The Toronto Stock Exchange: A Big Opportunity for Small Business
By Mark Adkins, Business Opportunities Journal. November/December, 2008.
With current turbulent market conditions in the major stock exchanges in the United States and around the world, as well as extremely tight credit markets, many small to medium businesses that have strong growth plans but who need expansion financing wouldn’t think of accessing capital by going public on any of the major U.S. exchanges. Legal and accounting costs are daunting for not only the initial offering (IPO), but also for ongoing compliance with SEC rules and the Sarbanes-Oxley Act of 2002 (commonly referred to as SOX). Growing businesses therefore face harsh financing choices. They can try to raise capital from venture capital funds, whose number and dollar value has declined of late, from private equity investors who are smarting from the recent drop in equity and real estate values, or from banks and other lenders whose recent reluctance to lend, even to strong credit risks, has been widely cited.
But some innovative businesses with strong growth prospects are looking beyond the U.S. markets, in fact, beyond the U.S. borders altogether, to the TMX Group, which owns and operates the Toronto Stock Exchange and TSX Venture Exchange in Canada. Indeed, over 140 U.S. companies, 17 in 2007 alone, have chosen to be listed on the TSX equity exchanges. These 140 companies represent big dollars--about $2.2 trillion in market capitalization. With almost 4,000 listed issuers calling TSX’s equity exchanges home, the Toronto Stock Exchange is second in the world for listings. In addition to plentiful listings, it also has strong and rapidly growing liquidity. Over 149 billion shares were traded in 2007. That marks a 25% uptick from the previous record for the exchange, reflecting on-going growth in trading volume. And not just U.S. companies are looking to the TSX for listing opportunities--some 240 international issuers account for 9% of the market’s total issuer market capitalization. In all, some 573 companies went public on the TSX equity exchanges in 2007, raising in excess of $54 billion.
But how realistic is it for a small business located in the U.S. to look to the TSX exchanges as a viable source of equity financing? Are there large up-front capital requirements? What about legal and accounting costs associated with a cross-border transaction? Many companies that have gone through the process say that being listed on one of the TSX exchanges is, in fact, a live option with relatively lower costs and regulatory burdens than associated with major U.S. exchanges, while potentially offering greater regulatory transparency and oversight than the over-the-counter (OTC) market in the U.S. The TMX Group argues that it provides a venue for earlier stage companies to access capital, and to do so in smaller financings, than elsewhere.
I recently had the opportunity to sit down with Kevan Cowan, President of the TSX Markets and Group Head of Equities, whose responsibility includes tradings, listings and other services of the TMX Group exchanges. We spoke about the Toronto Stock Exchange, its history, and its future as a viable alternative for U.S. businesses seeking public funding.
BOJ: How do the TSX Venture Exchange and the Toronto Stock Exchange relate to one another?
Cowan: What we’ve done, I would argue, is create an unrivaled two-tiered growth platform. We have two exchanges under the same umbrella. One’s called the TSX Venture Exchange which is primarily focused on micro and small cap companies, really micro by U.S. standards where the economic terminology and the categories are so large. And then we have the Toronto Stock Exchange. The Toronto Stock Exchange accommodates companies in the tens of billions of dollars of market cap. But really by U.S. standards, it too is a small to medium enterprise exchange.
Over the course of the last eight years in Canada, we took six different stock exchanges, merged them together into a national umbrella organization, and then tiered them for junior and senior companies. Our success story, which is unrivaled in the world, is the rate at which we allow companies to graduate from our junior platform to our senior platform. So for example, since we created it (our first full year of operations was 2000), we have had well over 400 companies move from the junior to the senior market.
BOJ: Has it been successful to merge six exchanges into a two-tiered platform?
Cowan: A phenomenal success. Of course, it was a very difficult challenge to get it done. Going back to 1999, the Toronto Stock Exchange really owned the market in Canada for senior equities, but we had 5 regional markets that competed for small cap companies. They were situated in Winnipeg, Calgary, Vancouver, Montreal, and an over the counter market based out of Toronto. So all five of these were merged together between 1999 and 2001 with a vision of creating a national liquidity pool for micro cap companies. We had a lot of interregional and inter corporate cultural challenges to get over. It took us probably two to three years to get over those challenges. But now that it is done it’s just been a phenomenal success. Even in the current market environment, our venture exchange is trading upwards of 200 million shares a day, which for a micro cap focused exchange is beyond all of our wildest expectations when the exchange was formed. Frankly, it has been that success that has allowed us to create this two tiered platform. That gives us our international distinction and is what is attracting companies, in many cases from the United States, China, and Australia. This two tiered platform is working very well.
