The circus of wall street seems a far-ways away from most small business concerns – but are you aware of how this stewing financial crisis may affect your business? As a fractional CFO, my job is to manage business risks and advise CEO’s of potential problems. To me, the chaos on wall street driven by WSB is the most dangerous risk since Covid-19. Here’s why.
Why WSB Has Been Successful with Gamestop (GME)
Institutional investors are not prepared to deal with a flash-mob of Wall Street Bets (WSB) on the trading floor. In fact, the highly automated algorithmic market makers and hedge funds have found their formulas turned against them. This happens through a combination of short squeezes and gamma squeezes.
This has been a remarkably successful strategy for WSB: one user claims to have made over $11 million dollars. The price of GME stock speaks for itself – as of Wednesday it had outperformed nearly every stock year-to-date at 1900%+ gains.
Who is losing money due to WSB?
For every winner on Wall Street, there is a loser. Who is losing? The financial markets are complex, and nobody has a complete picture about what’s happening yet. But here’s the losers we know of:
Hedge Fund Short Squeeze
WSB has intentionally targeted companies who publicly announce their short position on stocks, such as Andrew Left at Citron Research. By creating a short squeeze, short-sellers like Citron have been forced to cover or exit positions altogether, consuming their capital.
Market Maker Gamma Squeeze
The market makers that sold the call options are finding themselves in situations their formulas were not designed to handle. As a result of the gamma squeeze, they may find themselves holding highly over-valued shares of stock or paying cash to de-risk their portfolio. Even the brokers themselves are finding themselves in tight credit situations, as Robinhood was forced to raise one billion dollars to stay afloat.
Given the general recklessness with which they invest, there are likely some WSB members who have lost money in the game. Those members are not as forthcoming with their results on Redditt, but probabilistically there is must be a significant amount. Especially…
The guy left holding the bag
Everyone including the WSB retail bros knows this party will not last, and the last person left holding GME stock will be the biggest loser. That’s the nature of an asset bubble – the early investors profit big, and the late investors incur the losses. The question is: when do you get out? On the one hand, FOMO makes investors want to ride out future price increases; on the other, they are playing a game of chicken with everyone else on WSB.
The Broader Financial Markets
All this uncertainty is causing investors to rein in capital to either lower risk or due to contractual obligations (such as the case of the short sellers and market makers.) This is often done by selling equities, thus spreading the losses to the broader market and driving down the value of all investments. This is the same effect we saw in 2008 when the collapse of the mortgage security market affected all financial markets.
The Threat of Retail Bros to the Financial System
So what if a handful of guys is getting the best out of hedge funds? Why should a small business owner care? Pretending that small businesses cannot be affected by wall street is like saying you cannot catch Covid-19 because you do not eat bats in China.
Financial markets are connected, so I am concerned about WSB creating a financial crisis. A financial crisis is like a mega-recession. Most recessions are mild because they only affect one industry – think 2001 dot-com bust, which mainly hit the tech industry. A financial crisis is when a bubble bursts in the financial sector, which is tied to EVERY industry. This is what happened in 2008 with housing derivatives and 1929 with margin equities. When a financial crisis hits, capital freezes up and no business is left untouched.
Could the WSB bros create a financial crisis? A Bro-pocolypse? Maybe. I think the probability is low, but in the slim chance that happens, the impact would be especially hard on small businesses.
If the markets are unable to adapt to the WSB coordinated market manipulation, a liquidity crisis could quick precipitate resulting in widespread freeze of capital, just like in 2008. Credit becomes scarce and the damage spares no one; however, a capital freeze especially deadly for small businesses who have trouble accessing capital even in the good times.
How Small Business Owners Should Prepare for the Retail Bro-pocolypse
As a CFO, my job is to allocate business resources to manage risk and returns for stakeholders. Right now there is a significant risk in the capital markets, so I’m willing to sacrifice some returns in order to de-risk the business. If you want to de-risk your small business, here’s some precautionary steps to take:
Update Your Forecast
Run a business forecast to understand how dependent your company is on debt or equity capital. If you have lots of cash even in a downside scenario, you will likely be ok. But if your business requires an equity investment round in the next 12 months or you rely on cyclical debt to finance working capital, you are exposed in a financial crisis.
The next 2 months is not a good time to invest heavily in growth. Trim your plans to save capital. That might mean delaying the purchase of new machinery, reducing advertising spend, or delaying hiring new headcount.
In a financial crisis, nobody is willing to issue loans. Make sure you setup a debt facility setup now, such as a business line of credit or a HELOC. These facilities exist for a year or more and renew periodically, so you’ll be guaranteed cash available if a crisis ensues.
If you were planning to raise equity investment in March or April, you should consider accelerating that timeline in. Closing a round even a day or two before a financial crisis ensues could be the difference between success and failure.
Plan With Your Advisors
Take the time to discuss contingency plans with your CFO or financial advisor. Work with them to understand your capital position and potential vulnerabilities. By discussing options in advance, you will know how to react when a crisis begins.
Keep Your Ear to the Ground
The signs of the 2008 financial crisis began in 2007, but most didn’t realize what was happening until almost 10 months later. Keep reading the articles about WSB and GME, keep your eye on indicators like the S&P 500 and the yield curve, and keep any eye out for Lehman Brothers’ type of failures on Wall Street.
LJ Suzuki is a fractional CFO with CFOshare. He helps small businesses with forecasting, risk management and capital planning on a part-time basis. At CFOshare, we help clients with business strategy and capital planning to avoid risks and survive crisis. If you’d like a consultation with a fractional CFO, book an appointment or email us. Info@CFOshare.org