toward more democratic corporate financing

Toward more democratic corporate fi nancing

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TOWARD MORE DEMOCRATIC CORPORATE FINANCING

Why do Quebec‐based companies shun public capital markets? Compared to companies elsewhere in Canada, the proportion of Quebec companies listed on a stock exchange is much smaller, and the gap has been growing for several years. This reluctance means that high‐growth Quebec companies are depriving themselves of one of the most effective means to improve their competitiveness and achieve sustained growth, on global markets. Acting on their own initiative, PwC and FMC have attempted to address this question. To that end, we met with more than 60 business leaders from Quebec to elicit their comments. The pros and cons of accessing public capital markets are essentially the same from coast to coast since securities regulation has been largely harmonized across Canada. So why then are Quebec executives less willing to resort to public markets than their colleagues in other parts of Canada? The perspectives portrayed by the business leaders, our analysis of their comments and the conclusions we have drawn form the basis of this report. We have also provided a number of recommendations based on our observations. One of our findings was that the leaders of both publicly traded and privately held companies recognize the advantages of accessing public capital markets. Unsurprisingly, they also recognize a number of disadvantages. The following conclusions may be drawn about the relative advantages and disadvantages of going public, as described by our interviewees: Privately held companies:

Recognize the potency of public markets.

Underestimate the reputational benefits of being a public company.

Place more emphasis on the disadvantages of going public. Publicly traded companies:

By a vast majority, would “not hesitate to go public” if they had to do things over again. The CEOs’ perspectives led us to conclude that the answer to our question may be found, in part, by analyzing what we have referred to as Quebec’s “financial ecosystem”. The characteristics of this ecosystem are determinant factors in terms of the available options and the financing choices made by Quebec‐based companies .

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The consolidation of the Canadian securities industry by the banking sector has led to a focus on larger corporate issuers and their exit from the small cap segment. Moreover, private placement financing by public and tax‐advantaged funds is relatively more important in Quebec than it is elsewhere in Canada; these institutional investors have not demonstrated a great propensity to have recourse to initial public offerings (IPOs) as an exit solution. This report contains a number of recommendations that are designed to provide a better balance among various equity financing options. In developed economies, financing through public capital markets is an essential component of a balanced and high‐performing financial system. To that end, we call for measures aimed at:

Promoting public financing of Quebec’s small cap companies.

Promoting financing through public capital markets by rehabilitating the multiple‐voting share capital structure and correcting perceptions so that choices are made based on balanced and informed opinions about the pros and cons of going public.

Promoting a greater familiarity of the regulatory environment.

Encouraging individual investors to participate in small cap financing, including the use of tax incentives different from existing ones.

Fostering the long‐term growth and perennity of Quebec headquartered companies.

Promoting Quebec’s entrepreneurial culture. Our report places special emphasis on the mining sector, given its pivotal importance to the Quebec economy. Michel Brunet Chair FMC

Pierre Lortie Business Consultant FMC

Guy LeBlanc Associate Director PwC

Russell Goodman Partner PwC

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TOWARD MORE DEMOCRATIC CORPORATE FINANCING

INTRODUCTION

Even though Quebec accounts for 23.2% of the Canadian population, Quebec corporations listed on the TSX and TSX Venture Exchange account for only 13% and 9% respectively of the total number of publicly traded Canadian corporations. In 2010, 74 Canadian corporations were newly listed on the TSX, but only three of them were from Quebec, of which two graduated from the TSX Venture Exchange. Only 11 of the 206 new listings of Canadian corporations on the TSX Venture Exchange were from Quebec. In fact, in 2010, Quebec corporations accounted for only 5% of all new listings (5.5% excluding the oil and gas sector). Quebec companies’ share of the total new stock exchange listings in Canada has been rapidly declining. Why?

The vast majority of Quebec’s flagship companies accessed the public capital markets early in their development. It is doubtful that Alimentation Couche‐Tard, Astral, Bombardier, CAE, CGI, Cascades, SNC‐Lavalin, Transat, Transcontinental, Uni‐Sélect and many others would have been so successful had they remained private, relying exclusively on internal capital and forgoing the inflow of permanent external capital. More often than not, their IPOs sought to raise relatively small amounts: Cascades, $5 million; Uni‐Sélect, $3 million; CGI, $10 million.1 Who will be the drivers of tomorrow’s economy if so few Quebec companies adopt a capital structure aimed at promoting development and sustaining growth?

If companies hope to grow quickly, they need plenty of equity capital. Few companies can support accelerated growth exclusively with internally generated funds. Securing outside capital is therefore an obligatory step, an absolute condition of success—provided that management wants to maximize the company’s potential.

We acknowledge from the outset that public financing is not suitable for every company. It is a source of permanent capital with many advantages; however, it also entails various requirements and obligations. Nonetheless, in developed economies, financing via public capital markets is an essential component of a balanced and high‐performing financial system.

A number of hypotheses have been put forward to explain why Quebec companies are so under‐represented on Canadian stock exchanges. We sought to validate those hypotheses because the situation we observed leaves us concerned with respect to the future vitality of Quebec’s economy. Our investigation was therefore designed to identify why Quebec entrepreneurs behave so differently with respect to public capital markets compared with their counterparts in other provinces, particularly Alberta, British Columbia and Ontario. We also sought to identify the principal factors behind Quebec corporations’ seeming lack of interest in going public.

To answer the first question, we solicited the opinions of corporate executives because the decision to resort to the public capital markets stems primarily from the vision and objectives of senior management (and owners) concerning the nature and future of their company. For the purposes of our survey, we consulted individually with more than 60 senior executives, divided into five distinct groups.

1 The equivalent amounts in 2011 dollars are $10.4 million for Cascades, $5.5 million for Uni‐Sélect and $17.6 million for CGI.

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The first group consisted of executives whose companies have listed on the TSX in the period since 1985. Their experience made it possible to assess the advantages and disadvantages of being a listed company with some degree of objectivity. The second group consisted of executives of companies that are or were listed on the TSX Venture Exchange; this exchange differs substantially from the TSX in terms of dynamics and participants. The third group consisted of executives, often the owners, of privately held companies; to gain an understanding of the phenomenon we are examining, ascertaining their viewpoints was essential.

Two other groups were consulted because of their key corporate finance roles. The first consisted of executives from securities brokerage firms active in Quebec’s corporate financing sector; the second consisted of institutional and private investors.

This report is intended to provide decision‐makers in the private and public sectors with an informed diagnosis of the factors underlying the current situation and to propose measures aimed at accelerating the development of high‐growth or “dynamic” companies, which are responsible for most net job creation within an economy.

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1. PERSPECTIVES OF CORPORATE EXECUTIVES AND OTHER STAKEHOLDERS

1.1 CORPORATE EXECUTIVES

The decision to launch an initial public offering (IPO) has a number of serious consequences. Following an IPO, senior executives have to take on serious responsibilities towards the many individual and/or institutional shareholders who bought the company’s business plan and trust in the company’s ability to methodically implement it. The decision to go public is virtually irrevocable because it is so difficult to backtrack and take “their” company back by going private.

Public capital markets are the main source of financing for Canadian corporations. In December 2010, financial market instruments accounted for 64.9% of the total capitalization of Canadian businesses. The value of the share capital issued annually by listed Canadian companies is 10 to 15 times larger than that of financing obtained from other sources. This is an inescapable fact of life for all those who are concerned about the development of the Quebec economy and its key companies.

The main advantages and disadvantages of public company status are well known. We asked the leaders of the participating companies to rank the relative advantages and disadvantages associated with gaining access to public capital markets.

Advantages

- Raising equity for financing growth or acquisitions.

- Reducing company debt.

- Allowing founders/senior executives to realize a portion of their investment in the company and diversify their holdings.

- Creating a currency for acquisitions.

- Enhancing a company’s visibility and image with clients, suppliers, employees and governments.

- Facilitating the establishment of employee incentive programs.

Disadvantages

- Cost of an IPO.

- Weakening/loss of control of the company.

- Regulatory burden, including initial and recurring costs.

- Information disclosure requirements.

- Need to maintain ongoing contacts with investors and financial analysts.

The survey results for the advantages are shown in Table 1; those for the disadvantages are shown in Table 2.


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Table 1 Relative importance of the advantages of being a publicly traded company

according to public and private company executives

Creating a currencyfor acquisitions

Raising equity for financing growth oracquisitions

Enhancing the company’s visibility and imagewith clients, suppliers,

employees and government

Facilitating the establishment of employeeincentive programs

Allowing the founders/executives torealize a portion of their investment in the

company

Reducing company debt

83%

59%

45%

38%

50%

33%

56%

37%

38%

48%

77%

91%

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Table 2 Relative importance of the disadvantages of being a publicly traded company

according to public and private company executives

Based on the respondents’ answers, the main observations may be summed up as follows:

- Private company executives, like those of publicly traded companies, acknowledge the advantages of gaining access to the public capital markets.

- As a general rule, private company executives attach greater importance to certain advantages and underestimate others that public company executives deem very important.

- Private company executives attach much greater importance to the disadvantages than public company executives do.

The comments we compiled reinforce the message stemming from the quantitative data. The vast majority of public company executives stated clearly that they would not hesitate to go public if they had to do things over again. All those who had a favourable opinion insisted that they were pursuing demanding growth objectives, which their IPO had enabled them to finance by investing the offering’s proceeds or using their listed shares as currency. Companies with long‐term plans that were implemented as anticipated had success in the market and earned high valuations. On the other hand, those who did not achieve significant growth or failed to generate the expected return on their capital tended to struggle. Corporate executives’ viewpoints about their public company experience clearly varied according to category.

Need to maintain ongoing contacts with investors and financial analysts

Regulatory burden

Disclosure requirements

Cost of an IPO

Weakening/loss of control of the company

71%

45%

59%

43%

63%

42%

50%

38%

38%

56%


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Public company executives tended to disagree with the statement that “public companies are forced to focus on the short term at the expense of the long term”. The remarks of one executive neatly summed up the general opinion: “It is wrong to say that [public companies] are managed exclusively for short‐term considerations. A disciplined management team can respond appropriately to information requirements without losing sight of medium and long‐term objectives.”

A number of public company executives said that their main motivation in carrying out an IPO—and one of the main advantages of being listed on a stock exchange—was to diversify their financing sources. They see an IPO as a way of “making corporate financing more democratic”. One executive said that the banking syndicate he had done business with for decades “was suddenly no longer there in 2009, when the time came to renew our lines of credit”. In his view, the fact that the company was publicly traded and had performed well over the years allowed management to replace the banking syndicate on advantageous terms in record time. “As a private company, I doubt we’d have been able to complete the refinancing within the timeframe and on the same terms we obtained,” he said.

