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Should we go easier on small-cap companies?

To make the current regulatory landscape work for all companies, we need the right size regulation so investors have transparency into what matters to them and companies can grow with as few regulatory hurdles as possible.



The past two decades have seen an ongoing decline in the number of public companies — with organizations opting to remain private longer, venture capital-backed companies exiting through mergers and acquisitions, and the rise of private equity firms taking companies like WestJet private. Since the late ’90s, the number of publicly listed companies has decreased by half, raising concerns about the potential impacts to the economy, including shrinking job growth, expanded income inequality, and fewer investment opportunities.

One barrier to entry for the public landscape is the regulatory burden. Despite the various shapes and sizes of organizations on a given exchange, these regulations are assigned equally across the board. And while larger companies have the time and resources to address these regulatory considerations, they can present a prohibitive financial burden and time commitment for smaller growth-stage companies.

Take the International Financial Reporting Standards — usually referred to as IFRS. These guidelines focus specifically on financial performance and make it difficult for companies to report on any business development that falls outside their standards. For growth-oriented companies, stats like subscriber growth, churn rate, and revenue per user are among the most revealing, but there’s no current regulatory avenue through which to report these.

Despite the structure of current regulations, not all public companies are identical. Early stage companies need the ability to act on opportunistic transactions, many of which are not yet profitable. This includes financing when money is available or making acquisitions that can further accelerate their growth. These universal disclosures and regulatory obligations can put an unfair strain on small-cap companies that aren’t as well-positioned to weather the storm.

These limiting factors can be particularly detrimental to startups looking to make a difference in their industries. Consider biotech companies researching cures for cancer or miners sustainably extracting battery metals for electric vehicles. It’s important that these innovators aren’t hindered as they build out their products. And investors are more likely to gauge success based on a biotech company’s clinical results or a mining company’s technical reports than IFRS-compliant financial metrics.

To make the current regulatory landscape work for all companies, we need the right size regulation so investors have transparency into what matters to them and companies can grow with as few regulatory hurdles as possible.

The current investment landscape

The public market space has been getting a lot of attention recently, with big names like Lyft, Uber, and Pinterest claiming the spotlight. This interest is reflected behind the scenes as well.

Most notably, Andreessen Horowitz — a firm known for funding a number of Silicon Valley players — recently relinquished its venture capital status so it could extend its focus to the crypto and public markets. Recently, co-founder Marc Andreessen was identified as one of the backers of the Long-Term Stock Exchange, a newly announced U.S. exchange designed for growth-stage tech companies. To me, this indicates that the billion-dollar fund may see public company valuations as more attractive than those of existing private issuers.

The rise of cryptocurrencies and other digital tokens as investment opportunities also demonstrates that the investor community is open to funding companies that have limited (or no) disclosure obligations. This could be an indicator that publicly listed companies may not need strict disclosure regulations to effectively attract and engage investors — and ultimately forces us to question who’s being protected by certain elements of regulatory burden.

The rise of cryptocurrencies has opened up plenty of investment opportunities. (Photo by DepositPhotos)

For small-cap companies trying to capitalize on this increased interest in the space, there are now fewer dealers providing support through banking or research activities, leaving many organizations without the resources they need to navigate the public markets.

Investor relations advisors have picked up the slack. In addition to helping small-cap companies gain visibility, these IR professionals have also been instrumental in developing strategic transactions and providing guidance on capital market activities. Regulations need to evolve to recognize these changing roles, the important role they play, and the risk appetite of the investor community.

The role of exchanges

It’s tempting to suggest that regulators and exchanges take a more relaxed stance on small-cap companies when it comes to their regulatory burden, but this isn’t easily implemented. As it stands, there’s no strict threshold differentiating small- and large-cap companies, and it would be impossible to draw that line in the sand.

Consider a company like Uber, which just launched its IPO. While it’s still a startup in many ways — working out structural issues, navigating dynamic regulations, expanding rapidly, losing $3 billion a year — it’s also a global brand and among the top 10 IPOs to hit the U.S. markets. So should it be considered a startup or an established company?

A better indicator is whether a company is equipped to report on standardized financial metrics on a regular basis, as that can help determine the maturity of an organization. For companies that aren’t yet capable of reporting on these metrics and are more focused on capital formation, exchanges could offer tailored listing tiers — like TSX Venture Exchange — that are more accommodating with their reporting requirements.

These alternative tiers could offer streamlined reporting tools, extended timelines for reporting (e.g., biannually instead of quarterly), and efficient listing mechanisms like reverse takeovers and qualifying transactions — all of which allow smaller companies to spend more time focusing on their business development. Exchanges can also implement “sandbox initiatives,” where companies can engage with exchanges to discuss novel structures or ideas, encouraging an advisory relationship between the two.

How growth-stage companies can keep up

Small-cap or growth-stage companies may not be able to rely on traditional reporting metrics to accurately portray their strengths and potential, but there are things they can do to better showcase themselves to investors.

  • Hire (or contract) the right people. You can mitigate the toll of continuous disclosure and procedural obligations by employing the right advisors and systems to deliver on these quickly and effectively. Have your legal and accounting ducks in a row to ensure you can maintain transparency for the markets.
  • Develop consistent metrics. Your company is more than its financial metrics. To prove this to investors, identify a set of key performance indicators that reflect your business model and communicate these on a consistent basis.
  • Work with regulators. Until there’s a positive shift in regulations or listing structures, it’s important for small-cap companies to work hand in hand with regulators and exchanges. Consult with the exchange and regulators ahead of time to understand any complexities and requirements before and after the listing.

Despite the drop in the number of public companies, the economy has still flourished, offering a wealth of opportunity to businesses and their investors. The emergence of new industries, including the cannabis sector, has driven the broader Canadian markets and attracted new investors. Fostering the growth of new industries through public venture capital is a well-worn path for Canadian markets — it’s how Canada established itself as a leader in the resources space. Our ability to use these same mechanisms to foster new industries will continue to drive economic growth and reward investors who participate.

(Featured image by DepositPhotos)

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation for writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

Brady Fletcher is the managing director of TSX Venture Exchange, the world’s premier public venture market. Every year, hundreds of early and growth-stage companies raise billions of dollars via the TSX Venture Exchange. With a background in computer engineering, Brady spent almost a decade in investment banking, primarily focused on financing and advising technology and diversified issuers through strategic transactions. Throughout his career, he has advised hundreds of companies on business strategy, capital raising, public and private markets, and exit strategies. He has successfully executed more than $500 million in growth equity financings, secondary transactions, and sell side advisory mandates. The views, opinions, and advice provided in this article reflect those of the individual authors. This article is not endorsed by TMX Group or its affiliated companies.