It has been a rough year for initial public offerings in Canada. IPOs raised $1.2 billion in financing in 2008, less than half of the $3 billion raised in 2007. Given the meltdown in capital markets in 2008, it is easy to overlook the fact that it was not just a rough year for IPOs; it has been a rough decade.

“Looking back — post-Nasdaq meltdown in 2000 — the market has mostly been shut for growth companies,” says Mark McQueen, president and CEO of Wellington Financial LP, a $150-million venture debt fund based in Toronto. The IPO market “has not stopped, but it has shrunk.”

That does not mean that there are not great opportunities for investors and startups out there. Those opportunities, however, probably do not lie in IPOs right now.

For some advisors, IPOs — once vaunted as exclusive issues brokers could offer to their top clients — are losing their allure, or, rather, other securities are outshining them.

“Why chase something high-risk when you can get great value in Canadian equities?” asks Rob Lesourd, president of J.F. Mackie & Co. , an independent equity investment firm based in Calgary. He suggests that investors can pick up stocks of blue-chip companies at tremendous discounts as markets plumb the depths of the recession.

Typically, an investor is looking for 30% growth over three years from an IPO investment, and the reality is that in today’s market there are less risky ways to generate those kinds of returns. “Am I going to go buy Suncor, or chase a company that is drilling for maybe a couple of thousand barrels a day?” asks Lesourd. For the first time in a long while, value stocks are priced to sell.

McQueen suggests there is “no shortage of places to deploy a client’s money.” He says that preferred shares and structured products are the new go-to investments for brokers.

Taking into account the preferential tax treatment of preferred shares and the high dividend yields available at the moment, it is no wonder that preferred shares have brokers’ attention. And there is some product available. Canadian banks have issued hundreds of millions of dollars in preferred shares this past year.

But brokers are not the only market players who have had to find alternative new business to supplement the weak IPO market. “Right now there are 25 or 30 investment dealers trying to service growth capital,” says McQueen. “There is not enough business to keep those companies going — it is just like the car industry. If nobody is buying cars you do not need as many car manufacturers.” The money is in the big financing deals — such as the new listing for the major banks. So, that is where firms are turning their attention.

The extreme weakness in the IPO marketplace means that fewer startups are getting funding. And this suggests there will be a smaller cohort of young compa-
nies down the road. “A weak pipeline is bad for Bay Street, it is bad for investors,” says McQueen.

But some companies take the funding drought in stride, by spending less capital and staying private longer. Many young companies are battening down the hatches — raising money is probably not the typical entrepreneur’s main concern at the moment.

“Boards of directors are being more conservative, ensuring that they do not need capital right now,” says McQueen.

And McQueen notes that there are funding alternatives to IPOs for growing companies. “Raising debt is a lot cheaper than raising equity right now,” he says. McQueen’s fund provides companies with financing by way of debt rather than equity products.

Additionally, the TSX Venture Exchange offers alternatives to IPOs for companies that want to go public. A group of experienced financiers can set up a capital pool company that — after essentially issuing its own IPO — has 24 months to make a qualifying transaction such as a reverse takeover of a private company, which assumes the assets on the capital pool company’s balance sheet. The end result is that a private company is ultimately taken public and gets the financing it needs.

“It’s an alternative to traditional IPOs for very small companies,” says Kevan Cowan, president of TMX Group Inc.’ s TSX Markets division in which he is responsible for TMX’s equities business. “It gets a deal done where they might not otherwise get a deal done.”

@page_break@One solution to the lack of IPO business on the Toronto Stock Exchange, long known as the premier exchange for resources stocks in Canada, is to seek out business from non-resources companies in other global markets.

Over the past several years , the TSX has been looking for business from small- and medium-sized companies outside Canada. It has been aggressively promoting its own value proposition internationally — primarily in the U.S., China, Australia and Israel, with increasing focus on Britain, Mexico and South American countries.

The TSX’s tiered system — in which a company first lists on the TSX Venture Exchange and then graduates to the TSX — is a competitive advantage, Cowan says. Listing in Toronto has the added advantage of the expertise of a mature marketplace.

Down the road — as the market stabilizes and investors have to take on more risk in order to generate more returns — the TSX will be positioned as a major player for dynamic small businesses from all over the world.

In Canada, in the meantime, it remains to be seen if venture capital and equity will do their part.

In any event, Lesourd sees the traditional IPO market eventually coming back. Its current woeful state is part of the economic cycle and until the opportunity for good growth in value stocks disappears, investors will stay with value companies.

“Only then will investors start chasing growth again. The venture capital game will come back,” he says. IE