Public company executives often pointed out that being listed had increased their visibility and status with their clients and suppliers as well as with government authorities, which in turn helped to generate more business opportunities and thus facilitated both organic and acquisition‐driven growth. “It’s a nice way to introduce yourself to potential clients,” said one interviewee. Several individuals noted that public company status made it easier to recruit better qualified and more experienced personnel, thereby contributing to better performance. Most were of the opinion that it is much easier for public companies to obtain bank or institutional financing and implement employee and executive retention plans. Moreover, some pointed out that it was much easier for public companies to determine the division of assets among members of the second (and third) generation and thus to ensure the perennity of the company.

Most of the public company executives acknowledged that disadvantages did exist but felt that they were outweighed by the advantages. They had learned how to manage these disadvantages and had implemented various systems and procedures in response to public market requirements. Some even saw benefits for their companies: “Regulation forced us to be more rigorous in our financial management, which resulted in our closing the books faster, adopting corresponding financial controls and setting up an internal audit department. In short, we had the resources we needed to continuously improve our performance as well as our capacity to manage growth.” Nevertheless, public company executives remained critical of constantly changing regulations (IFRS conversion, etc.), which are becoming more onerous.2 They were also disturbed by the dysfunctional impact of “regulatory inflation”, especially as it affects small cap companies. But the aspect they found the most troublesome was the time they had to spend explaining strategic goals, major projects and results to analysts and institutional investors. Their complaints seem justified. The executives of small cap public companies often expressed more nuanced views than those of larger companies concerning the advantages of being listed and were less forgiving in their judgments about the related disadvantages and challenges.

2 Some Quebec companies are reporting issuers in the United States and therefore have to comply with US regulations (e.g. Sarbanes‐Oxley, etc.).

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Most of the private company executives we surveyed did not see an IPO as a desirable option. Dilution of control, “executive” personality traits (with many CEOs unwilling to take on the public role that being listed entails) and an externally “imposed” rate of growth were the arguments most often cited. Public company executives maintained that the standards imposed by public capital markets are demanding but manageable; in contrast, private company executives mainly see these standards as leading to a loss of autonomy and an increased workload, including activities that, in their view, do not add value to their companies. It is also clear that media visibility, pressure to grow and the obligation to issue quarterly financial statements hold no appeal for them.

A number of private company executives were quick to assert that in Quebec, the availability of capital to finance development and expansion is not an issue; they see capital as abundantly available. Several claim to enjoy the benefits that accrue to public companies without having to contend with the disadvantages. As they see it, they already have ready access to capital, rigorous management, high‐quality financial systems and good governance, thanks to outstanding boards of directors and advisory committees. Most of all, they feel that they have the flexibility they need to make required corrections quickly, if needed. They also contend that they have lower financing costs without the constraints of having to issue strategic and financial information about their activities.

Some executives see institutional private financing as a transitional step toward an IPO and being listed on an exchange. Significantly, a number of executives who see advantages in “staying private” are not interested in considering an investment by a private investment fund or a venture capital firm. Such investors generally seek returns that are commensurate with the risks they incur and their investment time horizon is relatively short. The objective of private investors or venture capitalists is to maximize the value of their investment when they exit; it is highly unlikely that their need for short‐term performance would be preferable to the “tyranny” of public markets, which, at least, provides permanent equity capital. In both cases, rapid sustained growth is required. Obviously, not all company owners or executives are willing to comply with such performance requirements, especially when they believe that Quebec society does not value such efforts.

Other executives see institutional private financing as a trap to be avoided. One interviewee said that one of the advantages of launching an IPO is that “you’re not locked into a shareholders’ agreement, especially if there are multiple institutional investors”. This individual said he would like to give the public capital markets a try but had put off doing so because of “the boycotting of small caps” and the fact that the size of the issue “would create liquidity problems”.

The costs associated with an IPO and the information, control and governance requirements imposed on publicly traded companies doubtless constitute another major disadvantage of going public.


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Table 3 shows that, in general, private company executives downplay the advantages of being listed.

Table 3 Perspectives of public and private company executives

I think that listing my company on the stock

exchange enabled (would enable) me to seize more investment opportunities

77

45

I think that listing my company facilitated (would facilitate) bank borrowing or bond financing

56

45

I think that our financing costs are (would be) lower than if we’d stayed private

48

47

Public companies are forced to favour the short term over the long term

40

43

The concerns that private company executives shared with us are valid and relevant. However, they do not explain the substantial gap between Quebec and the other provinces in the propensity of companies to access public capital markets. The regulatory requirements that apply to listed companies are essentially the same coast to coast, thanks to sustained efforts by provincial authorities to harmonize them. The stated advantages and disadvantages do not vary from province to province. The costs are the same throughout Canada, except for translation costs for Quebec‐listed issuers. So when the time comes to weighing their options, why do Quebec‐based executives reach different conclusions than those in other provinces?

1.2 MINING SECTOR

The importance of Quebec’s mining sector and the specific factors associated with financing mineral resource exploration and development in Canada justify the special attention that we have paid to this sector.

The viewpoints of executives of mining companies headquartered in Quebec are similar to those of public company executives with respect to the advantages and disadvantages of being listed. However, as far as the mining executives are concerned, being listed is a necessity, not a choice. Nevertheless, they remain highly critical of Quebec’s financial sector, which they consider deficient in several respects. They condemned the lack of major Quebec institutions willing to finance mining projects: “They wait until we are on third base!” One executive offered this terse assessment: “Montreal is out of it, as far as mining finance is concerned. In Canada, it all happens in Toronto, Vancouver or Calgary”; this pretty well sums up the mining executives’ point of view. We also noted that the relative lack of mining financing activity negatively affects the quality and expertise of professionals serving companies in this sector.

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We met with executives from mining companies of various sizes. They were unequivocal in their assertion: no public financing means no business. Overall, they see a TSX Venture listing as an obligatory step in financing “junior” exploration and production companies. The flow‐through share process is powerful and necessary, and the SODEMEX and SIDEX specialized funds play a little‐known but vital role in the financing of Quebec junior mining companies. Securities brokers active in this market segment also share that view.

In the mining exploration sector, emulation is an important factor that manifests itself in three ways. First, activity rapidly shifts to successful locations. For example, during the hard times between 1993 and 2000, exploration companies took advantage of the discovery of diamonds in Canada’s North and nickel, copper and cobalt at Voisey’s Bay. Similarly, in Quebec, the development of the Lac Bloom iron ore deposit led to several other potential projects in the Labrador Trough area. Second, to successfully finance junior companies, investors must be convinced that three key factors are present: favourable metal prices, positive prospects and good progress in project implementation. Once again, the participation of certain investors, particularly those considered highly knowledgeable, attracts other players. Third, the success of some companies encourages other industry “specialists” to jump in and start companies of their own.

Nevertheless, the comments we heard do not provide a satisfactory answer to the underlying question: why are Quebec mining companies under‐represented on the TSX and TSX Venture Exchange when Quebec is home to some of the most extensive and most promising mineral resources in Canada? The following observations offer some insights:

Entrepreneurship: The leaders we met with were bullish about Quebec’s mining industry and proud of the expertise and quality of Quebec geologists and mining engineers, who work all over the world. They added, however, that their enormous technical experience does not prepare them to lead a small mining company, where close interaction with the financial sector and familiarity with the demands of capital markets are key success factors.

Education: Mining exploration and development activities are inherently very risky. It must therefore be expected that many if not a majority will be partial or total failures. On the other hand, the successes generate high returns. This high‐risk profile is far from suitable for many investors. It must be admitted, however, that investors in other provinces show much greater interest in this profile than Quebec investors do. The suggestion that this might be a “cultural difference” is unconvincing.

1.3 SOCIAL ENVIRONMENT

One factor that often came up in our interviews was the conclusion, tinged with some bitterness, that entrepreneurial success was often disparaged rather than welcomed in Quebec and that any sense of entrepreneurial zeal had faded. The executives we met with were enthusiastic about the initiative taken by Marc Dutil, of the Canam Group, in founding the École d’Entrepreneurship de la Beauce, an unprecedented private venture in Quebec. Nevertheless, it soon became clear that the social environment was a significant factor in the phenomenon we were trying to understand.

Data on entrepreneurship in Canada published recently by the Fondation de l’Entrepreneurship du Québec and the Business Development Bank of Canada support the diagnosis provided by these executives. The survey results in Table 4 indicate that Quebec lags behind most regions of the country at every stage of the entrepreneurial process.


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Table 4 Entrepreneurship among the Canadian population

Canada Alberta/BC Ontario Quebec

Plan to become entrepreneurs 11.2% 16.9% 11.1% 6.9%

Efforts underway 4.6% 6.1% 4.8% 3.6%

Company owners 10.1% 13.2% 11.4% 5.1%

Closings 6.7% 8.5% 6.4% 5.5%

According to our survey results, the proportion of Quebecers who plan to become entrepreneurs is virtually half that of Canada as a whole—a warning sign that our pipeline of emerging companies with high‐growth potential will dry up. Where will we find the next crop of entrepreneurs ready to take the place of the many people who will be retiring in the next decade?

It would also be a mistake to underestimate the impact of emulation within the business world on the behaviour of business leaders. Our interviewees acknowledged that this factor is a powerful incentive. The strong crop of IPOs in the 1960s and the mid‐1980s clearly illustrates the ripple effect and the importance of emulation in creating and maintaining a fertile environment. There is little doubt in our minds that many of the private company executives we met with would not feel as hesitant if they did not feel that they were the only ones considering this step. Several public company executives emphasized that from 1983 to 1987, when Quebec companies launched an unprecedented number of IPOs, “there was a buzz in the business community”, sustained by frequent formal and informal contacts among business leaders, financiers, accountants and lawyers. The public status of a number of large institutional investors in Quebec fosters a sense of reserve among their executives and creates a more structured framework for their dealings. The situation is different in Toronto and Calgary: “When you go to a restaurant, you see the whole financial community interacting with business executives. Everyone is trying to do a deal. You don’t see that in Montreal anymore.”

1.4 QUEBEC’S FINANCIAL ECOSYSTEM

For companies that have passed the start‐up stage and need external capital, the financial sector is unavoidable. In our study, three facets of the financial sector were examined: the role of securities brokers, the role of institutional investors with respect to small cap companies3 and the role of institutional investors in the area of private placements. These roles are interlinked—a characteristic that was frequently noted by the interviewees. We also noted that the structure of Quebec’s financial services industry has a decisive effect on behaviour.