BOJ: How do you define “micro-cap?”
Cowan: In the United States you would probably have to say anything under $500 million or a billion dollars. In Canada, we would define it as much smaller. We would typically say small cap might be under $500 million and micro cap might be under $50 million. I think in terms of the U.S. context, micro cap is anything up to $100 million, which would be very well suited for the Venture Exchange and even the Toronto Stock Exchange. Then small and medium cap I would say cover up to about a billion. That is really the space where we are focused.
BOJ: Where do the TSX exchanges fit within the competitive landscape of equity exchanges?
Cowan: Right now, the world of exchanges and capital markets is expanding globally. There’s no better example of that than the United States. You look at NASDAQ and what they’ve done oversees, or you look at the New York Stock Exchange and what they’ve done overseas: everyone is now competing in each others’ backyard. What becomes absolutely critical is “what is your value proposition that can break through the noise of what the other exchanges are offering?”
We’re not going to compete with the New York Stock Exchange for $50 billion dollar companies based in the United States. That doesn’t make sense. We’re not going to compete with NASDAQ for the large tech companies. But what we do better, I think, than anyone else in the world, is provide a growth platform for small and medium enterprise.
BOJ: Do most of the companies that go on the TSX stay there, or do they use it as a stepping stone to other exchanges?
Cowan: We very much embrace the whole stepping stone opportunity. A great example would be U.S. Geothermal. It started on the Venture Exchange, moved up to the Toronto Stock Exchange, then interlisted back into the United States. And we very much encourage that. We have about 200 companies that are interlisted between our market and the U.S. markets. That is a part of our business that is growing significantly. The one big advantage that North America as a whole has, or Canada and the U.S. in particular have, is the seamlessness in which the public equity markets work. For example, of our listed issuers on our 2 exchanges, 40% of the trading is coming from the United States. So there is a huge cross border flow of capital. We are getting more and more trading from the United States all the time. We have fifteen of the major U.S. broker dealers that are members of and are trading on our exchanges.
BOJ: Are your biggest competitors other international markets or the U.S. markets?
Cowan: Well it depends on what strata of our markets you are talking about. The one area where we compete most vigorously with the United States is on those 200 interlisted companies I mentioned. We have about 90 companies interlisted with the New York Stock Exchange and about 60 each that are listed with AMEX, which is now part of NYSE Euronext, and NASDAQ. So on those roughly 200 interlisted companies we are competing for order flow. So people can place orders either in the United States exchanges or Canadian.
When you move to the listing side of the business and us offering companies the ability to access capital by listing on our exchanges, it is probably less intense because we see ourselves as very comfortable in that sweet spot of small and medium enterprise. We are down here [in the United States] looking for companies under $500 million market cap, and many cases under $50 million market cap. U.S. markets just aren’t that interested in those kinds of companies. So there is not a lot of direct competition. There is also the Alternative Investment Market (AIM) in London. It was doing very well two years ago. It gave us a little bit of competition in the sense that we had three Canadian companies that listed on AIM without listing in Canada and we also had 40 that interlisted between the two. All three of those have come back to Canada because they couldn’t generate any after market support there. No analyst coverage and no follow on financing. We’re not resting on our laurels, we’re trying to make our product better every day, but that competition has kind of gone away. There’s another small market in Canada called CNQ, but they have really taken no significant market share. There’s the OTCBB and pink sheets markets in the United States. But they have not been successful in attracting more than maybe one handful of Canadian companies that don’t also interlist with us. So right now I would say our value proposition is pretty focused and pretty unique on our small and medium enterprise story.
BOJ: What types of companies are good candidates for going public on the TSX exchanges?
Cowan: If you are going to tap into public equity markets, it has to be about growth. It’s got to be a growth story that investors are looking for. It’s a company that has a growth horizon either through growth of the current company that can’t be done organically. Or, consolidation strategies where people are looking for publicly listed currency to go out and buy other businesses. That can obviously be very valuable if you don’t have the cash but you are looking to buy something else. Investors are looking for that hockey stick projection with tremendous upside.
BOJ: What are the revenue thresholds required to be listed?
