TSX offers solid exit route for early stage VCs

After years in the doldrums, the U.S. IPO market got off to a bang in 2007 with large offerings from companies like MetroPCS and VMware coming out of the gate at record valuations. These mega-IPOs may be good news for the markets as a whole, but it’s still tough for most companies, especially those with market caps under $100 million, to go public in the United States—and it’s not going to get easier anytime soon.

As worries about the U.S. economy heighten, the U.S. capital markets are becoming increasingly difficult to crack. In the third quarter, just 12 VC-backed technology and life sciences companies managed to raise $945 million via IPOs, compared to 26 companies raising $4.3 billion in the second quarter. For small-cap companies, which have never had access to a reliable capital markets structure in the U.S. that supports their unique needs, completing an IPO on a U.S. exchange will be an even bigger challenge in the months to come.

But venture-backed companies do have options for raising growth capital beyond further venture rounds or private equity financing. They can, indeed, turn to robust and dynamic capital markets to raise public funds—just not in the United States. Many companies know they can list on London’s Alternative Investment Market (AIM), and more adventurous companies have sought listings in Hong Kong, Singapore and Dubai.

There’s also a market closer to home: the Toronto Stock Exchange (TSX) and its micro-cap market TSX Venture Exchange. TSX Group, which owns both exchanges, has more listed public companies than any other exchange in North America, including Nasdaq and the NYSE, and is home to more than 340 technology companies and over 140 life sciences companies. With over 3,900 listed companies, TSX Group is a significant player in the global equity markets, coming in fifth in total capital raised in 2006 and counting more listed U.S. companies than any other foreign market.

Not just Nasdaq

Most venture-backed companies that manage to go public on Nasdaq have annual revenue of well over $50 million and a market cap of at least $200 million to $300 million. But TSX, AIM and other small-cap foreign exchanges accept much smaller companies, even early stage startups that might otherwise seek to raise venture capital. On TSX Venture Exchange, for example, the current average market cap of a public company is just $29.1 million.

An IPO on a small-cap exchange like TSX can be a compelling exit route or growth vehicle for venture-backed companies, especially amid a tightening U.S. IPO and M&A market. As venture capitalists explore all options for exits in the months and years to come, they may do well to consider “early IPOs” over late-stage venture rounds, each of which successively dilutes their equity stake.

Many technology and life science companies—especially those heavily invested in research and innovation—have long-term horizons toward profitability and need significant capital to reach their goals. Early IPOs generate growth capital with potentially less dilution of equity holdings. VCs retain their existing equity stake and become shareholders of public stock, which they can either sell to generate returns, or hold until further value is realized.

An IPO on a small-cap exchange like the Toronto Stock Exchange can be a compelling exit route or growth vehicle for venture-backed companies, especially amid a tightening U.S. IPO and M&A market.”

Kevan Cowan

Many U.S. growth companies that want to raise capital never think about going public, because they assume the Nasdaq—with its structure supporting later stage, larger-cap companies—is the only game in town. Going public at an early stage is a relatively new concept for U.S. companies and their venture investors, who are more likely to seek late-stage financing rounds that knock down their equity stakes.

Early IPOs are especially advantageous to early stage VC firms, which can be dramatically diluted—or pushed out altogether—in later stage financings due to their inability to follow-on amid increasing valuations. With an early IPO, early stage firms retain their initial ownership and achieve an exit.

Web hosting company Hostopia.com, based in Fort Lauderdale, Fla., is one venture-backed company that successfully leveraged public capital raised on TSX to grow its businesses. Hostopia.com had previously raised $5 million in one round of VC from Telus Ventures of Vancouver. Already profitable when it listed on TSX in November 2006, Hostopia.com has since parlayed the $22 million it raised in its IPO into further growth, increasing revenue 25% in fiscal 2007.


When many VCs seek to exit their portfolio firms via international IPOs, they first think of London’s AIM. While several venture-backed companies from the U.S. have listed successfully on AIM, venture investors should know the risks before backing such exits.

For example, some companies are hesitating to list on the market as liquidity problems become more apparent. According to a recent article in The Financial Times, in the 12 months ended in August, AIM had 365 admissions and 259 cancellations, giving it a net gain of 106 companies—easily the smallest year-on-year percentage rise since its June 1995 formation. (TSX Group listed 283 new companies in the first six months of 2007.)

The Times article went on to say that in a typical month this year, about 40% of AIM’s 1,789 stocks saw turnover equal to just 1% or less of their market capitalization. In another comparison, during the first six months of 2007, AIM counted 2.1 million trades at a total value of $79.6 billion, while TSX Group had 58.3 million trades valued at $796 billion.

U.S. technology companies have been particularly attracted to AIM, but liquidity on the London market isn’t any better in that sector. The average number of daily trades on AIM in the tech sector numbered just 1,436 as of June 2007, compared to 21,343 average daily trades of TSX tech companies. Values of AIM technology companies are also fairly low: As of June 2007, the total value of AIM technology shares traded was $4 billion, compared to $28.2 billion for TSX Group tech companies.

Early IPOs are especially advantageous to early stage VC firms, which can be dramatically diluted (or pushed out altogether) in later stage financings due to their inability to follow on amid increasing valuations.”

Kevan Cowan

Raising funds the Canadian way

More and more U.S. venture-backed companies are finding TSX Group exchanges to be a highly attractive option for raising capital closer to home. TSX has been the go-to market for small-cap companies for 150 years. It understands the unique needs of small-cap companies and has a regulatory structure in place that is relevant to their size.

Chances are, a $150 million market cap company listed on Nasdaq will get little investor attention, low liquidity and no analyst coverage. A $150 million company on TSX is considered a sizeable company—and is much more likely to get analyst coverage and significant liquidity. Canada’s large retail and institutional investor base is used to trading small-cap companies alongside blue chips.

TSX Venture Exchange welcomes micro-cap companies, or even companies at the “nano-cap” level. Typically, companies raise just $5 million to $10 million when they first go public on TSX Venture Exchange, then they go back six to 12 months later and raise a further tranche.

When companies go public early, it’s a win-win for entrepreneurs and early stage VC firms, because companies can raise growth capital with less dilution. In fact, listing on a small-cap exchange is much more akin to a growth tool than a traditional exit. Companies like Hostopia.com not only raise the growth capital needed to expand their businesses, but their venture backers grow returns as well. If venture investors maintain their equity stake even after a portfolio company becomes public, the potential upside several years down the line is even greater than taking an immediate distribution upon IPO.

Going public on a small-cap exchange is not the right solution for every venture-backed company. Raising late stage venture funding in anticipation of a large-scale IPO is the classic venture model, and it still works for companies that plan to generate over $50 million in revenue before seeking public capital. But for successful, profitable companies on a smaller-scale—those that may never attain a multi-billion dollar market cap—going public early can make a lot of sense.

Being a public company on any exchange, whether TSX, AIM, Nasdaq or the NYSE, brings with it a dose of accountability that drives many companies to become more successful every quarter. And, who knows, if a company’s success is amply rewarded by shareholders, it may move up to a large-cap exchange and make it to that billion-dollar market cap after all.

As the U.S. economy navigates the rocky waters ahead, I think we’ll see more and more U.S. companies turning to foreign small-cap exchanges to raise capital. After all, Nasdaq isn’t the only game in town.

Kevan Cowan is President of TSX Venture Exchange. He may be reached at Kevan.cowan@tsxventure.com.