3 The criteria defining a small cap company differ by jurisdiction. In the US, the Advisory Committee on Smaller Public Companies defines a small cap company as one whose market value is approximately between US$129 and $787 million. Companies with a market value of less than US$128 million are defined as “microcap companies”. The EU defines SMEs according to the maximum value of their net assets: about $65 million for a medium‐sized company, $20 million for a small company and $4 million for a micro‐company. Statistics Canada defines an SME as any business establishment with 0 to 499 employee and less than $50 million in annual revenues. For the purposes of our report, a small cap company is defined as a public company with a market value of between $5 million and $50 million.

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1.4.1 Quebec’s securities industry

Amendments to the Bank Act in 1987 authorized Canadian banks to engage in securities brokerage activities either directly or through a subsidiary. Within the space of just a few years, these activities were consolidated within banks that today account for nearly 70% of the securities business in Canada. In Quebec, the five largest brokerage firms account for 82% of assets received from individuals. This concentration within large institutions is not without its consequences, in particular with respect to their policies on public financing of corporations.

We noted that our interviewees in the major banking institutions were all targeting the same market segment: IPOs with a minimum value of $50‐$75 million, corresponding to an average market capitalization of about $250‐$300 million. In their view, few Quebec companies meet their criteria; those that have reached the desired size are in no rush to access the public capital markets. In this respect, it must be recognized that the cost structure of these major Canadian institutions, the compensation packages for executives of their brokerage subsidiaries and their representatives and concerns about the risks of damaging a bank’s reputation due to the failure of a company underwritten as part of an IPO are important factors that influence bankers’ behaviour.

The same phenomenon was observed in the US: after the Gramm‐Leach‐Bliley Act was adopted in 1999, revoking the Glass‐Steagall Act and allowing the commercial banks to engage in securities trading, commercial banks acquired the vast majority of brokers specializing in small company financing. Concurrently with this restructuring of the US securities industry, the number of IPOs dropped significantly, mainly in the small and medium cap category, while the number of new listings on the American Stock Exchange and NASDAQ also declined.

It is important to distinguish between the characteristics and dynamics of the public capital markets and the internal considerations that determine which activities an institution wants to or can pursue. The argument that the “public markets are not made for small companies” is not very convincing in view of what is happening in other Canadian provinces and other parts of the world. In fact, 206 Canadian corporations were listed on the TSX Venture Exchange in 2010 and the average IPO value of these companies was $6.6 million ($4.0 million in 2009).

Two or three Quebec securities brokerage firms have focused on the small‐cap segment of the IPO market. Our interviewees indicated that this activity met their company’s profitability objectives. For some of these firms, this is a recent development. The fact remains, though, that this activity is viewed critically and marginalized by the Quebec financial sector. This attitude hinders the development of this market segment in a number of ways. For example, institutional funds generally refuse to participate as lead investor in these issues on the grounds that the investment would be too small for them. In another case, a specialized manager known for this type of investment was turned down by institutional funds on the grounds that they could do it better directly!

It would be surprising if the structure of the Quebec securities industry did not have an effect on Quebec companies’ propensity to resort to the public markets. A review of income trust IPOs is revealing. This financing structure, typically associated with the real state sector, was extended to other economic sectors beginning in 1995. The formula was well received: by 1997, the value of income trust IPOs in Canada stood at $10.3 billion. Yet the first income trust IPO was not launched in Quebec until 1998.


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In subsequent years, Quebec income trust IPO amounts remained low compared with those in Ontario and the rest of Canada; since 1995, the gross proceeds of Quebec income trust IPOs accounted for 9% of the Canadian total. However, Quebec companies that availed themselves of this form of public financing (such as Boralex, Genivar, Yellow Pages Group, Transforce, etc.) experienced strong growth, fuelled by numerous acquisitions.

The fact cannot be denied: in every jurisdiction, the vitality of public financing of small caps hinges on the existence of securities brokerage firms specializing in that market sector.4 The ownership of such companies is generally local and independent of major national and international financial groups. The conclusions of an impact analysis of Quebec’s provincial stock savings plan (REA) are especially relevant:

“In addition, the REA has literally enabled the public financing industry to take shape. Before the REA was introduced, few brokerage firms were really active in this field in Montreal. Expertise was generally lacking and little research was done locally. In 1986, there were at least eight Quebec firms active in public financing, up from two a few years earlier.” (Secor, 1986)

This structural change in the Quebec securities industry, characterized by the emergence of a significant number of independent firms, is one of the key factors explaining the large number of IPOs made under the REA program between 1983 and 1988. These independent securities firms have, for the most part, disappeared from the scene in Quebec but are still quite present in the other provinces. In theory, Canadian firms specializing in small cap financing should view Quebec as a promising market without much competition. In practice, the dearth of IPOs is a signal that the Quebec environment is IPO‐unfriendly—if not downright hostile. As a result, according to the executives of these companies, the chances of success are not commensurate with the resources and efforts that would have to be expended.

We asked executives of public and private companies the following questions: Do you think the quality of advisors in Quebec is comparable with that of advisors elsewhere in Canada and do you think there are enough such advisors (publicly traded companies)? As regards financing, would you have trouble identifying experienced advisors in Quebec (privately held companies)? The private company executives were considerably more positive (71%) than their public company counterparts (56%). The aspect that virtually everyone agreed on was that the vast majority of financial analysts are located outside Quebec. This has various consequences. First, it imposes English as the language of communication, which penalizes some management teams and the stock prices of the companies they manage. In addition, distance does nothing to promote informal relationships between analysts and company management. This situation has a greater impact on small cap companies because valuations place a certain weighting on management team quality in relation to the company’s business plan. Finally, analysts’ reports contribute significantly to promoting trading in shares, thus promoting liquidity.

4 An analysis of securities market performance following IPOs made between 1980 and 2000 in the US concluded that companies whose IPOs were underwritten by the main brokerage firms (“top‐tier underwriters”) or financed by a venture capital company demonstrated relatively higher volatility and had a lower rate of survival than those whose IPOs had been underwritten by specialized brokerage firms (Peristrani, 2003).

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1.4.2 Institutional investors and small cap companies

Liquidity, that is, the ability to quickly trade a security at the posted price, is one of the most important factors in determining the price of a security. Obviously, the greater the market value of a company and the greater the number of shareholders, the more liquid the market for its shares will be. Small cap companies thus face an unfavourable market dynamic. This impact on share price can be substantially mitigated by the adoption of certain market management measures or, in the absence of such measures, it may be exacerbated.

All major stock markets have mechanisms in place to support market liquidity. Specialists or market makers are obliged to buy or sell securities at the posted prices in the absence of a third party. Thus, share prices are not unduly influenced by patterns of buy or sell orders. Such a mechanism exists, for example, at the TSX and NASDAQ but not at the TSX Venture Exchange. This absence is hard to explain, at least for shares trading above a minimum price level.

Success in financing a small cap company depends on the liquidity of the secondary market for its shares. To achieve this liquidity, special conditions must be created, both at the time of the IPO and later on. These conditions may be summarized as follows:

‐ Significant participation by individual investors is a critical success factor because it increases the number of stakeholders.

The oft‐stated notion that due to market transformation, individuals no longer own company shares directly but rather through mutual funds and other investment vehicles, simply does not stand up to scrutiny. The data show that other than shares held in self‐directed retirement funds, 9.9% of Canadian families own shares, a proportion that has held steady since 1999. In this respect, Quebec basically reached the Canadian average back in 1984. By late 2010, the value of Quebecers’ equity portfolios (other than mutual funds) held by securities brokers stood at $81.6 billion.

However, it is correct to state that the major securities brokerage firms prefer to “manage the financial assets” of their clients and impose severe restrictions on the securities they can recommend to them. This does not promote the distribution of shares issued by Quebec SMEs because generally, they do not meet the brokerage firms’ cross‐Canada compliance criteria.

‐ The success of a new IPO is often based on obtaining one or more recognized lead investors.

Regulatory and liquidity requirements generally limit an institutional investor’s participation to 10% of the IPO. One quickly recognizes the problem that this creates for large institutional investors: 10% of an IPO of $5 to $10 million means an investment of $500,000 to $1 million—well below such institutions’ minimum threshold for investments in listed equity portfolios. The less imposing portfolio value of various pension funds should theoretically favour such investments. According to our interviewees who know this sector well, “pension committees are reluctant to make such investments.”


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We met with two specialized fund managers who met this lead investor requirement. The first, specializing in the technology, industrial and commercial sectors, ceased this type of activity at the express request of the institutions that contributed to its new funds under management and which, at the end of the financial crisis, adopted “capital protection” as their watchword. The second manager focuses on the mining sector, mainly in financing mineral resource exploration and development companies and junior mining companies. This type of institutional fund’s contribution to the success of IPOs and subsequent public financing of small cap companies is considered essential by the principal players in this market segment. The problem, according to our interviewees, is that these institutional or private investors are the exception rather than the rule in Quebec.

‐ Liquidity of shares on the secondary market is essential for maintaining fair value.

Regulations prevent issuing companies from trading their own shares and thus influencing market liquidity; this leaves executives mostly powerless to correct “market anomalies” that may have a serious impact on company value. This prohibition does not apply to financial sector stakeholders, insofar as their trading activities are not designed to manipulate the market.

Firms that act as “specialists” or market makers must devote a substantial amount of capital to this activity. Generally, brokerage firms specializing in public financing of small and medium‐sized companies do not commit the financial and human resources required for proprietary trading and the tight risk controls these activities demand. On the other hand, the experience of one Quebec institutional fund specializing in the shares of junior mining companies demonstrates that market‐making activities adapted to the market characteristics of securities traded on the TSX Venture Exchange can be both very beneficial for listed Quebec companies and their shareholders, as well as profitable for the investor in question.

1.4.3 Institutional corporate financing in Quebec

The equity financing situation in Quebec is unique. It is characterized by an abundant supply of capital from government organizations and tax‐advantaged funds. These features have already been pointed out in the report of the task force on the Quebec government’s venture capital role (Rapport Brunet, 2003), which at the time estimated that the Quebec government’s activities represented 70% of the supply of venture capital, not including the Caisse de dépôt et placement du Québec (CPDQ).

During our consultations, some executives of private venture capital funds expressed reluctance to compete with public or tax‐advantaged funds or even to associate with them in an investment. This reluctance was not due simply to “ideological” considerations but rather to hard‐to‐reconcile differences vis‐à‐vis the performance objectives and development orientations of the companies in which they invest.

