AN OVERVIEW OF THE SOURCES OF FINANCING FOR NEW COMPANIES

Introduction

Background

It's not that long ago when helping a corporate client get financing meant referring the client to the closest branch of a chartered bank or nearest office of what used to be called the Federal Business Development Bank.

But that was then. Today, there are many more financing sources to refer clients to, and let's be thankful there are, because when our clients get financing, we stand a better chance of being paid. Many clients in the early stages of growth, especially those in emerging or knowledge-based industries, are often unable to raise the money they need from traditional sources of financing. Of all small and medium sized enterprises, knowledge-based businesses, such as computer software and biotechnology, are the fastest growing, yet they have real difficulty getting financing. They certainly represent particular challenges to the banks, given their rapid pace of change, complex technologies, intangible assets and research and development uncertainties.

Yet the demand for financing for these new companies continues to increase. Canadians are starting new businesses at a faster rate than ever before. Government initiatives to promote technological development and innovation, together with the restructuring of the economy and merging of large corporations, have created numerous market opportunities for new businesses.

Fortunately for these new companies and their lawyers, there is capital available outside of the banks. Large pools of capital exist simply because of demographic changes in our society. People are living longer and have savings to invest, and are no longer content to leave all their money on deposit with banks or trust companies. Much of their money is now placed with pension fund and mutual fund managers who face pressure to keep this money invested, and some of it gets invested in new companies.

Given the impact of free trade, the globalization of financial services, the deregulation of the financial services industry, and the role of new technologies in delivering financial services, it is difficult to even recognize today those banks and trust companies which operated in the past. New financial services players have appeared on the scene in response to recent trends toward securitization and disintermediation. Securitization occurs when liquid assets like receivables are packaged as securities issued in the capital markets, and disintermediation occurs when borrowers go directly to the capital markets, displacing the banks as needed intermediaries between lenders and borrowers.

The focus of today's programme is on sources of equity capital for new companies, not debt capital, since new companies are often unable or unwilling to take on debt. However, to set the stage for today's discussion and the other papers being presented, this paper will provide a brief overview of sources of debt and equity financing for new companies, although it will by-pass those sources of financing for companies at the very earliest stage. Those sources ordinarily include use of the founder's own assets (pension funds, RRSPs, life insurance and home mortgages), "love money" from friends and relatives, "sweat equity" representing the founder's investment of time and labour, and personal credit cards and lines of credit.

Current Situation

Given the current state of the public markets, the trend to IPOs in the last few quarters has definitely slowed down. This has resulted in an increased demand from both privately held companies and smaller public companies for funding from private equity sources. According to a Toronto Globe and Mail article on October 8th, in the two quarters ended June 30th of this year, a total of 474 venture financing deals for 429 companies were completed. That's up from 402 transactions during the first six months of 1997, and 283 during the same 1996 period.

However, the amount of money invested in the first half of this year dropped to $689 million compared with $790 million invested a year earlier. Meanwhile, the number of IPOs on Canada's four major markets dropped to 72, worth about $4.6 billion during the first six months of 1998, down from 104 valued at $7.7 billion for the same period the year before.

This is different from the last few years of robust markets when privately owned companies were leapfrogging over venture capital funds and going public. At that time, unproven enterprises could go public based on projected earnings, particularly if they were Internet or high technology related. But these days it is more difficult without an established quarter-after-quarter record of strong revenues and some profit by a recognizable company to make it onto the public markets.

Stages of Financing for New Companies

Once a company has a commercial idea, there tend to be four financing stages in its development cycle. The models and definitions of financing stages used by various authors and researchers vary considerably, but for the purposes of this paper, we'll look at the following four general stages, keeping in mind that the boundaries are quite elastic and can't be rigidly applied to every company.

1. Seed Capital

At the earliest stage, seed capital is required. This is still at the conceptual or "alpha" stage, when there may not even be a prototype of a product, and additional product and market development work remains to be done.

2. Start-up Capital

Start-up capital is required when things are a little further along, when the product development work has produced a "beta version" and market research is completed or near completion. Sometimes referred to as the "pre-revenue stage", few, if any, commercial sales have been entered into. However, the management team is probably in place, and a business plan has likely been completed.

3. First Stage Expansion Financing

First stage expansion financing is required when the company has started commercial production and requires additional financing to materially increase production or development, and enhance sales and marketing efforts.

4. Second Stage Expansion Financing

Second stage expansion financing is required when the company wants additional expansion of both productive capacity and markets, and perhaps wants to fund acquisitions.

