The fundamental dilemma at the heart of securities regulation is ensuring that investors are protected while also allowing capital to flow where it’s needed to fuel economic growth. This dilemma is particularly acute where startups are concerned, which has some regulators thinking about resetting that equilibrium.

Canada is already a country with a large number of small companies. But with economic growth likely to slow in the years ahead because of the widespread effects of the latest recession, shifting global growth patterns and an aging population, the contribution of small companies may become more important than ever. Small, growing companies account for a disproportionate share of job growth and represent potential productivity gains in Canada, which historically has struggled on that count.

By some measures, the venture-capital market is relatively vibrant in Canada. The TSX Venture Exchange reports that through the end of October, total financing activity on the exchange has doubled from the previous year to more than $6.6 billion; and initial public offering activity has jumped to more than $154 million this year from about $39 million last year.

In addition, according to Dow Jones VentureSource, Canadian companies have already closed more VC deals and raised more capital from VC investors in the first three quarters of this year — $585 million from 76 deals — than in all of 2009.

But all is not rosy. Although the public venture-financing markets may be thriving and VC investing is improving, VC fundraising reportedly is struggling.

A number of the participants in the B.C. Securities Commission’s annual Capital Ideas conference in late October, which focused on operating in and regulating the venture market, report that the supply of new venture capital has been drying up for the past couple of years.

Junior companies and VC investors are a long way from the financial crisis, but it seems they are still having to face its knock-on effects. Hans Knapp, partner and general counsel with Vancouver-based Yaletown Venture Partners, explained to conference attendees that the traditional, large suppliers of venture capital (usually institutional inves-tors, such as pension funds) generally have backed away from making private-equity investments since the global financial crisis, both because of the losses suffered in their overall portfolios and the resulting shift away from riskier asset classes. As a result, Knapp noted, although there is venture capital deployed, there is very little fresh capital available.

Moreover, he added, the VC funds that do have money to invest are looking to make later-stage investments. Rather than investing with companies that are still in the research and development stage, VC funds are increasingly looking for companies that have both a product and a customer base but need funding for growth. So, not only has the overall volume of new VC money been reduced, but the supply of funding for very young companies has been particularly hard hit.

These trends aren’t necessarily affecting all sectors equally. The conference panellists noted that resources firms — particularly oil and gas plays — are having an easier time finding financing than other sorts of firms, for a few reasons. For one, their products tend to be in demand in the emerging markets that are still growing strongly. Also, there’s a greater level of investor comfort in these sectors because there is a history of successful VC investing in the resources sectors in Canada.

But, overall, there appears to be a lack of new venture capital available generally, and for early-stage financing in particular. Some of the consequences of these shortages include companies going public sooner than they might otherwise or turning to the exempt market to raise funds.

Increased interest in the exempt market is, in turn, catching regulators’ attention. Martin Eady, director of corporate finance at the BCSC, told the conference that the provincial regulator has focused increasingly on the exempt market this year in response to some of the compliance problems that have been cropping up.

As a result, the BCSC is stepping up its reviews of the offering memoranda that are being used, and is proposing to amend the reporting requirements for exempt distributions in British Columbia to increase the information available to investors.

At the same time, regulators are also concerned about the regulatory burden that small public companies are facing. They worry that this is needlessly boosting the cost of capital and making it tougher for venture companies to survive.

With that in mind, the Canadian Securities Administrators (led by Alberta and B.C., but also including securities regulators in Manitoba, Saskatchewan, New Brunswick and Nova Scotia) published a consultation paper earlier this year proposing a series of changes to venture-level issuer regulation, in an effort to reduce some of the regulatory burden that these issuers currently face.@page_break@Some of the changes they are proposing include: eliminating three-month and nine-month financial statements; reducing the disclosure requirements in annual reports; scrapping business acquisition reports; and modifying prospectus disclosure requirements.

Speaking at the BCSC conference, Bill Rice, chairman of the Alberta Securities Commission, said that these are big changes being proposed, and he indicated that regulators believe that if they are going to create a new regime for venture issuers, they’d better be large, meaningful changes; tinkering with the rules to make it easier on junior firms would probably just be confusing and annoying.

The downside of that approach, he said, is that proposing big changes is more likely to provoke concern among those who fear that these sorts of changes could represent the advent of a more lax regulatory regime.

Indeed, Rice suggested that one of the biggest challenges facing this project is the fear of change. The other main challenge, as he sees it, is getting the attention of some of the other members of the CSA. Notably, Ontario and Quebec, two of the big four provinces in terms of capital markets, are not participating in this project.

Notwithstanding these obstacles, Rice said, the regulators hope to have something concrete to propose soon.

So far, the CSA has not published the submissions it has received on this matter, although, at the conference, Eady outlined a couple of the major themes the CSA had heard during its consultations. For one, he said, most people are supportive of a tailored regulatory regime for smaller companies; very few disagree with the idea that there should be different requirements for companies of different sizes.

Many also support the notion of consolidating all of the relevant rules for venture companies in one place, instead of having them dispersed throughout the regulators’ rule books, making it tougher for firms to know precisely what the requirements are. At the same time, there’s also support for the idea of consolidating disclosure, so that investors have an easier time comprehending it, and companies aren’t producing unnecessarily numerous, voluminous, repetitive documents.

However, Eady also said, there is some concern that this initiative could have unintended consequences for the reputation of Canada’s capital markets. There’s a sense that the public venture markets are thriving in part because their reputation has improved in recent years; thus, there’s also some fear that if regulators are now perceived to be loosening the requirements for junior companies, that could unravel some of that goodwill.

Indeed, these concerns are spelled out in the submissions of a few of the groups that had commented on the CSA paper.

For example, in its comment, the Canadian Foundation for Advancement of Investor Rights indicates that although it is supportive of tailored regulation for the venture market, it believes that the existing regime is already sufficiently tailored: “We do not see the need to undertake a major overhaul of the existing ‘lighter-touch regime’ with further reductions in compliance obligations and shareholder protections.

“To introduce a regime with reduced requirements for venture issuers could add confusion, particularly for investors, and send a negative message to foreign investors about the strength of Canada’s regulatory environment,” the FAIR Canada comment adds, noting that the prospect of some provinces adopting these changes, but not others, would only add to the confusion.

The comment from Toronto-based Canadian Advocacy Council for Canadian CFA Insti-tute Societies notes that although the council believes that facilitating access to the capital markets is in the public interest, it is also important “to ensure that inves-tor confidence and trust in the capital markets is maintained.”

The CAC’s comment says it does not believe that the proposed changes will do that: “We understand the challenges faced by many venture issuers but do not believe that investors should be disadvantaged due to reduced reporting and disclosure requirements.”

Indeed, the CAC comment adds that, given the speculative nature of many venture issuers, more — not less — information is required. And neither should such firms have less onerous governance standards.

The Toronto-based Canadian Coalition for Good Governance echoes those sentiments in its submission. The CCGG’s submission urges the CSA not to go ahead with the proposal, noting that it is worried that reduced disclosure and governance requirements contained in the proposal “will result in less protection for inves-tors” and could hurt the market’s reputation. IE