The comments we heard about the role and behaviour of public and tax‐advantaged funds with respect to financing small and medium‐sized companies with high growth potential raised a number of questions. Some executives indicated that they put up with the participation of public and tax‐advantaged funds “because they are silent and undemanding partners as long as value is created.”

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Given the limited size of the Quebec economy, the success of a dynamic company necessarily requires breaking into external markets. The contributions of individual and institutional investors who successfully finance SMEs are based essentially on their intimate knowledge of the sector in which “their” SME operates and on their ability to promote closer relationships with industry leaders. They also have access to other experienced CEOs, whom they do not hesitate to call on to guide the executives of the companies they are financing. Some were critical of the ability to integrate Quebec SMEs within North American industrial and financial networks: “When you compare the results obtained by US managers with those of Quebec managers in similar businesses of the same size and in the same industry segment, the performance of US companies is substantially better than that of Canadian companies, both in terms of growth rate and performance.” On the same topic, a financial executive noted that Quebec entrepreneurs/managers were not “connected” to North American industrial and commercial networks, partly because the sources of private placements in Quebec do not maintain ties with such networks and partly because the importance of the language barrier is generally underestimated. According to a recent study conducted by the Institute for Competitiveness and Prosperity (2010), one of the effects of this segregation is that creativity is a less important competitive factor for Quebec companies than it is for companies in Ontario and the US.

Although there are a number of public and tax‐advantaged funds in Quebec, some of our interviewees pointed out that they tend to consult each other when making investment decisions. For example, Teralys, a fund of funds, is funded by an investment of $250 million by the Caisse de dépôt et de placements du Québec (CDPQ), $250 million from the Fonds de solidarité des travailleurs du Québec (FSTQ) and $200 million from Investissements Québec. GO Capital is another case in point. Managed by the BDC, this venture capital fund, which was established to support the creation of companies in all science and technology sectors in Quebec, includes FIER Partners, BDC, CDPQ, FSTQ and Fondaction CSN. We have no doubt that the instigators of these groups were well intentioned. However, this oligopolistic structure and the propensity of the main players to band together have certain consequences: in the niches they target, independent decision‐making centres have been eliminated. The primary advantage of a market comes from the fact that decisions are made by a large number of individuals motivated by distinct and independent evaluations and considerations. It appears that the main funds’ management teams are aware of this problem and have taken steps to mitigate these consequences by acquiring interests in a number of private venture capital funds and companies.

Apparently due to the significant amounts that public and tax‐advantaged funds must invest, they tend to discourage private company executives from accessing the securities markets. When voiced by investment bankers, this criticism might be seen as aimed at the competition. However, when private company executives themselves confirm that these institutions “put quite a bit of pressure on me not to go public and offered to give me whatever capital I needed instead,” questions about their responsibility in the under‐representation of Quebec companies on stock exchanges takes on a whole new meaning.


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1.5 CONCLUSION

Data on the Quebec economy reveal that Quebec companies remain under‐capitalized compared to the situation prevailing in Canada as a whole despite the Quebec government’s large‐scale efforts to stimulate the supply of equity through various programs and agencies.

This relative under‐capitalization invariably translates into chronic under‐investment in information technologies, communications, machinery, innovation‐related marketing and the development of export markets compared with our main competitors. It also results in lower productivity than in Ontario and the US and in the gradual erosion of our competitiveness. This situation requires us to conduct a rigorous diagnosis of the Quebec economy’s relative performance aimed at better identifying the issues at stake and taking a clear‐eyed look at the Quebec financial ecosystem’s strengths and weaknesses.

A number of interviewees suggested that eliminating a large number of direct government initiatives was a necessary condition for better allocating venture capital to dynamic companies, which are responsible for most economic growth and job creation. Without subscribing to this view, we believe that a public capital market‐oriented approach would yield much better results than those obtained to date in Quebec.

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2. THE GROWTH ENGINES OF THE QUEBEC ECONOMY

Many of the executives we consulted expressed concerns about the strength of the Quebec economy and its ability to compete and generate increases in collective wealth over the medium and long terms. This feeling reflects a sense of unease precipitated not only by their experiences at the helm of their firms, but also by the competitive challenges they face and by Quebec society’s lack of recognition of successful business leaders.

While we take comfort in the fact that the employment situation over the last three years meant that Quebec was relatively sheltered from the worst of the economic crisis that struck hard in other regions, we must not delude ourselves: Quebec’s public finances face major challenges and cannot accommodate a significant increase in debt. The accelerated decline in the proportion of the workforce (individuals 16‐64 years of age) compared with the total population will inevitably result in a serious slowing of economic growth. According to the Quebec Department of Finance, the average real GDP growth rate, which stood at 2.1% from 1982 to 2008, will gradually drop to 1.4% between 2021 and 2025. That means we will experience a drop in per capita wealth unless there is a substantial increase in productivity, which will only occur through innovation and better penetration of external markets. Among other things, this will require a much better record in developing, adopting and marketing innovations. Given the nature of the challenges looming on the horizon, a concerted effort will be required by our entrepreneurs and Quebec’s private sector to reverse the probable course of events.

The structural nature of the economic challenges confronting Quebec means that growth is an unavoidable necessity. A society may pride itself on its history; however, its future will be uninspiring if its economy is weak. Given business’s central role in ensuring sustained economic growth, we have sought to validate the diagnosis offered by corporate leaders. The framework of economic growth analysis and a comparison of the situation in Quebec with what is happening elsewhere in Canada with respect to access to capital, one of the most critical growth factors provide a strong basis to assess their concerns.

The conclusions from the following analysis confirm a number of corporate executives’ observations and comments, particularly as regards the undisputable advantages of public capital markets and their motivating effect on company performance. Furthermore, some conclusions refute certain widespread beliefs concerning public and private corporate financing.


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2.1 GROWTH ENGINES

The understanding of job creation mechanisms took a decisive turn in 1981 with the publication of the results of an exhaustive study conducted by David Birch of the Massachusetts Institute of Technology. Since then, it has been generally assumed that about two‐thirds of new jobs are created by SMEs. That is not the whole story, however. Subsequent studies, based on more comprehensive longitudinal databases, have made it possible to refine the analysis and better identify the sources of job creation. The main conclusions from these studies cast a more balanced light on this complex reality and identify the growth engines :

‐ Differences in regional growth rates in North American and Western Europe are explained by

the fact that rapid‐growth regions are those in which the pace of job creation is most vigorous because the rate of job loss is substantially the same from region to region.5

‐ A minority of companies (between 4% and 7% of the total) are responsible for creating most net jobs. Between 2002 and 2006, these high‐growth or “dynamic” companies created 84% of net jobs in the US (Acs et al. 2008). In Canada, dynamic companies with continuing operations between 1985 and 1999 created 56% of net jobs during that period, even though they accounted for only 6% of all companies.

‐ Dynamic companies come in all sizes: small, medium and large. They are found throughout the

country in various regions and are present in all industries. They are not concentrated in the high technology sectors. They are generally quite successful exporters. Between 1993 and 2002, high‐growth export companies created 47% of jobs even though they accounted for only 5.5% of Canadian companies (Parsley et al. 2008).

‐ New companies are generally oriented toward local markets. Because they respond generally to local demand (the market), their contribution to the increase in collective wealth is marginal. These new companies create plenty of jobs but, since their failure rate is so high, the net result is minimal. Only a minority of them will grow larger than 20 permanent jobs.

‐ The creation rate of new companies depends on the population growth rate, not the other way around, as is often claimed. Between 1989 and 2009, the annual average growth rate of the Quebec population was only 44% of the rate in Ontario, so the relative vitality of the Quebec economy in terms of company creation must have been affected accordingly. Indeed, in December 2009, there were in Quebec 3,930 fewer employer establishments than in July 2002, whereas during that period, the number in the rest of Canada increased by 56,177.

The results of productivity and innovation studies are fully consistent with these observations.

‐ Dynamic companies post the highest productivity growth rates (Leung et al. 2008). This is because they generally use the most advanced technologies and displace less productive companies.

5 From 1977 to 2005 in the US, the annual average rate of new job creation was 18% of total jobs while the job loss rate was 16% (Haltiwanger et al. 2008).

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‐ The productivity level of companies is a function of their size. This positive correlation between company size and productivity applies to all sectors. In Canada, it has been observed that companies with more than 500 employees and those with 100 to 500 employees have productivity levels that are 30% and 20% higher, respectively, than that of companies with fewer than 100 employees. This productivity gap also increases over time. It stems from the fact that productivity gains depend on the assimilation of expertise, competencies and best practices within companies and from their continuous adaptation. This process takes time.

‐ Increases in productivity according to company size are linked to better capitalization. Indeed, productivity differences between exchange‐listed companies of different sizes are much less pronounced (Lee and Tang 2001).

‐ R&D spending increases with company size. However, the data are less convincing with respect

to the intensity of R&D, which is generally measured in terms of R&D spending per employee or as a function of revenue. In some industries, intensity grows with company size, while the opposite may occur in other cases. In any event, R&D entails major risks and requires a lot of capital—but it cannot be debt‐financed because of factors such as the intangible nature of the assets it uses and generates. The ability to convert R&D results into genuine commercial innovations is a key success factor for dynamic companies.

‐ In all industrial sectors, the volatility and variability of job growth rates are significantly higher in

private companies than in public companies (Davis et al. 2006).

2.2 PERFORMANCE OF THE QUEBEC ECONOMY: A DISTURBING DIAGNOSIS Over the last decade, the number of jobs in Quebec has grown from 3,402,000 to 3,844 000, an increase of 13%. This compares favourably with that for Canada as a whole (14%). The GDP per capita trend in Quebec is also in line with the Canadian average. These comparisons are reassuring for many observers and no doubt account for the apparent lack of concern about our dwindling competitiveness and the magnitude of the challenges that Quebec will have to face with growing urgency in the next few years. A more detailed analysis of the situation paints a more disturbing picture.6 It has been noted that:

‐ Quebec’s population, which accounted for 25.27% of the Canadian population in 1990, dropped to only 23.2% in 2010.

‐ From 2001 to 2010, Quebec’s real GDP increased by 15%, compared with 20% in the rest of Canada.

‐ Between 1981 and 2009, Quebec created only 16.8% of the full‐time jobs in Canada. Since 2000, full‐time jobs have increased by 10% in Quebec, compared with 13% for the rest of Canada.