Seed stage financing is probably the most difficult to get. Raising $100,000 or so at a time is expensive and time consuming. Seed stage companies are often based on a good idea, may have world class intellectual property, and even great people. But they generally lack a proven product, defined market, initial customers, revenues, positive cash flow and a business plan. While needing "proof of concept", they essentially have no "critical mass" to finance - no assets to speak of, no seasoned management team in place. What they need is sufficient capital to get them to a point where they can raise money from other sources. That's the goal of seed capital.

The smallest businesses in the seed stage may not even need $100,000. For those having gone through their "love money" with no more room on their credit cards and lines of credit, they may be eligible for assistance from various micro-loan programs. Micro-loan programs target very small businesses, often with five or fewer employees and gross revenues of less than $500,000. Loans are generally less than $15,000 for new businesses and less than $25,000 for existing businesses. The funds are provided by not-for-profit community organizations, private donors, other businesses, financial institutions and the government. Loan applications and approvals are stripped down to the bare minimum.

As a company moves away from the seed financing stage into the start-up and expansion stages, it increases its opportunity to access more diversified financing sources. No longer having to rely on just one supplier of capital, it soon is able to use the contacts, ideas, expertise and experience of those representing such additional sources.

Financing needs of companies differ. The best source of financing for one company may be too risky for another company. The suitability of different types of financing changes as the company grows. The financing needs for the start-up stage differ from those for the expansion stages. But without raising equity, significant company growth is unlikely. It is unusual for a company to be able to generate sufficient cash from its operations to finance a material expansion. And borrowing by a new company to finance expansion may entail more risk than is warranted.

Alternative Sources of New Company Financing

Leasing, trade credit, and factoring are all alternatives to borrowing. And there are a number of specialist financial sources which have expertise in particular aspects of financing - insurance companies, commercial mortgage lenders, specialty equipment financiers, international trade finance companies, private term lenders, merchant banks, pension funds and bridge financiers. Many lend money for specific uses and may be able to offer cash at a cost that doesn't impair the company's credit rating or give away equity.

However, for those companies in the seed and start-up stages, where revenues are not being consistently earned, angels, venture capital and certain corporate investment programmes may be more appropriate. While public offerings have tended to come later on when a company has sustainable revenues and growth, there was, up until this past spring, perhaps too much public money chasing too few quality investments, causing public offerings to come earlier in the cycle and for smaller amounts than in the past.

SOURCES OF DEBT FINANCING

Bank Financing

While the banks continue to be a main source of financing for many new companies, their lending practices still don't support risky ventures. Bank personnel usually don't have the time or experience to assist in a borrowing company's management, and tend to prefer companies that are mature, with long established relationships to their bank and with cash flows sufficient to support bank debt. Consequently, new companies generally face higher interest rates and more stringent terms than their more seasoned counterparts, including the need to provide personal guarantees from their founders.

Banks generally lend in the form of term loans and operating loans. Term loans are granted to acquire specific items of plant and equipment, for terms of from one to five years or longer depending on the expected life of the item being financed, and are often repaid periodically with payments of both principal and interest at fixed rates or floating rates. Operating loans are granted for working capital purposes and to help bridge a company's cash flows between payment of expenses and receipt of revenues. They come with a maximum credit limit and interest usually payable on a floating rate basis.

One way the banks have traditionally assisted new companies is by providing loans covered under the Small Business Loans Act, first enacted in 1961. Small businesses that might not ordinarily get loans can obtain a term loan from a bank or other "approved lender", a high proportion of which is guaranteed by the federal government. Without this guarantee, a bank might refuse to loan to new companies or to companies that the bank otherwise perceives as being too risky. The loan proceeds must be used to finance land, premises, equipment and certain other items, but not to finance working capital, share acquisitions, refinancing or intangibles. The guarantee is not free, as the borrower must pay an initial fee as well as an annual fee.

More specifically, businesses with annual gross revenues of less than $5 million (excluding farming, and non-profit, charitable and religious organizations) may qualify for a guaranteed loan. The bank may finance at its discretion up to 90% of the purchase or improvement costs involved. The loan can be repaid over a period of up to 10 years. The maximum rate of interest is the bank's prime plus 3% for floating-rate loans, and fixed-rate loans can use the bank's residential mortgage rate plus 3%. Part of that interest rate is the federal government's annual 1.25% administration fee. The initial 2% registration fee is usually added to the principal amount of the loan. The maximum a borrower can access under the programme is $250,000. If the business fails, the federal government will share up to 85% of the loan losses with the bank.