Cowan: In terms of companies that would be eligible for the junior market, believe it or not, revenue is not a requirement. We have lots of companies that are pre-revenue. Now, those that are pre-revenue are well capitalized. As a substitution for revenue or profitability, we look for capitalization. We actually reference it to the company’s own business plan. So if a company has a business plan to meet a certain milestone a year from now and they are well enough capitalized to do that, we’ll take a look at that company. Now that passes our test. It still has to pass the investor test and again, investors are looking for that hockey stick growth projection. But we are really looking at working capital and capitalization. We want to make sure that investors have a fair shake. Then we bring the company onto our platform.
BOJ: Is being listed an end in itself?
Cowan: No. A listing in a public market should be all about a means to an end. People shouldn’t think of a listing as an end in itself. Particularly listing on our Venture exchange is not an exit strategy. It is very much a growth tool. If management is thinking about exiting from their investment and moving on this is not really the place to do it. It is a growth platform.
BOJ: What about companies that are revenue positive but that are small?
Cowan: That would be the absolute sweet spot for the Venture Exchange. And potentially again, depending on how profitable, how much revenue, and how well capitalized, possibly even for the Toronto Exchange. I don’t want to give the impression that companies have to go to the Venture Exchange first. Many, many, many of our companies list right on our senior market, the Toronto Stock Exchange. The things we are looking for are, first of all, we have to know that the management is suitable. We check every single director and officer for suitability. We have to know that among the members of the board, there is both public company experience and experience running the business. We do a background check on every single one of them. When you move into the financial requirements, what we are really looking for is some combination of profitability or net tangible assets. But by U.S. standards these entry thresholds are extremely low. For example, if a company just has positive cash flow or is positive net income, that by itself will allow it to qualify for our exchange. If it doesn’t have that again it is either working capital or we might look at net tangible assets on the balance sheet and want to see positive net tangible assets.
BOJ: How does the regulatory environment compare at the TSX exchanges to that of the U.S.?
Cowan: I think the best way to describe the regulatory nature of our market is that it is much more vigorously regulated than the unregulated U.S. markets (the over-the-counter markets and pink sheets), but much more sensibly regulated than what you would get under SOX. And we have done two significant things in Canada that are different than SOX. This is all on the basis that good corporate governance in Canada and on the TSX exchanges is extremely important. Where we think SOX went too far was, for
example, SOX 404, which is the infamous requirement that a company must have its internal controls audited by an outside audit firm. We don’t require that on the TSX exchanges. The second thing we’ve done in Canada as steering away from SOX is that on our senior exchange, the Toronto Stock Exchange, the CEO and the CFO have to certify that they’ve designed internal controls and evaluated their efficiency, but they don’t have to hire an outside auditor. On the Venture Exchange, we don’t have that requirement. So the CEO and the CFO simply have to say that the financial statements are fairly presented. And again, we’re after rigourous governance but we’re not after paying millions of dollars to auditors to come and certify that.
BOJ: Do most U.S. issuers go with Canadian or U.S. bankers?
Cowan: What we’re seeing now is that it is mostly bankers in Canada but with institutional investors it is typically with banks back in the United States. So you will see a retail component from Canada, sometimes an institutional component from Canada and sometimes an institutional component from the U.S. as well. Part of our goal is now to move from the trading sides of those businesses and into the investment banking sides as well, and get them excited about this opportunity. I think we are going to make some inroads there. And then of course, the picture will be complete. Ideally, you would love to have the progression where you have a U.S. based company, it taps into U.S. institutional, Canadian institutional and Canadian retail investment, avoids Sarbanes-Oxley for a year or two while it gets its legs, then interlists back into the United States and then gets the retail component from the U.S. there. Then, of course, the sky is the limit in terms of financing opportunities.
BOJ: How do the costs compare to the costs of going public in the U.S.?
Cowan: The biggest message we get back from the customer is that it is cheaper across-the-board than in the United States. The lawyers are cheaper, the accountants are cheaper, and the exchange fees are cheaper. That’s without getting into corporate governance. When you then get into Sarbanes-Oxley compliance costs, then we are significantly cheaper. On the other hand, I was speaking to one of our issuers today who spent a lot of money going cross border because his legal and accounting help had not done this before and so he was essentially paying to have them go to school on him. That is a danger. You’ve got to make sure you work with people that have done this before. But by and large, Americans will find they get a lot more value for their dollar north of the border just in terms of overall costs.
BOJ: What are some ballpark cost estimates for being listed?