6 Several analyses have examined the Quebec economy’s performance in recent decades. See in particular “Le Québec économique 2009: Le chemin parcouru depuis 40 ans” (CIRANO 2010), “La performance et le développement économiques du Québec : Les douze travaux d’Hercule” (CIRANO 2009) and “Le Québec économique 2010 : Vers un plan de croissance pour le Québec“ (CIRANO 2010).


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‐ Quebec is facing a substantial challenge in the form of the rapid demographic decline of its workforce. Despite this worrisome evolution, we observe that in 2009, the participation rate of 55‐64 year olds in the workforce was only 51.2%, compared with 59.4% in the rest of Canada and 62.1% in the US.

‐ Commercial bankruptcies in Quebec in 2009 accounted for 35% of the Canadian total. In relation to GDP, the rate of commercial bankruptcies in Quebec is double that in the rest of Canada.

Quebec’s competitive environment is not limited to other provinces; we are North Americans. In terms of productivity, Canada has lagged behind its main commercial partners, principally the United States, while Quebec lags behind Ontario and the Canadian average. We have no choice: we must compare ourselves to the top‐performing Canadian and US regions. Empirical data indicate that the most productive companies are characterized by:

‐ Larger investments in machinery and equipment, especially in information technologies and communications (ITC).

‐ A presence in foreign markets.

‐ A greater willingness to invest in research and development (R&D) and innovation. As regards investments in machinery, equipment and ITC, Quebec does not fare well, and this has been the case for decades. The difference in the ratio of private investments to real GDP in Quebec compared with the rest of Canada between 2000 and 2008 represents an under‐investment of $66.6 billion over the entire period and $7.9 billion in 2008 alone. This gap is leading to a gradual deterioration of our production and innovation capacity and is having an adverse effect on our competitiveness. For example, it has been observed that the reduction in investments in machinery and equipment has been accompanied by a relative reduction in the productivity of the Quebec economy, especially since 2000. But the real problem is that comparisons with the Canadian average mask the scale of the accumulated lag compared with the United States. Between 1987 and 2009, investments per worker in machinery/equipment and in ITC in Canada were on average 77% and 59% respectively of US investments. In 2009, Canadian workers enjoyed on average only one‐half of the value of capital investments in machinery and equipment and ITC of their US counterparts.

The main flagships of Quebec industry have an impressive international presence. But that does not alter the fact that only 4.2% of Quebec companies export abroad. Since 2000, Canada’s share of exports to the US has declined from 20% to 14% (this trend has accentuated since 2005), while the share of US imports from China has risen from 8% to 19%. Our declining share in our largest market is, in several respects, attributable to our dwindling productivity. The emerging economies account for approximately two‐thirds of global economic growth and one‐half of the increase in global imports. If we cannot maintain our market share in the markets of our closest neighbour, how can we hope to achieve greater success in new Asian and Latin American markets or even in Europe?

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Quebec’s performance in R&D investments offers proof that well‐designed public policies can change the course of events. In 1982, R&D spending represented 1.1% of Quebec GDP; in 2007, it was 2.53% of GDP, higher than in Canada as a whole (1.91%), the EU (1.77%) and the OECD countries (2.28%) and very close to that in the US (2.66%). Worth noting is that most R&D investments here are made by companies, which is not the case in the rest of Canada. On the other hand, our record with respect to innovation is not quite so stellar. The World Economic Forum ranks Canada 19th, far behind the United States, Germany and Japan, with respect to our ability to convert R&D into commercial success.

2.3 ACCESS TO PUBLIC CAPITAL MARKETS BY CANADIAN COMPANIES Surveys of owners of small and medium‐sized Canadian and US companies reveal that gaining access to financing is more difficult in Canada than in the United States. The proportion of debt in the capital structure of Canadian and American SMEs is comparable, but the sources of funds are different. Canadian SMEs turn less often to financial institutions; they make up for this by making greater use of loans from individuals, family members and friends (Leung et al. 2008). The increasing number of angel investor networks constitutes a growing source of financing across Canada. Acquiring this essential start‐up capital is not enough to ensure that dynamic companies will develop to their full potential. There comes a time when a company must solidify its financial base and consolidate its past growth, which may be threatened by an excessive debt ratio; it must facilitate future growth either organically, by making consistent investments in machinery and equipment and expanding into external markets, or through acquisitions. Equity financing needs can be met by private placements from large investors or by issuing shares on public capital markets.

2.4 PRIVATE PLACEMENTS Private placements are an importance source of external capital for companies. These financing transactions are conducted in the exempt market in accordance with securities regulations, which are generally more liberal in Canada than in other industrialized countries. Empirical studies demonstrate that in Canada, most private placement is a local, intra‐provincial activity. The data in Table 5 are quite revealing. Between 2003 and 2010, Quebec venture capital investors carried out 90.7% of their private equity investments in Quebec; these investments represented 88.6% of the venture equity capital invested in private placement in Quebec (the corresponding figures are 78.6% and 83.7% for Ontario and 85.5% and 53.0% for British Columbia). The data signify that this source of capital brings less knowledge and fewer connections to North American and international industrial networks in Quebec than it does elsewhere in Canada.


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Table 5 Source and destination provinces of investments by Canadian venture capital companies in Canada

(January 2003–April 2010)

Companies financed (no.)

% of Canadian total

% of investments received from the same

province

% carried out in the same province

Alberta 87 3.7 79.0 60.9British Columbia 365 15.7 53.0 85.5Saskatchewan 100 4.3 84.1 58.0Manitoba 57 2.4 83.6 80.7Ontario 859 36.8 83.7 78.6Quebec 778 33.4 88.6 90.7Atlantic provinces 86 3.7 46.4 60.5

Total: 2332 100 81.6 81.6 Source: Suret, Jean‐Marc and Céline Carpentier, “Réglementation des valeurs mobilières au Canada: un réexamen des

arguments avancés pour justifier la commission unique,” report prepared for the Autorité des marchés financiers du Québec, June 20, 2010.

Over the years, the Canadian venture capital industry has not generated the returns necessary to attract Canadian and foreign institutional investors. In the past decade, the annual return of Canadian venture capital companies was below the return of Treasury bills in every year except 2001. As Table 6 shows, the rates of return are unsustainable. That explains why the amounts invested annually by the venture capital industry in Canada have levelled off at about $1.0 billion, the same level as in the mid‐ 1990s.

Table 6 Rate of return of venture capital companies in the US,

Europe and Canada, 1995‐2005

All companies (%) First quartile (%)

US 27.6 76.6 Europe 6.5 38.1 Canada ‐3.0 19.2 Fonds de travailleurs ‐1.4 n/a Private independents ‐3.9 23.3 Others ‐3.6 14.5 Source: Duruflé, Gilles, “La performance du capital de risque au Canada, en Europe et aux États‐Unis, éléments de comparaison,” Canadian Venture Capital Association, Canada‐France Forum, February 13, 2007.

Private and independent venture capital companies (PIVCs) have amassed about 62% of the new capital allocated for this purpose in Canada since 2005; government funds and tax‐advantaged funds make up the difference. These two groups contribute more or less equally to investments in Canadian companies because PIVCs invest about 40% of their capital abroad, mainly in the United States. For the past few years, foreign venture capital funds have accounted for about one‐third of venture capital investments in Canada.7

7 Data on venture capital companies are from “Canada’s Venture Capital Industry in 2009”, Thompson Reuters.

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As regards investments by venture capital companies in Canada, we note that:

‐ Most investments are made in information technologies (53%), biopharmaceutical and life sciences (20%) and energy/environment (9%). The non‐technological sectors account for less than 20% of investments.

‐ The average investment per company by a Canadian venture capital company is $3.1 million, much less than the average investment of foreign companies in Canada ($8.5 million).

‐ Between 2008 and 2009, 35% of the value of venture capital company investments in Canada was invested in Quebec ($411 million/year). During that period, Ontario’s share was 36% and British Columbia’s was 17%.

‐ In 2009, four of the 10 largest venture capital investments in Canada were made in Quebec companies (three biopharma/one ITC). It is noteworthy that 65% of the capital invested in these 10 companies came from outside Canada.

‐ Between 2003 and 2009, venture capital companies liquidated their investments in 264 Canadian companies. Of this number, an IPO was used in 46 cases (17%), whereas in the US, this option was used in more than 30% of cases.8

‐ Selling the company to other interests is thus the route preferred by risk capital companies in Canada, including public institutions and tax‐advantaged funds. This exit strategy has long‐term consequences for the Quebec economy. First, selling eliminates any possibility that they will become large independent companies, except in rare cases of consolidation of Quebec companies. Second, analyses conducted in the US indicate that most jobs created by companies supported by venture capital companies come after the IPO, that is, after the company has gone public.

2.5 ACCESS TO PUBLIC CAPITAL MARKETS Quebec accounts for about 21% of the Canadian economy and 23.2% of Canada’s population. However, the Quebec companies listed on a Canadian stock exchange represent only 10% of listings and 11% of the total capitalization of Canadian listed companies. This under‐representation is hardly surprising given that Quebec companies were involved in only 8% of the public offerings in Canada and account for only 17% of the total value of IPOs launched between 1993 and 2004. And the under‐representation of Quebec companies continues to grow. Only three of the 74 new companies listed on the TSX in 2010 were from Quebec, including two graduating from the TSX Venture Exchange. As regards the TSX Venture Exchange, Quebec companies account for only eleven of the 206 new Canadian companies listed in 2010. The ratio of companies’ market capitalization to GDP is a good indicator of the development and efficiency of public capital markets. According to this ratio, Canada leads the developed countries. In 2009, this figure was 1.45 for Canada as a whole, nearly double that for Quebec (0.79). This is another clear indication of deficiencies and weaknesses in the operations of public capital markets in Quebec.

8 Between 1991 and 2004, venture capital companies in Canada monetized their investment through an IPO in 5.85% of cases, compared with 35.65% in the US.