The banks are changing to help new companies. All of the major banks have established innovation and knowledge-based business centres in key markets across Canada. These centres are staffed with specialized account managers who assist customers in preparing business plans, and provide software programs to allow new companies to forecast growth and devise marketing plans. They also provide a portfolio of automated financial and management information services, including electronic banking, cash management, payroll and human-resources services, merchant credit and direct-payments services.

Business Development Bank of Canada

In 1995 when the federal government changed the name of the Federal Business Development Bank to the Business Development Bank of Canada, the bank's mandate was also changed from being a source of last resort financing. Previously a lender whose job was to help out businesses that had great difficulty getting financing from traditional sources, it's now another financing source to be considered in addition to the banks. BDC today assists technology-based firms that might lack collateral, established firms that have reached the limit of their operating loans, and business start-ups whose owners are willing to accept BDC sponsored training.

Some of the financing programs it offers new companies through its extensive network of approximately 80 branches across Canada are described below.

Micro-Business Program

The Micro-Business Program supports the early growth needs of some of the smallest businesses. This program combines financing of up to $25,000 to new businesses and up to $50,000 to existing businesses which have business proposals that demonstrate potential for growth and good prospects for success. Funds can be used for working capital, acquiring fixed assets and product research.

Patient Capital Program

The Patient Capital Program provides innovative and knowledge-based companies, headed by high-quality management, with almost equity-like loan financing of up to $500,000. Funds can be used for working capital, market development projects, and product research and development. Repayment can be postponed and interest capitalized for up to three years. These loans are usually amortized over six to eight years, and priced to include a base interest rate plus a royalty on the borrower's sales.

Working Capital for Growth Program

The Working Capital for Growth Program is designed to "top-up" a business with an already existing line of credit through loans of up to $100,000. Applicants must have recognized business skills and be prepared to work with the BDC's counsellors to ensure the growth plan is properly managed. Principal payments may not be required in the first year, although the loan must ordinarily be repaid over four to seven years.

Term Loan Program

Term loans are offered for a variety of commercially viable projects, including expansion projects, plant overhauls, the purchase of existing businesses and the acquisition of fixed assets. In some cases, term loans may be used to reconstitute working capital depleted by capital expenditures or to finance sales growth. Repayment methods are flexible to accommodate cash flow fluctuations, interest may be at fixed or floating rates, and terms may be for up to 20 years.

Venture Loan Program

The Venture Loan Program is for companies that don't have the assets for term loans, but have established earnings and a strong potential for growth and which need more money to take on competitors, introduce new products or enter new markets. It provides royalty based financing for growth companies whereby BDC shares in the profits of the company but doesn't require the giving up of ownership. Venture loans are typically more than $100,000 and can go as high as $1 million. The loans are a hybrid of traditional term loans and venture capital, and are priced to include a base interest rate plus a royalty. The repayment schedule takes into account cash flow and the level of working capital needed to operate the business. In some cases, the commencement of principal and royalty repayment can be postponed for over a year. The normal amortization period is six to eight years.

Trade credit

Not thought of as debt financing, trade credit is financing obtained from suppliers and is one of the more important sources of capital for new companies, particularly in the early expansion stage. Trade credit simply means lengthening the time a company has before having to pay its suppliers. However, the "discount" which may be offered by suppliers for early payment may reflect what is really a substantial interest rate being charged to those who are allowed to make later payment.

Factoring

Factoring is the process by which companies sell their accounts receivable. The larger its receivables and the more working capital it requires to finance those receivables, the more likely a company might be prepared to consider factoring. When the company sells its receivables to a factor, the factor often advances 70 to 90% of the invoiced amounts. When a customer pays in full, the company gets the rest of the money less the factor's fee and any interest charges. Some factors may agree to acquiring the company's receivables on a "non-recourse" basis, which means they assume the risk for bad debts. Factors look for a good credit history on the company as well as on the company's customers.

Factoring firms can also provide other services for fees, including the carrying out of credit assessments, making credit decisions and generally collecting on accounts by generating statements and follow-up notices, in much the same way as the company's own in-house credit and collections department might perform.

In years past, factoring companies were considered a last resort because a company's customers would be instructed to pay the factor directly, suggesting the company's business was in receivership or worse. Today, many factoring companies operate behind the scenes, acting as outsourced billing departments.

