Public Equity Markets and Early Stage Companies

Author Name: 
Tom Kloet and Kevan Cowan


Building a Successful SME Exchange

The importance of small and medium enterprises (SMEs) to economic growth is widely acknowledged. SMEs are vital to job creation, and contribute significantly to GDP. A fundamental concern for both SME business owners and policy makers is access to growth capital. Growth capital can take many forms, from the notorious “Three F’s” (friends, families and fools), to venture capitalists, over-the-counter equity markets and banks. Another option for SMEs, and one that is gaining increasing international attention, is the SME focused stock exchange.

While conventional thinking dictates that public equity markets are most appropriate for mature companies, there are successful examples such as the TSX Venture Exchange that offer access to public growth capital beginning at the very earliest, micro-cap stages of a company’s life cycle.

What follows is a discussion of some of the key ingredients of a successful SME stock exchange, including appropriate regulation, engaged stakeholders, alternative going public structures and exchange support for listed companies.

Regulation Generally

The question of regulation is a critical one for an SME focused exchange. Long term sustainable market integrity is the core objective for any stock exchange in order to build and maintain investor and trader confidence. Some argue that SMEs - being early stage and potentially risky - require the very highest levels of regulatory oversight in order to achieve investor confidence. Like most things in the design of a stock exchange, finding the right balance is critical.

The example of Sarbanes-Oxley in the United States is instructive in terms of seeking regulatory balance. As the tide of SOX threatened to sweep across the border, there was vigourous debate as to the right path for Canada. The answer was found in Canada’s tradition of proportionate governance, manifested in two principal ways. First, the widely-debated SOX 404 (auditor attestation for internal controls) was not mandated for Canadian public companies (typically of smaller average size than US companies), and second, a different level of CEO / CFO certification was applied based on whether a company was listed on the senior Toronto Stock Exchange (more prescriptive) or the junior TSX Venture Exchange (less prescriptive).

Proportionate governance is consistent with feedback from those investing in junior public companies. Such investors generally indicate a principal focus on identifying quality management and good growth stories. Investors further indicate that they are diversified in their investments, and want to see their investment dollars funding the companies’ projects as opposed to SOX style compliance. In the result, proportionate governance has been a key ingredient in the success of the public SME marketplace in Canada, and there is now widespread debate in the United States concerning the chilling effect of SOX on SME financing.

The Goal of Regulation

The goal of regulation must also be considered. Some commentators have criticized the investment record offered by certain SME listings. TSX Venture is designed predominantly to manage regulatory risk as opposed to investment risk. Investment risk is managed by investors and their advisors. TSX Venture’s financial listings tests are primarily focused on ensuring that a company has the means to advance its publicly disclosed business plan, not on whether the business plan will be successful.

In this regard, the very concept of a public SME marketplace offers a unique value proposition. In the traditional world of private venture investment, investment opportunities are limited in number, limited to larger investment sizes, and limited to members of the private investment “club”. In contrast, the public SME marketplace offers open access to all investors, investments of all sizes, wide ranging diversification, and a more ready investment exit through the public marketplace. In addition, participants in the TSX Venture marketplace understand that this public SME marketplace is a “venture” exchange, designed specifically for early stage companies.


All stock exchanges thrive on a complex ecosystem of complementary stakeholders and market participants. Nowhere is this more critical than in the case of an SME focused stock exchange.

The SME stock exchange is well positioned to be the hub for building awareness around SME public financing, investing and trading opportunities. To a much greater extent than with traditional stock exchanges catering to larger cap companies, it is critical to get the community working together, including company founders, financiers (from “finders’ to investment bankers), lawyers, accountants, traders, analysts and investor relations professionals. It is also often the case that advisors such as lawyers and accountants play an influential role in early stage company decision making, including the decision to go public. The SME exchange’s success will be closely tied to the level of engagement among all parts of the advisory community.

Traders and investors are a critical constituency for the SME exchange. SME exchanges dominated by institutional buy and hold investors have resulted in lacklustre secondary market liquidity. Market making programs are not always an easy solution, due to the chicken and egg conundrum of market makers (both traditional and electronic) seeking greater opportunity in high liquidity stocks. Building retail interest as the foundation of secondary market liquidity is critical. Some programs employed by TSX Venture to advance investor awareness include an annual TSX Venture 50 ranking of top listed company performers in five sector categories, investor forums and guidance for companies on undertaking quality investor relations activities. Many TSX Venture (and Toronto Stock Exchange) listed SMEs have attracted relatively strong analyst coverage, for example, TSX and TSX Venture listed mining companies boast approximately 200 analysts, many of whom focus on SMEs.

Alternative Going Public Structures

The IPO is the most widely known method for going public. Often, however, the traditional IPO’s requirement for a broad-based investor distribution may not be available to an SME, particularly during a challenging market cycle. Alternative going public structures can provide additional capital raising options.

The reverse takeover (also know as a reverse merger) typically involves the merger of a listed “shell” company with a more valuable operating private company. Reverse mergers usually combine the shareholder list of the shell company with a smaller group of investors funding the SME. In the result, the shareholders of the shell company get a second lease on life, and the new investors in the SME are invested in a public vehicle.

There has been much criticism of reverse takeovers as an opportunity for regulatory arbitrage. The key challenge to maintaining integrity is ensuring that the applicable regulatory regime holds IPOs and reverse takeovers to the same standards. For example, on TSX Venture, reverse takeovers provide an alternative structuring opportunity but are largely subject to the same rules and due diligence as IPOs, from background checks on directors, officers and significant shareholders, to disclosure documents and financial listings tests. It is also important that the shareholders of all outstanding stock in the shell company are identified.

