Canada’s venture capital markets are in a state of “epic collapse,” says Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC). His latest industry letter examines the causes and suggests ways to revive this critical source of capital for small and medium-sized businesses.
“It is not enough to blame weak economic conditions and poor resource markets,” Russell says. The problem is multi-dimensional, and includes:
- changing demographic patterns, with aging investors shifting from speculative equities to balanced portfolios that emphasize dividend and income streams;
- heightened regulatory scrutiny of suitability standards, confusing speculative investments with speculative portfolios and discouraging investment;
- lessened institutional interest as foreign investments have replaced speculative equities to achieve alpha returns;
- market structure changes that have escalated trading and dealing costs;
- competitive regulatory advantage of the lightly regulated Exempt Market Dealers (EMDs);
- increased support of viable early stage issuers by private equity companies, thereby allowing issuers to defer listing until they are at a more mature stage, or avoid the listing process if they are acquired by a larger entity.
“Small businesses will still find access to capital through angel networks and venture funds, and mid-sized businesses through private equity funds and direct placement through agents like EMDs and other registrants,” says Russell. “But as domestic institutional boutiques are squeezed from the market (21 boutique firms, or 13%, have disappeared in the past two years), the underpinnings of the venture markets will collapse.”
Fixing the problem
Russell says the solution requires action from regulators, the market and the federal government:
- Regulators need to examine closing the regulatory gap between SRO-regulated dealers and EMDs, raising the standards of the latter group and strengthening investor protection. Regulators also need to re-think market structure. For example, is a central order book for venture shares more effective than multiple marketplaces?
- Marketplaces need to reconsider their listing and trading practices.
- Federal government could stimulate venture markets by introducing a capital-raising incentive such as a deferred capital gains tax for reinvestment of proceeds into small-business shares, effectively channeling locked-up capital earning uncompetitive returns into the shares of small enterprise.
And dithering isn’t an option. “We must tackle the underlying causes of deteriorating liquidity and the financing in venture markets soon,” says Russell, “or run the risk of losing the best source of capital to grow small- and medium-sized Canadian businesses into globally competitive enterprises that drive job creation, innovation and economic growth.”