Of the roughly 2,250+ listed companies on the Canadian venture exchanges, which are among the most active startup stock exchanges in the world, approximately 5%, if not less, are profitable. Most companies on the Venture exchanges (TSX-V; CSE) are very early-stage startups rather than true growth opportunities.<\/p>\n
This tends to mean that their ongoing operations are dependent on raising capital, in an environment where terms are at the mercy of market volatility and trendy (spotty) demand. This is not a new dynamic of capital markets and isn\u2019t expected to change any time soon. Public venture markets are a match-making environment of pairing companies with risk-takers.<\/p>\n
In this article I will attempt to help investors and companies seeking their next financing understand the true costs associated with a private placement (the most common financing structure for Canadian Venture-listed companies).<\/p>\n
Experiencing both sides of raising capital has helped me understand the complexities of the situation. On one side, there\u2019s the risk taker, who invests his capital seeking a return. On the other side, there\u2019s the Company, which is looking for investment to continue growing.<\/p>\n
It\u2019s a delicate balance, and at first I didn\u2019t spend much time trying to understand the implications from a Company\u2019s perspective. But an understanding of what happens inside a Company when they\u2019re trying to raise capital in the public markets can also help investors understand what to watch for, or watch out for, when a company they are invested in is raising money. A company financing can tell investors a lot about management, the company\u2019s existing investor base and the general investor appetite for the company or its industry.<\/p>\n
Let\u2019s start with what is often most easily understood, the numbers.<\/p>\n
Expense and fee structures for each private placement are unique, but roughly follow some guide as below:<\/p>\n
At first glance the net costs of $875K from roughly $1M aren\u2019t so bad. However, while I\u2019d love to imagine raising capital was this easy and transparent – unless management or the board of directors has sufficient capital markets experience, or the Company has a bonafide sponsor, many companies end up going down a different path. Let me share with you, more commonly, how private placement transactions proceed.<\/p>\n
Some examples of hidden costs not included:<\/p>\n
After including a relatively small marketing budget of $250K, the gross proceeds after all costs are $625K for management to re-invest in the business. Remember, it costs roughly $200K per year for a public company to operate, given exchange fees, lawyers, accountants and miscellaneous public fees, which leaves a relatively small amount left for the business.<\/p>\n
It\u2019s typical to include some type of marketing costs, whether it be hard cash or a cheque swap (which is when a Company pays for a service with a cheque and the service provider then gives a cheque back to the Company to participate in the private placement), because this is how the brokers or sponsors typically protect their investment.<\/p>\n
A broker\u2019s primary incentive is collecting fees, which in this scenario is based on the total dollars raised. Therefore, while focused on raising capital to pay themselves, brokers also need to maintain their clients\u2019 snowball of cash. The broker\u2019s true investment is turning over their clients\u2019 cash to repeat the process with another company.<\/p>\n