Cowan: In terms of the cost of going public, your lawyers, your accountants and your exchange fees, what we typically see is the absolute best case scenario for a Canadian based company would probably be around $200,000 dollars Canadian. For a U.S. based company with some cross border issues it could be around $300,000 dollars. Now that is your professional advisory expense. On top of that, you’ve got a commission to the investment dealers who raise the money and the commission, typically depending on the size of the deal, would go anywhere from 6 to 10 percent. So a larger cap company dealing with a major investment bank might be in the 6 percent range. As you get more junior, typically there’s a premium. You could be up to the ten percent range. So that’s your percentage of the proceeds you pay in addition to your fees. There are horror stories out there where companies have hired professionals who haven’t done it before and they basically go to school on them and it costs them a lot more. I’ve certainly heard a couple of horror stories of over a million dollars. By and large, for a typical U.S. company that was looking to deal with it, had its house in order, so it didn’t have a huge mess of issues but had some cross border issues, it could be anywhere from, I would say, the $400K to the $800K dollar range.
BOJ: And ongoing fees post-IPO?
Cowan: We’ve heard a lot of different things in that area as well. There’s quite a landscape. But a very well run Canadian based company that is not dealing with SOX could be anywhere from $50,000 to $100,000 per year. Some are much higher. Of course as the market cap grows it could be a lot more than that. And then you get into investor relations and those kinds of costs. For a U.S. company doing it, that was listed in Canada and not registered under the SEC so no Sarbanes-Oxley costs, you’re probably looking at $100,000 to $200,000 per year, or more, again depending on the complexity and sophistication of the company and its programs. If you get into Sarbanes-Oxley, so you’re also SEC registered, then of course your cost can be an awful lot more. Those are ball park figures by the way. And it probably would be good to speak to the issuers themselves.
BOJ: What about volatility versus volatility in other international markets?
Cowan: I suggest we talk about both liquidity and volatility. One of the things we’ve been doing, like all the exchanges, has been building liquidity. So both of our exchanges have had, over the last five years, phenomenal growth, in terms of total value and total number of shares traded on an annual basis. That was until we came into the current financial crisis. So the liquidity has been phenomenal. Volatility has been I think just typical. All of us over the last several months in terms of the current financial crisis have gone into periods of unprecedented volatility. And we’re experiencing it just like all of the other exchanges as well. It is not unusual for our market right now to be swinging 600 or 700 points a day (which doesn’t relate directly to the Dow Jones Industrial Average) but there is big volatility. But the other thing I should mention is that there is massive liquidity right now. The volatility is driving liquidity. So we’re setting records almost every second week in terms of total volume and total value and order flow. Once the financial crisis levels out, we’ll see where it goes from there. The other thing on liquidity generally is that the whole nature of the trading market is changing drastically in the United States and Canada and elsewhere. There is more liquidity. Traders are getting more and more sophisticated and are firing more and more messages and orders into all of the exchanges around the world. That generates much more liquidity. That is a good for everyone, from the most junior to the most senior company.
BOJ: Is it more volatile than the United States?
Cowan: No - I would say that it is similar. I suppose one could argue that the current financial crisis began with the sub prime mortgages in San Diego County or Salt Lake City or elsewhere. That’s a phenomenon that we don’t have in Canada because in Canada we don’t have a sub prime mortgage market. And in Canada if you take out a mortgage you also sign a personal covenant that you will pay the money back, so it doesn’t pay to walk away from your mortgage. So no sub prime mortgage plus personal covenants is a different situation. So, I think for several months the U.S. financial crisis was brewing and was relatively contained. But that’s not the case anymore. Now it has spread everywhere; Western Europe and parts of the Asian markets are suffering more than the United States. I would say Canada is by and large around about the same. There is a lot of volatility right now. There is no question.
BOJ: What is your vision for the future for the TSX exchanges?
Cowan: We have found that in this globalizing market place, we are getting a lot of international traction. We have 250 international listings, of which 145 are from the United States. That, by the way, makes us the largest foreign listings destination for U.S. based companies. We want to grow that. That’s the big thing. In terms of where the exchange is going, we recently completed the acquisition of the Montreal Exchange which is a derivatives exchange. So, we now have under one roof for the first time all asset classes. Cash equities and derivatives. So our vision going forward is to bring those together in a way that allows investors to access both derivatives and cash equities with respect to the same company which will improve efficiencies for everybody. It will be great for the companies and great for the investors. So that’s our next generation in terms of our overall vision.
We also own a majority interest in the Boston Options Exchange. That is our first major foray into the United States. So we are making investments down here as well. The Boston Options Exchange has about 6 percent of market share of U.S. equity options markets. So we are looking hard south of the border. | BOJ
