THE MYSTERIOUS DECLINE OF THE CANADIAN PUBLIC COMPANY.
HOW VOLATILE MARKETS HAVE MADE PUBLICLY TRADED COMPANIES SCARCER
Add the publicly traded company to the endangered species list. Since 2007, the number of publicly listed companies in Canada has dropped 16.7 per cent, according to statistics from TMX Group Ltd., the company that operates both the Toronto Stock Exchange and the junior market TSX Venture Exchange.
The drop isn’t merely a blip explained by a recent economic downturn. It’s an entrenched, structural trend that has seen the number of listed companies shrink at a fairly steady rate of about 1.6 per cent per year.
Market experts say no single reason explains why Canadian publicly listed companies are going the way of the dodo and most say the answer is a mix of conditions. But the incredible shrinking equity market has massive implications for entrepreneurs used to tapping public equity, as well as for the securities lawyers, investment bankers, accountants, and stock exchanges who depend on serving that market.
Countless small investment banks have recently ceased business. No fewer than 50 boutique investment firms — some 25 per cent of the market — have disappeared, merged or changed their business models over the past three years, according to the Investment Industry Association of Canada.
“That’s a big issue for Canada because our market is just dominated by small issuers,” said Bryce Tingle, who holds the N. Murray Edwards Chair in business law at the University of Calgary. “Outside of the S&P/TSX Composite Index, our listed compan- ies would almost universally be considered small cap or micro cap in every other market.”
Listings are not disappearing due to simple attrition. Where once upon a time the pool of companies lost to takeovers or insolvencies would be quickly replenished by new listings, the number of initial public offerings has slumped.
IPOs hit a two-decade high of 355 in 1997, according to Financial Post data. Last year, there were just 42 IPOs, and that was up only slightly from the two-decade low of 38 in 2014.
One explanation for the decline might be that the Canadian market just doesn’t need as much public equity as it has in the past. New, alternative sources of funding, such as private equity and venture capital, are available in greater numbers.
The Canadian Venture Capital and Private Equity Association said the value of venture capital investments in the first quarter surged to a record $838 million, nearly double the amount recorded during the same period last year.
Mike Woollatt, the CVCA’s chief executive, said private capital has exploded in Canada over the past 10 years and is rapidly growing.
About $440 billion in private equity and $110 billion in venture capital North America-wide has been raised, but not yet invested — a sum Woollatt calls a “ton of dry powder.”
The bulk of that money has been raised in the U.S., but Canadians are just as likely to be on the receiving end of an investment because there is “basically no border for private capital anymore,” he said. “The impact is that basically you don’t have to go public to get serious scale and money.”
Shlomi Feiner, a partner at Blake, Cassels & Graydon LLP in Toronto, said recent Canadian regulatory changes have also opened the door to other financing alternatives, such as private placements.
“At one end of the curve, there’s crowdfunding. You’re not taking away the big TSX companies, but it’s really opening up the pool for private finance alternatives,” he said.
Kurt Sarno, another partner at Blakes, said these new private pools of capital are attractive to companies seeking certainty.
“The recent volatility of capital markets makes it hard for issuers to choose the right time to go public,” he said. “Not only is private equity out there in great abundance, you can essentially access that private capital at any time.”
Lawyers have noticed that corporate clients struggling due to the economy, or that have problems with their business plans, increasingly prefer to address those challenges in private.
Patricia Olasker, a partner at Davies Ward Phillips & Vineberg LLP in Toronto, said that means publicly traded companies facing troubles tend to try to find a buyer for the company or do a “go-private” transaction that buys out public shareholders and delists the stock.
“I certainly hear that advice more often being given to companies that are struggling: Don’t keep yourself in the spotlight where you’re forced to report every quarter. Get out of that arena, fix your problems, then think about going public later,” she said.
Lawyers also note that public companies have been exposed to a new risk in recent years: class-action lawsuits launched by disgruntled investors.
Ontario, for example, amended its Securities Act in 2005 to create new grounds for investors to sue companies. Those amendments are now a decade old, but the courts are still working through the “first impression” cases that will lay the foundation for how these lawsuits will work in the future.
“Litigation risk is probably something to be mindful of," said Philippe Tardif, a partner in the Toronto office of Borden Ladner Gervais LLP. “There’s definitely exposure to investors because of the advent of class actions, particularly in securities. That’s definitely a factor.”
The U.S. experience with class actions over the past 20 years is revealing. At first blush, litigation risk seems to have levelled off in the U.S. According to statistics compiled by NERA Economic Consulting, a little more than 200 companies are sued in securities class actions each year.
Yet the number of publicly listed companies is also shrinking in the U.S., down to about 5,300 at present from about 8,800 two decades ago. That shrinking denominator means the odds of a U.S. public company getting sued in a securities class action have almost doubled.
Another reason frequently mentioned for the decline in public companies is the cost and hassle of regulatory compliance.
Legislators tend to respond to market crises with fresh laws that tend to be quickly passed but slowly or never fully enacted. For example, the U.S. Sarbanes-Oxley Act of 2002 and The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 may herald fresh protections for investors, but they also erect regulatory burdens.
Compliance isn’t cheap. And U.S. laws also impact a lot of Canadian compan- ies with dual U.S.-Canadian stock listings or cross-border activities.
“The cost burdens have increased over time," said Jeremy Fraiberg, co-chair of the mergers and acquisitions group at Osler, Hoskin & Harcourt LLP in Toronto. "Since Sarbanes-Oxley and so forth, there have been increased controls on public companies. That may be a good thing ultimately, but when you increase the cost of something, there may be a corresponding decrease in demand. It’s economics.”
The University of Calgary’ s Tingle, who has launched several startups of his own, has heard all these arguments to explain the decrease of public companies — the availability of private equity, the rise in litigation risk, and the increased regulatory costs and burdens — but he’s not convinced any of them get to the root cause.
He thinks companies choose to go private or remain so for a much simpler reason: Company founders and managers recognize that going public comes with a loss of control and a lot of hassle. “I think that managers are looking at public markets and thinking, ‘I don’t need that crap,’ ” he said.
And this, Tingle said, is an issue that should interest Canadian securities regulators, who should be surveying public company executives on which rules they find most burdensome and then determine whether they can be fixed. He also said securities commissions should be reaching out to private company managers to ask why they’ve avoided going public.
He suggests Canadian securities regulators focus too much on addressing corporate governance issues, such as setting rules on executive compensation, and not enough on things that might stop the continuing decline in the number of Canadian public companies.
“They’re presiding over a ship that’s taking on water quickly,” Tingle said. “The decline of public markets means that the kind of businesses that are the future are getting less money.”
The commodity downturn has, in recent years, dealt a blow to the TSX Venture Exchange, a marketplace for emerging companies.