms do not issue shares to the public whereas public small cap companies do. The definition of "small cap" varies from country to country; a small cap company in the United States might be equivalent to a medium cap in another country. Long-term speculators hunt for small caps that are poised for growth or possible buyouts from bigger companies, which can dramatically raise equity value. Benchmarks that define small cap public companies and small cap private equity firms fluctuate with economic changes.
Small cap private equity firms have funding between $10 million and $25 million. Equity firms are difficult to research because they are not required to report earnings to the public. Investments in private equity are made by financial institutions such as venture capitalists, which may own, fund and manage multiple businesses. Funding can also come from pension funds and universities. One of the attractions to this type of financial instrument is that it adds long-term diversity to a portfolio.
Small cap public companies usually have a capitalization between $500 million and $1 billion. Small cap public company stocks that trade under the $5 per share benchmark are called "penny stocks," although not all small caps are penny stocks and not all penny stocks can be categorized by small capitalization. Many penny stocks reflect financially struggling companies emerging from or headed for bankruptcy. Penny stocks do not face the same Securities and Exchange Commission reporting requirements as large cap stocks, making them difficult to research. Small cap companies can be pioneers of new industries as well as laggards or former leaders in established industries
Liquidity is difficult to manage in thinly traded small cap public companies because sellers of shares cannot always be matched with buyers. When a stock has zero volume it means there is no trading activity among investors and could mean that buyers and sellers cannot agree on share prices, which can lock a holder into a position indefinitely. Illiquidity is also a risk factor with private equity, whose valuations are often uncertain. Private equity investments usually involve long term fixed agreements by limited partners. Many times private equity companies are financed to be upgraded and sold to bigger companies.
Both private and public small cap equities are considered speculative investments that encompass a degree of risk. For many decades, both small cap stocks and private equity investments have generated annual returns of about 14 percent, with small cap stocks having a slight edge, notes Bruce Grantier in a 2009 Brandes Institute report. Since the Great Depression, small cap stocks have also slightly outperformed large cap stocks. The main risk with both equity investments is that earnings performance may not meet expectations among financial analysts, which can have adverse effects on share prices. Lack of public financial information also adds risk to both investment instruments.