Thursday Thinkpiece: Tingle on Canada’s Public Venture Markets

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Start-Up and Growth Companies in Canada – A Guide to Legal and Business Practice, 2nd Edition
Bryce C. Tingle
Toronto: LexisNexis Canada: 2013

Excerpt from Chapter 14

Canada’s Public Venture Markets – A Success Story

Most discussions about entrepreneurial finance in Canada, and certainly most of the public policy initiatives of the federal and provincial governments, revolve around institutional venture capital. The VC industry is important to Canada and recent government initiatives, such as the Venture Capital Action Plan, are important to solving some of the problems that have historically plagued startup and growth companies in this country.

The fact is, however, that the amount of money raised on Canada’s venture public markets dwarfs that handed out by institutional venture capitalists. Recent research suggests the venture market also does a better of job of producing successful companies, although these are strongly concentrated in the natural resource industries. Canada’s largest venture public market is the TSX Venture Exchange.

There are some foreign competitors to the TSX Venture Exchange, such as the London Stock Exchange’s AIM market and the OTC bulletin board (OTCBB) in the United States, but these have historically also played only a very minor role in the financing of Canadian start-ups. The U.S. junior markets, in particular, have developed an unsavoury reputation as a place for Canadian issuers to receive financing. (For example, the incidence of fraud litigation on average represents over 5 per cent of Pinksheet listings, compared to 1.9 per cent NYSE listings, 0.3 per cent TSX listings and 0.1% TSX Venture and AIM listings.) The costs tend to be high and the reality is that very few of the foreign exchanges are actually comparable to the TSX Venture Exchange. Over the past 20 years, more than 70 per cent of the IPOs on the TSX Venture Exchange involved companies with negative earnings and the median gross proceeds raised in all IPOs on the exchange was $800,000. These are clearly very early stage companies. The size of companies listing on London’s AIM market, for example, and the amounts they raise when going public (the mean financing is $22.58 million), actually much more closely resemble IPOs on the TSX.

The very small size of issuers on the Venture Exchange makes it all the more surprising that the Exchange has flourished when many of its larger competitors have stumbled. Eleven venture markets were begun in the OECD after 1995, only five now remain. Meanwhile the Venture Exchange (and its predecessors) have thrived for over 100 years.

While many institutional investors in Canada invest in TSX Venture-listed companies, most of the market is made up of retail investors. The small amounts raised by individual issuers and the low trading volumes in most TSX Venture companiesʼ shares means that most of them are too small for institutions, which tend to limit their investments in Canada to the country’s 60 largest public companies. What institutional investment that does occur on the venture exchange tends to be concentrated in natural resource firms. This is particularly true of U.S. and other foreign institutional investors.

The survival rate of companies on the Venture Exchange is surprisingly high, given so many of them are very small and pre-revenue at the time they list. Approximately 50 per cent of newly listed firms fail, 14 per cent graduate to a senior exchange and the remainder continue to trade on the Venture Exchange. Approximately 62 per cent of Canada’s reporting issuers are listed on the Venture Exchange (2,374 out of a total of 3,848). In 2010, 330 of the 1,474 public companies on the TSX were graduates of the junior exchange. This number does not include TSX-Venture graduates that were acquired or merged with other TSX companies.

To give some sense of comparison, the Venture Exchange has a success rate that, according to a recent paper on the exchange, is “approximately four times the corresponding rate for private VC”. The venture market provides seven times the number of TSX listings as Canadaʼs venture capital firms and over five years the delisting rate of junior public companies is lower than the failure rate in the Canadian venture capital sector. (This latter statistic is at least in part a function of very low delisting standards on the TSX Venture Exchange.) Finally, the financing received by startups on the Venture Exchange dwarfs that provided by private venture capital firms. By way of comparison, in a typical year Thompson Reuters estimates just over $1 billion is disbursed by Canadian venture capital firms of every type and description. Companies on the Venture Exchange regularly raise in excess of $10 billion.

The most surprising comparison, however, is between the Venture Exchange and the TSX. Between 1986 and 2006, the S&P TSX Index generated an annual return of 10.70 per cent. The 1,626 new companies that listed on the TSX Venture Exchange during this time period generated an astonishing annual return of 15.69 per cent. Again contrasting this with Canada’s institutional venture capital industry is illustrative: the VC industry has generated negative long-term returns over most of its short history in this country.

A litany of reasons is usually given for a company’s decision to go public on the TSX Venture Exchange. Only one of these, access to capital, is valid. The trading volumes in the stock of most issuers on the Exchange are too low for the listing to confer other benefits on the company. For the most part the company will remain unable to use its stock as specie to acquire other businesses or assets. The ability of employees to liquidate their stock options does mean that most employees value them more, but it also means that it is easier for an employee to exit the company and that employees have the chance of seeing the share price fall below their option prices. In any event, the enhancement in the value of options contributes too little value, and the use of shares as specie is too rare among early-stage companies, for these considerations to carry much weight. Ultimately the decision to go public must be a function of how much capital the corporation can raise in the course of doing so.