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The TSX ranks eighth in the world in terms of capitalization; it is without doubt the main stock exchange in Canada. Nevertheless, its listing criteria are less demanding than those of most stock exchanges around the world. They are comparable, for example, with those of the Alternative Investment Market in London, which was established precisely to facilitate stock market access for medium‐sized companies. Against that backdrop, the relative shortage of Quebec companies listed on the TSX raises many questions about the impact on Quebec’s growth prospects. Given the characteristics of the companies listed on the TSX Venture Exchange, this market is dominated by individual investors. Institutional investors are generally absent because the capitalization levels involved are small. In 2009, the average value of an IPO for an issuer listed on the TSX was $69.5 million, compared with $4.0 million on the TSX Venture Exchange. This has prompted some to disparage the TSX Venture Exchange—an attitude that deprives Quebec entrepreneurs, especially those with young dynamic companies, of access to public and private markets, in which dynamic companies have benefited handsomely. Investments in TSX Venture Exchange companies certainly involve a higher risk level; the rate of failure and disappointing results is high. To a large extent, this inherent level of risk stems from the age and size of these companies and the nature of their activities. The returns of venture capital companies shown in Table 6 make this point clear. In the case of the TSX Venture Exchange, all results are in the public domain. In contrast, discretion with regard to failure is more often the rule with respect to the results obtained by venture capital companies and institutional investors. A rigorous analysis of the market for shares listed on the TSX Venture Exchange puts matters in perspective. Studies demonstrate that between 1995 and 2005, the average return of an index comprised of companies listed during that period was 15.69% for the TSX Venture Exchange, compared with 10.7% for the TSX (Carpentier et al. 2008). In Canada, compared to the venture capital route, the TSX Venture Exchange yields better results, in the sense that four times as many companies operating in sectors other than mining exploration that have chosen to list on the TSX Venture Exchange (rather than pursuing the private financing option) have achieved the size and performance required to be listed on the TSX (Carpentier et al. 2008). From the perspective of growth and development by dynamic companies, the following facts cannot be ignored:

‐ 31.5% of Canadian companies listed on the TSX between 2007 and September 2010 had previously been listed on the TSX Venture Exchange.

‐ 20% of Canadian companies included in the S&P/TSX index are companies that “graduated”

from the TSX Venture Exchange.

2.6 PRIVATE PLACEMENTS IN PUBLIC COMPANIES In Canada, private placements in public companies have become the preferred mode for subsequent share issues by listed companies. In 2010, the value of private equity capital financing by TSX and TSX Venture Exchange companies was $6,609 and $6,392 billion, respectively. That same year, private placements accounted for 82% of the value of the equity financing of TSX Venture Exchange companies. In 2008‐2009, TSX Venture Exchange companies obtained $10.3 billion in equity financing, compared with $1.2 billion in venture capital investments in Canada during the same period. Other than the natural resources sector, where they are prevalent, private placements are frequently used by SMEs in

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the technology and health sectors. In the US, these sectors account for nearly 65% of the total value of private placements in listed companies. The main appeal of this type of financing for listed companies is that it occurs under an exemption from prospectus and registration requirements. Companies generally only have to file an offering memorandum and state the risk factors. They can negotiate the investment terms directly with “informed” investors or through a securities broker. The costs and time periods involved are reduced accordingly. The companies remain subject to securities regulations, in particular those regarding disclosure requirements. One conclusion is clear: listing a company on a stock exchange does not mean that it will have no further access to private financing; in fact, the opposite is true. Experience shows that this avenue opens more doors and does so on terms that are often less cumbersome and burdensome.

2.7 FINANCING QUEBEC’S MINING SECTOR Quebec has developed a substantial mining sector, which, helped by the global economic situation, should be an important source of investment and jobs. Influenced by mineral prices on world markets, the value of mineral shipments, which remained relatively stable from 1990 to 2004, began to climb rapidly in 2004 and topped $6.2 billion in 2009. Mining investments in exploration, development and construction during this period came to $1.3 billion per year on average. The prospects remain very good because the increase in mineral prices reflects global demand for raw materials, which is expanding faster than supply. Relative to Canada as a whole, mineral deliveries from Quebec fell from 19.8% in 1999 to 13.2% in 2008, due in part to the start‐up of new mines and the expansion of existing mines elsewhere in Canada. No doubt Quebec’s relative under‐performance over the past decade is related to the fact that, due to falling mineral prices, exploration and production in Quebec collapsed in 1988 and 1989 and remained at anemic levels until 2004, when the first signs of recovery were seen. But that does not explain it all: between 1998 and 2008, exploration and production expenditures increased by 813% in British Columbia and 667% in Ontario, compared with 396% in Quebec. Small mining companies have long occupied an important place in exploration and in bringing Canada’s mineral deposits into production. Since 2004, investments by junior companies in these activities have exceeded those of large companies and have been the main driver of exploration in Canada. From 53% of total exploration and development spending in 2004, this ratio grew to 65% in 2008. The same phenomenon was observed in Quebec: the value of exploration and development investments in 2009 was twice what it was in 2004. This result stems from the work of junior companies because activity by large companies continued its downward slide. This structural characteristic of the industry has two main consequences. First, the activities of exploration companies are performed off site. In 2008, they conducted 71% of all surface diamond drilling activities. As a result, their discoveries result in new mines, together with the major investments they require for their development into production. Second, this structure has a major impact on the financing of exploration and development activities because junior companies generally do not have internal sources of revenue. Furthermore, due to the nature of their activities, they have no access to financing from banks or venture capital companies.


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As at December 31, 2010, there were 353 mining companies listed on the TSX and 1,178 on the TSX Venture Exchange. Only 12 mining companies listed on the TSX had their head offices in Quebec, compared with 104 in Ontario and 111 in British Columbia. Similarly, with regard to the TSX Venture Exchange, 82 listed companies are headquartered in Quebec, compared with 199 in Ontario and 755 in British Columbia. Since 2006, Quebec‐based mining exploration companies and junior mining companies account for only 6% of new listings. In 2010, only six of the 136 new companies listed were Quebec‐based. The ownership issue cannot be dismissed as irrelevant. In 2009, large Canadian mining companies spent 30% of their total exploration budgets in Canada, compared with 55% by small companies. According to the Metals Economics Group, the acquisition of large Canadian companies such as Inco and Falconbridge has resulted in a migration of Canadian exploration budgets abroad. Thus far, this effect been overshadowed by the increase in exploration expenditures by small Canadian companies. The TSX Venture Exchange plays a key role in mining development in Canada. Mining exploration companies and junior mining companies account for 55% of the TSX Venture Exchange companies. In 2010, 30% of the value of shares issued by companies in the mining sector in Canada came from TSX Venture Exchange companies, even though they accounted for only 8% of the sector’s total capitalization. The marked under‐representation of Quebec companies on the TSX Venture Exchange inevitably means a lower share of this new capital. The consequences of this should not be under‐estimated. For example, Osisko Mining (Canadian Malartic) and Consolidated Thompson Iron Mines (Lac Bloom) initially listed their shares on the TSX Venture Exchange before moving up to the TSX. On February 24, 2011, Goldcorp’s announcement that it would be investing $1.4 billion to start up production of the Éléonore gold project in the James Bay region was positively received. The fact that this deposit was discovered in 2004 by a Quebec junior, Virginia Gold Mines, was overlooked in the media din.

2.8 CONCLUSION To succeed, a growth policy must adequately address the specific needs of the minority of dynamic companies capable of achieving strong growth. Strong growth obviously increases the risk of failure. There is no known formula for predicting which high‐growth companies are likely to flourish over the longer term. In economic terms, they account for only 4% to 7% of all companies. Experience shows that the financial markets are the best mechanism for identifying such companies. The marked under‐representation of Quebec companies listed on the TSX and TSX Venture Exchange is a source of concern with respect to the future performance of the Quebec economy. Suggestions to the effect that this situation is due to a chronic lack of savvy entrepreneurs in Quebec or that “Quebec private companies are not big enough to access public markets” are not convincing. In December 2009, 22% of employer establishments in Canada were located in Quebec, a proportion that is roughly commensurate with the relative size of the Quebec economy. It has also been noted that mid‐sized establishments in Quebec (100 to 499 employees) accounted for 1.7% of all employer establishments, compared with 1.6%, 1.4% and 2.1% in Alberta, British Columbia and Ontario, respectively. Large venture capital investments in Quebec in 2009 suggest that the prevalent explanations are not necessarily correct and that we must look elsewhere for an explanation of Quebec companies’ under‐representation on Canadian stock exchanges. And then we must adapt our solutions accordingly.

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3. GENERAL CONCLUSIONS AND POTENTIAL SOLUTIONS

In a few years’ time, the main issues facing Quebec’s economy will combine to form a vise that will substantially squeeze our society’s resources and our ability to act, unless we manage to increase the pace of economic growth in a sustainable way. The true engines of such growth are high‐growth or “dynamic” companies. Such companies are generally characterized by their ability to innovate and market their innovations, as well as by higher productivity levels and greater external market penetration. These dynamic companies are found in all sectors of the economy and in all regions. They comprise a minority of the companies in a given economy, accounting for only 4% to 7% of the total. Statistics reveal that just 4.2% of Quebec companies export abroad. A well‐designed growth policy should promote the emergence and growth of these dynamic companies. Quebec’s objective should be to ensure that the proportion of dynamic companies in the province reaches the upper limit of about 7%, rather than a much more modest 4%. The impact of such an increase should not be underestimated. Within a given economy, dynamic companies are generally responsible for creating about 60% of net jobs. Accordingly, increasing of the proportion of dynamic companies in our economy from 4% to 7% would increase the total number of new permanent jobs by about 45%, year after year. The problem is this: it is unrealistic to claim that dynamic companies can be identified in advance. A large number of promising companies in the high technology or life sciences sectors have failed, whereas others in less trendy fields have gone on to become North American or global leaders. The number of “bad” investments in the portfolios of venture capital companies is a strong indicator of the uncertainties associated with young companies’ growth trajectories. Given such uncertainties, it appears that as a general rule, public capital markets constitute the most efficient mechanism for identifying dynamic companies and supporting them on their growth path. Obviously, gaining access to the public capital markets is not a miracle cure, although it does constitute a powerful option that should not be neglected. The potential solutions described below are intended to reduce the gap with the rest of Canada in terms of Quebec companies’ willingness to take advantage of the possibilities offered by public capital markets.

3.1 PROMOTING PUBLIC FINANCING OF QUEBEC’S SMALL CAP COMPANIES Our consultations with company executives and securities brokerage firms did not identify any serious barriers to accessing public capital markets for Quebec companies with market capitalizations exceeding $250 million. However, a number of public company CEOs regretted the low participation rate by large Quebec institutions in their capital structure, not to mention the chronic lack of financial analysts in Quebec and the fact that they must regularly travel to Toronto and other financial centres to arrange financing and follow up with institutional investors. That said, their successes lead them to describe these shortcomings of the Quebec financial ecosystem as irritants rather than as serious obstacles to growth.


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As noted earlier, besides the fact that the large securities brokerage firms that dominate the industry in Quebec are not interested in financing small cap companies, it must be acknowledged that public financing of these companies presents a number of pitfalls in addition to those associated with public financing of larger companies. These relate mainly to the lack of liquidity in the market for their stock.

