The outlook for the initial public offering market in Canada is murky at best, according to many industry experts. IPO activity came to a grinding halt in the second half of 2008 — IPO financing is at its lowest level since 2003 — and there is not much optimism for the year ahead.

“Until equity valuation comes back to a level [at which] companies think that it makes sense to come to market, there might be a limited number of deals coming to the marketplace,” says Jack Rando, director of capital markets for the Toronto-based Investment Industry Association of Canada. “The market for IPOs was severely impacted by the global economic and financial crisis, and equity issuance obviously had a pretty depressing year.”

Both private placements and initial public offerings dropped significantly from 2007 and only $1.2 billion in financing was raised for common share IPOs — its lowest since 2003.

“Even in a reasonably good market, IPOs can be a risky and challenging investment. So, in today’s market, I think there has to be a lot of things sorted out before we will see activity coming back to the IPO market,” says Ross Sinclair, national leader of Toronto-based PricewaterhouseCoopers LLP. “I think we have to see a significant turnaround in the overall market before we see much life coming back into IPOs. And I can’t predict when that will be.”

However, IPOs are not the only way for companies to go public and in the present market, alternative methods may be able to provide start-up companies with valuable solutions.

“The general public tends to think of IPOs as the only barometer of going public when, in fact, in Canada they have never been the sole barometer,” says Ungad Chadda, vice president of business development and strategy for the TMX Group Inc. ’s Toronto Stock Exchange and TSX Venture Exchange. “The IPO has never been the main source of going public in Canada — recession or no recession.”

Of the 126 companies that went public on the TSX in 2008, only 52 were IPOs, which suggests that 70% of those transactions came from alternative options. On the TSXV, 75% of all new company listings were of the non-IPO variety.

Companies can obtain a listing on the TSX or TSXV through a number of alternative methods including a reverse takeover, a capital pool company program or a special-purpose acquisition corporation.

“The bottom line is that the companies that either cannot or choose not to do an IPO for various reasons, end up using one of these alternative means,” says Chadda.

Chadda says that one of the main reasons a company would decide to use an alternative vehicle is that during the last 10 years the size of the minimum IPO has increased considerably.

“On average, companies in Canada are going public at an earlier stage than their peer group in the U.S. If they are going public earlier and being told that the minimum threshold for an IPO is $40 million, that is very diluted and may mean the owner manager could lose control of the company — and [he or she wouldn’t] want to risk that,” says Chadda.

“I think emerging companies tend to want to raise less money in the earlier stages and hang on to more of their company. They want to start developing their business plan and have a bit of a following. Then they would be in a much better position to say ‘now we want to raise a $100 million because we are not giving away the firm.’ ”

A reverse takeover (also known as a back-door listing or reverse merger) allows shareholders of a private company to acquire a public company and then merge them.

This process provides the private company the opportunity to go public without having to raise additional capital and is much quicker than a direct IPO. The private company’s shareholders receive a majority of the shares of the public company and control of its board of directors.

The capital pool company is a unique listing vehicle offered by the TSXV. Like the reverse takeover, the CPC has been available to investors for more than 20 years and entails two phases. In the first phase, a group of individuals raises capital — between $200,000 and $2 million — in a shell company. Once the funds have been raised, the process moves into the second phase, in which the management team identifies an appropriate business as a “qualifying transaction,” and issues a statement that it has entered an agreement in principle to acquire a business. It has up to 24 months to take a company public.

@page_break@Over the years, qualifying transactions have been surprisingly resilient, says Chadda. Although numbers have been dropping for IPOs, qualifying transactions on the TSXV have seen an increase of 24.6% since 2006.

“The increase could be part of the fact that a lot of the companies that were at that bottom end of being able to do an IPO may have had to change gears and choose an alternative route,” says Chadda, “The qualifying transaction program seems to be benefiting businesses in tough times compared with IPOs.”

One of the newest alternative vehicles is the SPAC, which was approved by the TSX in December 2008. SPACs have been around since the early 1990s in the U.S. They are pooled investment vehicles, which allow public stock market investors to invest in private equity transactions. Similar to a CPC, funds are raised within a shell company but the amounts are much larger. SPACs have a minimum of $30 million.

This investment vehicle allows the public to invest in companies or industry sectors normally sought by private equity firms.

Unlike a traditional IPO, the SPAC program also enables directors and officers to form a corporation that contains no commercial operations or assets other than cash. After raising a minimum of $30 million, a SPAC is first listed as a non-operating cash entity. The funds must then be targeted at an acquisition of an operating company or assets within 36 months of listing.

There have been no SPAC deals completed yet in Canada and the TSX is currently winding up a cross-country road show educating law firms and investment banks about the SPAC market.

Chadda says he is hopeful about the future of the SPAC market and only has to look back to 2001 and the introduction of the CPC program in Ontario.

“We spent 18 months marketing the CPC program across the country and then it just took off. Today, it is one of our flagship products,” he says. He notes the CPC program was launched during a rocky economic period, as was the SPAC program. The CPC program “took some time, but when it caught on did it ever go,” he says

Chadda says he thinks the SPAC progam will eventually affect the IPO market.

“I think it will take us into some new areas [in which] we can find bigger international companies that may appreciate being able to come and merge with [shell companies] that have all the listing and regulatory requirements,” he says. Also, the SPAC program may appeal to customers who were thinking of doing the IPO but preferred the slightly lower risk of doing a SPAC transaction.

Although there are high hopes for the SPAC market, the IPO market is far from forgotten, says Rando. But its revival depends on valuations and restoration of public confidence in the financial system.

“I think right now a lot of investors are still quite shell-shocked. It is going to take some time for their mood to swing and, when we see that mood swinging, we will be in position to see the return of the IPO,” says Rando. IE