Hidden out of sight of the Toronto Venture Exchange's record lows sits a vehicle, known as capital pool companies, that observers say will continue to weigh down the venture exchange unless reforms are enacted.
The TSX Venture Exchange composite index closed Wednesday at 584. The resource-heavy exchange has lost more than 80 per cent of its value since 2007.
"Things are a hell of a lot worse than what that index shows," said Tony Simon, co-founder of the Venture Capital Markets Association, a non-profit association that aims to improve access to capital for emerging companies.
"Capital pool companies contribute to a problem for the industry and for the retail [and other] investors."
The capital pool company program, or CPC, is not unlike its bigger brother, the special purpose acquisition vehicle. The CPC program, instituted in 1986 on the venture exchange, is intended to provide an alternative way for private venture companies to go public instead of going through the traditional and costly initial public offering process. The CPC then has two years to find a private company that would acquire the shell in a reverse takeover. There have been 2,420 CPCs listed since the program began, with 85 per cent completing their transactions with private companies. All CPC company tickers end with .P. Some higher profile companies that went public through a CPC include Element Financial Corp., Calloway REIT, and Peyto Exploration and Development Corp.
The crux of the problem lies in the fact that some of these CPCs have negative working capital, which should render them dead except for the fact that they are paying listing fees to remain trading.
Research conducted by Mr. Simon between September and November, 2014, found that between the TSX and the TSXV, there were 596 resource companies with a total of $2-billion of negative working capital. Mr. Simon says the venture exchange constitutes at least 80 per cent of that.
"The last thing that the TSX Venture needs is too many shells," Mr. Simon said.
That's because if the exchange has many CPCs, it diverts investor attention and funds away from the "legitimate" companies, otherwise distracting "from the companies that should be actually getting the retail investors' funding," Mr. Simon said.
On top of that, for the resource sector, he says there are only so many viable exploration targets for such a large pool of shell companies to exist.
John Kaiser, independent mining analyst and editor of kaiserbottomfish.com, says CPCs became a "big business" when the resource-focused Vancouver and Alberta stock exchanges merged in 1999. He said that helped "dilute the exchange with too many 'pretend' companies."
The death of companies – which happens when a it finds a target asset, fails and then can't fund its activities any longer – doesn't happen because the venture exchange's working capital requirements are not enforced and the companies are allowed to continue to exist, Mr. Simon said. According to the exchange's rules, companies must show a working capital of $50,000 to remain listed.
A spokesperson for the TMX Group, which owns the TSXV, said that CPCs make up only a small percentage of total listings on the venture exchange, representing 0.1 per cent of the exchange's market capitalization. The spokesperson adds that CPCs make up 25 per cent (89 out of the 359 companies) of the NEX Board – the separate listing board for companies that don't meet the venture's listing requirements.
As of June 30, 46 CPCs were listed on the venture exchange, with 15 completing their qualifying transaction, TMX Group said. Seven companies have been suspended, three have had their trading halted and the remainder continue to trade. Eleven of those CPCs have identified a resource company as a target.
Darrin Hopkins, director and co-head of the public venture capital division of Richardson GMP Ltd., has worked on 110 CPC deals over 21 years and doesn't buy the argument. "I really think it's crazy to think that the pool of capital is diluted because there are CPCs trading on it that haven't done a qualifying transaction yet," he said. "I think it's completely irrelevant. You are buying into a specific company.
"If you looked at the Top 10 reasons why there's a lack of capital in the TSXV, CPCs are not one of them. And, in fact, it's probably the CPC program that's still attracting capital to the TSXV."
Mr. Hopkins adds that the problem of declining capital flow to the venture exchange has many tentacles, including the consolidation in the investment industry, where brokerage firms – some of whom backed these venture firms – dropped off.
"Without the CPC program, I think it gets much, much worse, not better," he said.
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Editor's note: A previous version of this article in print and online incorrectly said the listing fee for capital pool companies on the TSX Venture Exchange is $200,000. In fact, CPCs pay an initial listing fee of $15,000, with successive annual listing fees largely determined by the firm's market capitalization.