3.1.1 Financing small cap companies in the primary market Consolidating the securities industry in Canada‐wide institutions and the large size of the main institutional funds pose serious structural problems for the public financing of small cap companies. The success of a stock issue depends on the number of participants since that has a direct bearing on liquidity in the secondary market. Moreover, an investor’s status and the associated regulatory requirements change as soon as his/her interest crosses the 10% ownership threshold. In 2009, the average value of an IPO for a company being listed on the TSX Venture Exchange was approximately $4 million. That means that an institution wishing to participate in the process will not invest more than $400,000, which is much too small for most institutional funds. Furthermore, the target of 200 investors works out to an average investment of $20,000 each. Such a small amount is obviously of little interest to an institutional fund. One conclusion is clear: small cap financing is first and foremost within the realm of individual investors. It is pointless to seek other avenues, except for the lead investors. Lead investors, who generally take 20% to 30% of the value of an issue, perform three main functions. First, their participation significantly reduces the risk of the issue failing, either for the company or the brokerage firm. Second, these informed investors have a decisive influence on the terms of the issue. Their consent is a reliable sign that the terms are consistent with market terms. Third, informed investors’ participation is a strong indication that the investment is worthwhile for other potential investors, particularly individuals. Some fund managers specialize in lead investments. The evidence, based on experiences here and elsewhere, is clear: this type of activity in an institutional setting must be carried out independently of listed stock portfolio management. The investment analyses, the forms of participation and the small size of these lead investments are all inconsistent with “normal” large portfolio management practices.

3.1.2 Secondary market operations Small capitalization implies that the volume of securities trading is limited, which in turn leads to a lack of liquidity and interferes with the efficient operation of the secondary market. Low trading volume increases risks for investors and influences share prices. Left to its own devices, the market cannot correct this deficiency; structural and institutional initiatives are required to increase liquidity and fix these shortcomings. Stock exchanges, especially the more active ones, have instituted systems of “specialists” or “market makers” to ensure the price continuity and liquidity of their listed securities. Unfortunately, that is not the case for the TSX Venture Exchange. The examples of SIDEX, SODEMEX and SIPAR demonstrate that specialized funds can provide lead investments and inject liquidity into the secondary stock market for small cap companies through very active management of their portfolios, in a profitable manner. Such funds thus facilitate the maintenance of a more robust secondary market—one that is more attractive to investors.

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We suggest that the main financial stakeholders in Quebec should seriously consider creating independent segregated funds oriented toward lead investment activities and active participation in the secondary market for the shares of listed Quebec SMEs.

3.2 PROMOTING FINANCING THROUGH THE PUBLIC CAPITAL MARKETS The public capital markets are by far the biggest source of equity financing for Canadian companies. Moreover, this capital is permanent in nature and interest‐free. But it should be acknowledged that companies that are not in a good position to access the public markets should refrain from doing so since going public prematurely could cause considerable damage. But when the contribution of outside capital is required, the choice of financing options should be based on real and justifiable reasons, not on inaccurate perceptions. In other words, an environment that promotes fair and informed decision‐making, based on a fair assessment of the benefits and disadvantages of accessing public capital markets, must emerge in Quebec. Could Quebec companies be less present on the stock markets because false perceptions are more widespread here than they are elsewhere in Canada? Do we have a disproportionate number of private company executives who believe that the disadvantages outweigh the advantages, that the short term must be emphasized over the long term, that loss of control is inevitable, that the regulatory environment is unmanageable and that growth expectations are unattainable? Private company executives who weigh the pros and cons of an IPO aimed at reinforcing their capital structure should take comfort in the comments of those who successfully decided to go public and would not hesitate to do it all over again. At the risk of repeating ourselves, it should be noted that: ‐ For a large number of well‐known successful Quebec companies, the listing process took place when

they were at a relatively early stage and their capitalization was fragile.

‐ These companies have executed their business plans in a disciplined and methodical way.

‐ These companies have achieved the continuous growth demanded by the public capital markets.

‐ They have often maintained control by issuing multiple‐voting common shares. 3.2.1 Maintaining company control The oft‐cited fear of losing control is a sensitive matter. We might do well to remember that the use of multiple‐voting shares is an excellent way to offset this “disadvantage”. These shares give company founders effective protection against loss of control. Unfortunately, use of this measure is often criticized by large institutional funds and other financial stakeholders, who invoke corporate governance principles and their preference for a market that poses no obstacles to corporate acquisitions. According to one rather common myth, this capital structure is characteristic of Quebec companies. However, in April 2005, two‐thirds of TSX‐listed companies with this capital structure were located outside Quebec. Some 13% of all S&P/TSX companies have issued two types of common shares in order to keep control in their founders’ hands. These structures are also very common in Europe and, to a lesser extent, in the US. Successful entrepreneurs such as Google’s two co‐founders used them during their IPO; Berkshire Hathaway, led by Warren Buffet, has a capital structure of this type.


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The Institute for Governance of Private and Public Organizations (IGOPP) has studied this issue:

“For an entrepreneur‐founder to keep shares with superior voting rights in order to maintain control over his company seemed, and still seems, a reasonable solution. In fact, in the absence of such protection, most entrepreneurs will shy away from the public markets to finance the growth of their company. They will prefer to reduce the pace of growth of their company or find other, often less efficient, sources of financing. The consequences will be negative in several respects: the rate of innovation, the investment opportunities, economic growth and even employment will suffer. Even the fiercest opponents of multiple‐voting shares agree but want to reserve the ‘privilege’ of multiple‐voting shares for small companies, such as those listed on the TSX Venture Exchange.” (IGOPP, 2006)

In particular, IGOPP proposes “a framework and benchmarks that will protect the advantages of this type of capital structure while minimizing its negative aspects”. (IGOPP, 2006)

Regulations governing TSX or TSX Venture Exchange listings of companies whose capital structure includes multiple‐voting shares are not clearly understood by the business community, although the rules were established long ago. Multiple‐voting shares are authorized provided that they are accompanied by protection for other shareholders in the event of a takeover bid aimed at the “controlling shares”. Therefore, such a takeover bid would be allowed only if it were presented to the other shareholders on the same terms (the so‐called “coattail” clause). Given that it is generally acknowledged that companies controlled by their founders and their families often generate results that are better than many other types of companies and given the prevailing regulatory environment, it would be desirable to promote multiple‐voting shares and encourage their use within an appropriate governance structure.

3.2.2 Changing perceptions Whether the issue is growth, control, regulation or information, there is an obvious gap between the perceptions of many private company owners and those of executives who have direct experience of working within a public traded company. In large part, this gap is unjustified. Private company executives who are determined to realize the full potential of their companies and who execute their business plans in a disciplined fashion must receive more balanced information and an informed perspective on the numerous advantages as well as a balanced view of the disadvantages of being listed. Of all our recommendations, this one should be, in theory, the easiest to implement. If most entrepreneurs who have listed their company on an exchange are satisfied with their experience, it is certainly possible to change other people’s perceptions. In our view, negative perceptions, informed or otherwise, appear to be deep‐rooted and are often conveyed by influential financial stakeholders. The consolidation of Quebec’s financial sector and its specific dynamics do not favour public financing of small cap companies. These conditions make it difficult to change attitudes and mobilize informed and credible participants.

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In view of this situation, a two‐step process might be helpful: ‐ First, forums including financing professionals, representatives of institutional investors and public

companies from here and elsewhere in Canada should be organized to promote a better understanding of approaches and methods used in other parts of Canada and to identify how conditions and practices differ from those in Quebec. Several organizations would be justified in taking the initiative to organize such financial industry forums (e.g. the Fédération des Chambres de Commerce du Québec, the Board of Trade of Metropolitan Montreal, the TMX Group, the Finance Montreal cluster and other institutions or professional firms active in the sector). This step is crucial because it is unrealistic to think that private company executives will be likely to look more favourably on the option of IPO financing if the main players in the financial sector seek to undermine interest in public financing of small cap companies, whether in public or privately.

‐ Second, communication and familiarization efforts will be necessary. These could take the form of

information symposiums, conferences or workshops with groups interested in financing start‐up companies and SMEs (angel investors, regional economic intervention funds/FIERs, etc.).

3.3 PROMOTING GREATER FAMILIARITY OF THE REGULATORY ENVIRONMENT The comments made to us by corporate executives and other players concerned by the issues pertaining to the public financing of Quebec SMEs showed a certain degree of ignorance of the rules that govern primary and secondary capital markets as well as those that apply to public companies. They also raise questions about the degree to which regulators understand the conditions in which public and private companies in Quebec have to operate. In our view, the gap that appears to separate these two worlds is not as large as some seem to think. In any case, Quebec would be better served if a solid bridge existed between them. In 2002, the Ontario Securities Commission (OSC) established a Small Business Advisory Committee, consisting of 12 members appointed for a two‐year term. The Committee’s terms of reference were to regularly express its views to the OSC and executive staff on aspects of securities regulation affecting SMEs in Ontario. This Committee also provided an ideal forum for facilitating relations between the OSC and small companies. The Committee exercised influence during the preparation of Rule 45‐501 and its adoption by the OSC in 2003. The purpose of this Rule was to substantially expand the circumstances in which issuers were exempted from the requirement to produce a prospectus for share issues involving accredited investors. A study of the impact of Rule 45‐501 concluded that this revision of the regulations governing private placements in public companies in Ontario had the effect of increasing the number, value and average size of equity financings and substantially expanding the range of issues in terms of value. Moreover, this revision had the effect of increasing the number of individual, corporate and institutional accredited investors who participated in these new stock issues. These provisions are now integrated in Canada’s harmonized National Instrument 45‐106 respecting prospectus and registration exemptions and Regulation 31‐103 respecting registration obligations and exemptions, thus clearly illustrating the positive effect that such a mechanism can have.


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The mission of the Autorité des marchés financiers (AMF) is not only to protect investors and promote the efficiency of the public capital markets but also to “promote the availability of high‐quality, competitively priced financial products and services for individuals and companies in all regions of Quebec”. We recognize that the AMF has taken a number of steps to align its actions with those of the financial community. The annual conference with Quebec’s legal community is clearly a great success. We believe, however, that a closer and more structured link with the business community would be appropriate. For example, none of our interviewees were aware that a consultation conducted by the securities authorities of Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia and Saskatchewan, with the support of the AMF, on tailoring regulation for venture issuers, was underway. We are convinced that the AMF’s creation of an SME Advisory Committee would contribute to the development of regulatory policies better aligned with the needs of Quebec entrepreneurs and would favour constructive dialogue between the AMF and the business community.