To provide even greater flexibility for SMEs, a TSX Venture innovation is the Capital Pool Company (CPC). The CPC is a newly created shell vehicle that undertakes a small IPO (up to $ 5,000,000) on the strength of its management and sponsors. It then lists on TSX Venture and is given 24 months to successfully merge with an active business that meets the Exchange’s listings standards. All of the operations of the CPC, from how funds are raised to how they are disbursed (including in the event of missing the 24 month deadline), are tightly regulated. To date over 2,200 CPCs have been formed and listed on TSX Venture, of which about 80 percent have successfully merged with active companies and become full-fledged TSX Venture or Toronto Stock Exchange listings.

Listed Company Support

SMEs face an important decision when it comes to deciding whether to access public capital. Most notably, the obligations of being a public company can be costly in time and money (note, however, that the costs and restrictions in the world of private equity can often be just as burdensome). Programs and services designed to ease the challenges of being a listed company will enhance the SME exchange’s success.

Examples of programs and services offered by TSX and TSX Venture for SMEs include multiple mentorship and learning programs for directors and officers (upwards of 1,000 attendees per year), town hall meetings for listed companies on key policy developments (e.g. rule changes) and industry evolution (e.g. high frequency trading), investor relations tools (screen and workshop based), investor forums and financing forums.

TSX Venture Exchange – A Case Study for Success

TSX Venture Exchange is the result of mergers of five regional stock markets in Canada between 1999 and 2001. It was acquired by TSX in 2001, bringing it under the umbrella of the current TMX Group, and forming one-half of the two tier exchange ecosystem comprised of TSX Venture Exchange and Toronto Stock Exchange.

TSX Venture has 2,250 listed issuers (of which 162 are currently CPCs), with an additional 200 listings traded on its NEX board, a facility for companies which have fallen below TSX Venture’s financial listings standards, but otherwise comply with management and disclosure standards. NEX is often a source of traditional reverse takeover vehicles, complementing the listed CPCs as alternative avenues to the IPO method of going public. In 2011, TSX Venture had 334 going public events (IPOs, CPCs, CPC merger transactions, and reverse takeovers).

As SMEs globally seek growth capital, TSX Venture’s international stock list has continued to grow, currently with 157 international listings.

In the all important area of financing, a total of $41 billion has been raised by TSX Venture listed companies in the last five years.

The original goal of combining Canada’s regional stock markets to create a significantly enhanced liquidity pool for SMEs has been a success. Annual trading volumes have risen from 21.1 billion shares in 2005 to 64.5 billion shares in 2011, a growth rate of 206% percent.

Finally, as an ultimate measure of the success of a growth platform, since 2000, approximately 540 TSX Venture companies have graduated to the Toronto Stock Exchange, with an additional 110 which started on TSX Venture and were subsequently acquired by or merged with Toronto Stock Exchange listed companies. TSX Venture graduates now comprise about 25 percent by number of companies of the TSX Composite Index, Canada’s benchmark.


Designing a successful SME exchange is a mix of (i) finding the right balance of regulation that both fosters ease of access for issuers and maintains investor confidence; (ii) motivating and engaging the broad spectrum of market participants necessary to build a thriving market (from advisors to traders); and (iii) providing programs and services to assist the SME in meeting the challenges of being a public company. The Toronto Stock Exchange / TSX Venture Exchange two tier exchange structure has provided an ideal platform to both differentiate early stage listed companies and to integrate growth opportunities across the complete life cycle of a company.

© 2012 TSX Inc. All rights reserved. Do not copy, distribute, sell or modify this document without TSX Inc.’s prior written consent.


About the Authors :


Thomas A. Kloet became CEO of TMX Group Inc. on July 14, 2008. Prior to that time Mr. Kloet served as Senior Executive Vice President and Chief Operating Officer of the American Zone for Fimat and its successor, Newedge Group. From 2000 to 2002, he served as the first Chief Executive Officer and Executive Director of Singapore Exchange Limited. At SGX he led the exchange through its transformation from a mutual utility to a commercial entity.

He was an elected member of the Board of Directors of the Chicago Mercantile Exchange from 1996 until he assumed his position at SGX. In addition to his past board memberships at SGX and CME, Mr. Kloet served on the board of CBOE Futures Exchange, Inc., Chicago Stock Exchange and National Futures Association. Mr. Kloet currently serves on the boards of the Boston Options Exchange (BOX), the Investment Industry Regulatory Organization of Canada (IIROC) and the World Federation of Exchanges (WFE) as well as the non-profit boards of Elmhurst College and Elmhurst Memorial Healthcare.

A certified public accountant, Mr. Kloet is a member of AICPA and the Illinois CPA Society. He graduated with a bachelor’s degree in business administration from the University of Iowa in 1980.


Kevan Cowan is President of TSX Markets and Group Head of Equities, TMX Group.

Kevan joined the Toronto Stock Exchange's Canadian Dealing Network in 1997 as General Counsel. Prior to that Kevan was a partner in a major Canadian law firm. Since 1997, Kevan has been closely involved in the transformative changes that have occurred in the Canadian public markets, serving as Director of the Canadian Dealing Network, Senior Vice President of TSX Venture Exchange, Senior Vice President, Business Development of Toronto Stock Exchange, and President of TSX Venture Exchange. Kevan assumed his current role in 2008, and is responsible for the equities business of TMX Group, including Toronto Stock Exchange, TSX Venture Exchange and related trading and issuer services.