Can Venture Exchanges Be The Answer To The Small-Cap Liquidity Woes?
While we wait for the SEC to decide the next step for the tick size pilot (they have delayed action until May 6, 2015), other capital formation ideas are being discussed. In a speech delivered on March 5th, SEC Commissioner Kara Stein discussed three alternatives to the public equity markets:
Reg A+ which “would enable companies to offer up to $50 million in a 12-month period without registering its securities with the Commission, as opposed to the current $5 million limit.”
Crowdfunding which “allows small companies to harness the power of a community of small investors via the internet, to fund themselves quickly and efficiently.”
Regional exchanges – “Local or regional exchanges could be a beneficial method for connecting local enterprises to local investors and providing more secondary market liquidity. An exchange focused on venture or smaller issuers may also hold promise.”
Why are folks talking so much about alternative methods of capital raising for small companies? It’s because our public markets are no longer doing the job. Our good friends David Weild and Ed Kim from IssuWorks have issued another fantastic report titled “The U.S. Need For Venture Exchanges” which highlights the problems that continue to plague the public market for small cap stocks. Dave and Ed illustrate the problem very succinctly in this chart:
Despite major bull markets from 2002-2007 and 2010-2014, the IPO market has not recovered to its pre-Dot Com Bubble size (1991-1995)
Clearly something has changed with the US stock market model. Dave and Ed believe that market structure changes brought about by ill-conceived regulatory changes have caused the U.S. IPO market for small caps to crumble. In addition to conceiving and promoting the tick size pilot program, Dave and Ed believe that a new form of stock exchange, a venture exchange, could help solve our small-cap market problems. They say:
“The inescapable conclusion is that the collapse of the small IPO market in the United States was caused by ill-conceived and nearsighted public policy and that it can be rectified by improved and farsighted public policy that includes the creation of a regime designed to meet the very different needs of small-cap public companies. Intelligently designed “Venture Exchanges” would create a foundation for a resurgence in entrepreneurship, innovation and job creation. We believe that, once established and after perhaps a decade of operation, Venture Exchanges would lead to the creation directly (by companies accessing and investing capital) and indirectly (“muliplier effect” of jobs being created in the service sector of the economy because of the money spent by these companies and their employees) of 10 million jobs for the U.S. economy. ”
There is precedent for setting up a small cap exchange. In the U.K, London has the AIM Exchange and in Canada there is the TSX Venture Exchange. While both these exchanges have good intentions, they are also saddled with one major problem: both are owned by public stock exchange companies that have the main goal of creating wealth for their shareholders, and not the shareholders of the companies that they list. Dave and Ed believe there is a better way:
“We believe that the member-owned model was and would be superior to balancing interests and that stock exchanges with public shareholders will inevitably be tempted to siphon economics in ways that undermine the ecosystem required to support a vibrant small cap marketplace.”
What would a new venture exchange look like? According to Dave and Ed, the exchange would be member owned and regulated by a separate division at the SEC. The venture exchange would also be exempt from Reg NMS, Reg ATS and decimalization since these rules have a large cap bias (“Trading in U.S. equities markets is “one-size-fits all” optimized for the trading of large-cap stocks.“) . Dave and Ed go into much more specific detail on the makeup of a venture exchange in their paper which closes with this statement:
“The ability of the United States to sustain itself as a world leader may rest on our ability to reverse the decades long trend of lower company start-up rates and lower IPO rates. Higher levels of entrepreneurship are the bedrock of a vibrant economy. The creation of Venture Exchanges, and the natural advocacy for entrepreneurship that would emerge from these exchanges, is one of the single most important actions that policy leaders can take to reignite the American Dream and restore America’s position as the “Capital market envied by capital markets throughout the world.”
While Dave and Ed have their critics who are concerned with the standards of companies that would list on venture exchanges, we applaud them for their creative thinking and desire to help small companies raise capital.