3.4 ENCOURAGING INDIVIDUAL INVESTORS TO PARTICIPATE IN SMALL CAP FINANCING The Quebec stock savings plan (REA) proved remarkable in more ways than one. When developing a new incentive program for financing on the public capital markets, we would do well to look at the lessons learned from implementing the REA program since its adoption in 1979 and from the changes it subsequently underwent, particularly in 1983. Studies demonstrate that companies that issued “REA shares” generally had a higher debt ratio than the Canadian average in their industry, due to the fact that they had difficulty in obtaining equity financing. This same message came through loud and clear during our interviews. “Our company was a prisoner of bank financing. The REA made financing more “democratic” and gave us the resources to carry out our development plan.” Indeed, the data show that the debt ratio of companies that issued REA shares fell from 80% before their IPO to 45% in the following years. The REA program thus played an important role by providing a way to change the tendency of SMEs to be undercapitalized at a critical stage of their development. It should also be noted that during the 1982‐1986 period, the growth rate of REA companies was higher than the Quebec average. Since the 2003 moratorium, the REA program has had no further structural effect. Neither the SME Growth Stock Plan introduced in 2005 nor the amendments made in 2009 to create REA II generated consistent interest. On January 7, 2011, the AMF’s list of eligible shares consisted of only 35 companies. Most of the corporate executives we consulted told us that REA II held little or no appeal for their companies.

3.4.1. A widely shared concern The financing of high‐growth companies in the public capital markets is a concern shared by most of the OECD countries. Incentive programs seek to stimulate both supply and demand. For example, the programs of countries as different as Korea, Spain, Portugal and the United Kingdom essentially involve the tax treatment of capital gains.

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In our view, Quebec would do better to take its inspiration from the program introduced in the UK to promote the financing of dynamic companies and their listing on London’s Alternative Investment Market (AIM). The main program components may be summed up as follows:

The provisions concerning the taxation of capital gains realized on an investment in shares acquired during their primary issuance by a Quebec company listed on the TSX Venture Exchange, TSX or NASDAQ, and whose market capitalization is less than $500 million at the time of the issue (“eligible issue”) would provide that: a) The capital gain would be taxed at 50% of the current rate if the shares are held for

more than 12 months.

b) The tax rate would be zero if the shares are held for more than 24 months.

c) The income tax on a capital gain realized on other investments would be deferred if the gain is reinvested in an eligible investment.

d) The maximum eligible investment per taxpayer would be limited to $100,000 per annum.

e) The tax treatment of capital losses would be unchanged. The advantages of such an incentive plan would be superior to those of REA II. First, it should be noted that few securities brokers offer their clients individual REA accounts or issue them with the required tax forms at year‐end. The program has been difficult to administer for individuals and has thus been neglected by brokers. However, individual investors’ participation is essential to the success of public financing of small cap companies. Implementing the suggested program would not require complicated IT changes for the securities industry and could be easily explained to representatives of securities brokerage firms and to their clients. Second, the plan does not have any “perverse” or unwanted effects: investors profit only if the company in which they have invested progresses and achieves its development objectives, whereas the current programs offer a tax break just for investing. Third, from the point of view of public finances, the budgetary burden is extended over time. In this respect, the beneficial effects of growth must be taken into account, along with the fact that better capitalization will have a positive effect on government revenues since borrowing costs are a deductible expense for corporate tax purposes.

3.5 FOSTERING THE LONG‐TERM GROWTH OF QUEBEC‐HEADQUARTERED COMPANIES If there is one trait that characterizes corporate executives, it is their competitive spirit. Their other main trait is cautiousness; this does not mean that they avoid taking risks, but rather that the risks they take are calculated. Since Quebec companies that use the capital markets are the exception rather than the rule and given the oft‐cited thinly veiled criticism of the “going public” option, the reluctance and hesitation among so many private company executives is understandable. Because emulation is such a powerful motivator, it is vitally important that this situation be changed.


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The importance of private placement and its dynamics in Quebec have been described in the previous sections. As previously noted, IPOs are used less often as an exit strategy in Canada than elsewhere; this proportion is even lower in Quebec. We are not questioning the position of some venture capital companies, according to which an IPO does not enable them to “get back all their marbles”, whereas selling the company allows them to realize their investment. However, the executives of public and tax‐advantaged funds we met emphasized that they managed “patient capital”. Consequently, the reservations expressed by private venture capital companies should be given less weight in their decisions about how fast to maximize the value of their investments. Given the nature of the funds they manage, it seems incongruous that the exit route most often used by public and tax‐advantaged funds would be to sell off the Quebec companies they have helped grow to other, often foreign, interests, rather than adopting an approach that would favour the development of autonomous companies in Quebec. In short, concerns about the long‐term growth and development of autonomous companies headquartered in Quebec ought to weigh more heavily in decisions about how to realize their investments in Quebec companies. Based on the large number of SMEs in their private placement portfolios, public and tax‐advantaged funds in Quebec should be able to encourage various high‐potential companies to access the capital markets. As indicated earlier, these funds have the resources and can acquire the instruments required to increase the liquidity of these securities on secondary markets. Such actions on their part would lead to the emergence of a more balanced environment with respect to public corporate financing and would foster the emulation necessary to reduce hesitation and create a climate conducive to the development of an active financial sector, attuned to the needs of this capital market segment. The corrections we are suggesting are particularly relevant to the mining sector. Quebec is fertile ground for the rapid development of companies that create jobs in this sector. While the mining sector is currently dominated by multinational companies, a firmly established and broadly shared objective ought to consist of facilitating the emergence of a solid group of listed mining companies headquartered in Quebec. We believe that this objective is entirely within reach, although improving the financial ecosystem will require a concerted effort. To that effect, we propose organizing in the fall of 2011 a summit of the main stakeholders in the Quebec mining industry, together with the principal financing organizations working with exploration, development and production companies and other players who participate directly in financing mining sector companies. The objective of the summit would be to secure a commitment by the private sector aimed at reinforcing the financial ecosystem so as to benefit Quebec‐based mining companies and to suggest public policies in support of this objective.

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3.6 PROMOTING QUEBEC’S ENTREPRENEURIAL CULTURE

According to data provided by the Fondation de l’Entrepreneurship du Québec and the Business Development Bank (BDC), Quebec lags behind most other Canadian regions in terms of entrepreneurship. The corporate executives we met with often mentioned this problem, along with a climate they described as not particularly welcoming to entrepreneurs or to those who succeed in business. We subscribe to the recommendations developed by several organizations seeking to promote Quebec’s entrepreneurial culture, including the following:

‐ Pay special attention to the importance and value of entrepreneurship and dynamic high‐growth companies in the media and in government policies.

‐ Establish a network of mentoring programs, similar to the Fondation de l’Entrepreneurship’s Programme M and the US‐based Entrepreneurship Mentoring Program , aimed at encouraging experienced and successful entrepreneurs to offer advice to newcomers.

‐ Step up efforts to promote business success stories in secondary schools, CEGEPs and universities.

‐ Increase the number of business incubators, such as the Centre d’entreprises et d’innovation de Montréal, Techstars (US) or the Difference Engine and Seedcamp (UK).

‐ Promote the creation of more research centres aimed at meeting the advanced research needs of small and medium‐sized organizations, such as the National Optics Institute (INO) in Quebec City and the Marine Biotechnology Research Centre (CRBM) in Rimouski.


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4. CONCLUSION

This report seeks to provide decision‐makers in the private and public sector with an informed diagnosis of the situation and to propose measures aimed at promoting the development of high‐growth dynamic companies in Quebec.

We must work together to change perceptions and actively support the emergence within Quebec’s financial ecosystem of firms and activities which are dedicated to facilitate access to public capital markets by high‐growth dynamic small‐ and medium‐sized companies in all sectors of our economy. Emulation will be an important success factor. Celebrating success and securing a much firmer commitment from the financial sector and the business community in support of business leaders who opt for IPOs will have a beneficial effect .

All stakeholders must help to promote an entrepreneurial culture, facilitate access to public capital markets and encourage the growth and development of autonomous companies headquartered in Quebec.

The individuals we met with showed great generosity and open‐mindedness on these subjects, which are of great interest and concern to them. We are extremely grateful for their cooperation.

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BIBLIOGRAPHY

Acs, Zoltan, William Parsons and Spencer Tracy, “High‐Impact Firms: Gazelles Revisited”, Contract for the Small Business Administration, June 2008. Birch, David, “Job Creation in America”, New York, The Free Press, 1987. Carpentier, Cécile, Jean‐François L’Her, Stephan Smith and Jean‐Marc Suret, “Risk, Timing and Overoptimism in Private Placements and Public Offerings”, CIRANO, November 2007. Carpentier, Cécile, Jean‐François L’Her and Jean‐Marc Suret, “Stock Exchange Markets for New Ventures”, CIRANO, April 2008. Coté, Marcel, “By Way of Advice”, Mosaic Press, 1991. Davis, Stephen J., John Haltiwanger, Ron Jarmin and Javier Miranda, “Volatility and Dispersion in Business Growth Rates: Publicly Traded Versus Privately Held Firms”, June 2006. Haltiwanger, John, Ron Jarmin and Javier Miranda, “Business Formation and Dynamics by Business Age: Results from the New Business Dynamics Statistics”, CES preliminary paper, 2008. Huot, Patrick and Christine Carrington, “Les PME à forte croissance”, Programme de recherche sur le financement des PME, May 2006. Institute for Competitiveness and Prosperity, “Assessing Quebec’s Key Prosperity and Competitiveness, Opportunities and Challenges”, September 2010. Institut de la gouvernance des organisations publiques et privées, “Les actions multivotantes: quelques modestes propositions”, Document de politique #1, October 2006. Leung, Danny, Césaire Meh and Yaz Terajima, “Are there Canada‐US Differences in SME Financing?”, Working Paper, Bank of Canada, 2008. Leung, Danny, Césaire Meh and Yaz Terajima, “Firm Size and Productivity”, Working Document 2008‐45, Bank of Canada, 2008. Lee, Frank and Jianmin Tang, “Multifactor Productivity Disparity between Canadian and U.S. Manufacturing Firms”, Journal of Productivity Analysis 15, 2001. Parsley, Chris and David Halabisky, “Profile of Growth Firms: A Summary of Industry Canada Research”, Industry Canada, 2008. Peristiani, Stavros, “Evaluating the Riskiness of Initial Public Offerings: 1980‐2000”, Federal Reserve Bank of New York, Staff Report No. 167, May 2003.

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