A few months ago, I was at a conference reception in the basement of a hotel in Toronto. Owing to the two free drink tickets in our hands, or perhaps to the unusually warm weather outside, spirits were high.
Most of the participants at this dog and pony were somehow connected to the public markets, but there were some private companies presenting as well. I approached the founder of one and struck up a conversation. The subject of funding came up. When pressed, the young CEO told me his job in that area was to access the cheapest capital possible. Good answer.
As we continued to talk it struck me how different our experiences were. When I was in my twenties all anyone talked about was a huge IPO. Today, young people want to be acquired by Google or FaceBook or Twitter. Makes sense, you simply go where the money is, right? The founder of this company was 23. That would make him 11 when the Nasdaq crashed and 19 when the market plummeted again because of a worldwide financial crisis. To someone of that age, the stock market must seem like a gigantic money losing machine, fraught with unintended peril. Best to stay away…
Not so fast. I believe there are a number of reasons startups, especially those in Canada, should take a second look at our markets.
The founder of this company was 23. That would make him 11 when the Nasdaq crashed and 19 when the market plummeted again because of a worldwide financial crisis. To someone of that age, the stock market must seem like a gigantic money losing machine, fraught with unintended peril. Best to stay away, right? Not so fast.
First, some perspective. Over the past dozen years we have been in the midst of a massive bull market in commodities. This has been fueled by a growing middle class in China and India, who need things like copper for pipes, wires and circuit boards, and palladium for catalytic converters and spark plugs. This boom has been good for resource rich Canada, but lately things have started to change. The fact is, all bull markets eventually end and this one is showing signs of a slowdown. Investors aren’t getting the automatic returns they have grown used to, and some are looking around for other investing options.
Technology, meanwhile, once represented a significant part of the total value of the Toronto Stock Exchange, but no longer. The failure of Ottawa’s Nortel and the ongoing struggles of BlackBerry has neatly bookmarked the sector’s time since dot-com morphed into dot-bomb. But things are changing. Technology was actually the top performing sector on the entire exchange last year. This was without doubt helped by the fact that many companies have been acquired by larger, U.S. -based concerns at significant premiums, but it also reflects the fact that Canadian tech companies are growing their profits again.
Technology was once more than 40% of the value of the Toronto Stock Exchange, but today it represents barely 2%. The problem? With outsized returns available in the commodities sector, investors had little reason to look at technology stocks. Consequently, this meant there was little reason for private technology companies to IPO. Being public is expensive and adds scrutiny and looks like a bad deal when returns are flat or negative.
But you may have heard about the recently announced IPO of Ottawa’s Halogen Software, a cloud-based talent management software firm that was founded in 2001. Why would Halogen go public now? Simple: with a scarcity of listed technology companies there is a better chance Halogen will get noticed and a better chance its shares will command a premium. This makes capital cheaper to access.
Now lets look at the other side of the coin. Since 2005, the number of incubators and accelerators has exploded to the point that some are now thinking that method of growing and funding technology companies is a bubble. In a recent article for Bloomberg BusinessWeek, noted venture capitalist Paul Kedrosky joined other VC’s in his skeptcism about the current model.
“If we get out of 2013 without some noteworthy contraction, I’d just be gobsmacked,” Kedrosky told writer Patrick Clark recently. The bottom line, notes Clark, is that more and more companies are fighting for less available capital in the world of early stage funding. Not every company will be acquired by Google for a billion dollars, as messaging platform WhatsApp was recently rumoured to be. But what happens to those that aren’t acquired by Google?
The stock market in Canada is not a magical panacea for a small tech company that is looking to grow. But the funding of smaller companies does differ here from the United States in fundamental ways. Canada does not have a history of large, powerful venture capital firms that will invest in founders, nurture their companies and exit through an IPO years later. This may be changing with the emergence of firms like OMERS Ventures and iNovia, but the fact remains that a vital part of early stage funding in Canada comes through the TSX Venture Exchange.
The TSX Venture Exchange is the little brother of the TSX. The TSXV is home to earlier stage companies, and has a decent track record of graduating companies to the senior board. There have been some spectacular successes; Catamaran Corp, for instance, went public through a reverse-merger in the late nineties and went on to be named the fastest-growing company in America by Fortune magazine in 2011.
But those kinds of successes are, of course, few and far between. For most startups, even in Canada, going public is not really an option to consider. But for those more mature companies who have slipped through the cracks of private funding, I believe the scarcity of and demand for new technology companies suggest their founders should educate themselves on all the options available, including the stock market.
Those of us who follow technology in Canada aren’t waiting on a boom in tech stocks. We’re waiting on a reversion to the mean. To me, this means a healthier balance that includes more listed technology companies that will reflect the fact that tech is absolutely flourishing in places like Kitchener-Waterloo, Montreal and Vancouver.