Asset-based Financing

Asset-based financing means that a company borrows against a specific asset, often the particular asset for which the company needs the funds. Leasing, term loans and conditional sales contracts are all examples of asset-based financing. Instead of looking at a borrowing company's ability to repay a loan, as a bank might ordinarily do, asset-based lenders look at the value of the asset itself since the asset is the security for the loan. An asset-based lender may be a manufacturer's capital finance arm, like those firms operated by the automotive and computer companies, or one affiliated with a bank

Asset-based lenders usually have a thorough understanding of the equipment they finance, as they might have to take the equipment back if the borrower defaults on the loan or no longer needs the equipment. They also have a close relationship with equipment manufacturers, as some of the financing they raise comes from the manufacturers, and sometimes the equipment they end up taking back is resold through the manufacturers. Many asset-based lenders are members of the Canadian Finance and Leasing Association.

Leasing

Leasing is perhaps the most common form of asset based financing, where an asset-based lender simply buys the equipment and then leases it to the company. For new companies lacking predictable cash flow, leases allow them to acquire assets that would otherwise require them to make a considerable cash outlay. Furthermore, leases may be more convenient and entail less obsolescence risk to the company. Certain assets such as heavy industrial or commercial equipment, medical instruments and computers may be more amenable to leasing.

There are other advantages to new companies through leasing. As leasing contracts are considered a current expense, they don't have to be listed as a liability on the company's balance sheet, whereas loans do. The company may also be able to write off the full leasing costs for tax purposes and not just take the capital cost allowance on the value of the assets as if they were purchased. Since a leasing contract can be tailored to match the revenue generated by the company's business, a seasonal business that takes in most of its revenue during the winter can arrange for its largest lease payments to be made during that time. And because lessors usually develop a field of expertise, they can give expert advice to the company in determining the best equipment which the company might be in need of.

SOURCES OF EQUITY FINANCING

Angel Investors

Angel investors are generally wealthy individuals who invest their own money directly in a business. The expression "angel" is said to be derived from those who provided financing for new plays or musicals on or off-Broadway in New York City, and were credited with preventing a worthy production from folding before opening night. While angels might come with much needed cash for a struggling new company, they also might come with considerable business experience, contacts, fresh ideas and lots of personal energy.

Often anywhere between $25,000 and $250,000 can be raised from individual angel investors, although $100,000 may be the average angel investment. However, a syndicate of angels pulled together by an "archangel" may be able to invest up to $500,000.

But this money doesn't come cheaply. Angel investments are the most risky investments around, and new companies in the early stages of development with unproved products or services and an incomplete management team represent risks that demand high returns. Because an angel investor might invest instead in the stock market and possibly get an average 10 % to 15% rate of return, or co-invest with an institutional venture capitalist in a later stage company and expect more than a 30% annualized rate of return, an angel expects to be well compensated for the extra risk. Consequently, angels often want to take out seven dollars for every dollar they put into a new company, although they may have to wait seven years to do so. While this may be a high return in relation to returns on other investments they could make, often only a minority of these investments are profitable for them.

Besides this return, they usually want something else. Because angels are often retired business owners or executives with money to invest in promising companies, they may want to play an active role in the company, doing more than simply oversee their investment. They like to invest in businesses which they know something about and in which they might have had previous entrepreneurial experience. Many angels want to affiliate with like-minded individuals, identify with a successful company, and simply be part of the business process. For those new companies in the seed and start-up stages lacking a well-rounded management team, a "hands-on" angel can be a tremendous help.

Although the angel market is a largely untapped capital market, it is unfortunately little known. Access to it is difficult, owing in large part to the fact that angels don't advertise themselves. Because many are relatively wealthy, they prefer to remain quite private. As a result, the angel market is very fragmented, with no central meeting place, clearing house or "matchmaking" service where those seeking capital can predictably meet those with capital. Any introductions which do take place within the angel market are either random encounters or the result of persistent networking. While some organizations like the Toronto Venture Group and other "venture fair" conveners are attempting to remedy this situation, there doesn't yet appear to be in Canada the kind of "angel infrastructure" which early stage technology companies are able to access in California.

The federal government, however, has recently tried to make angel financing more accessible. Under the Canada Community Investment Program, the government subsidizes local governments or institutions that form facilities for investor / entrepreneur matchmaking. These facilities draw on the Program's funds to support mentoring of fledgling firms, linkages with investors, identification of investment communities and post-investment advisory services.

Under the Program, the federal government will spend up to a total of $12 million over five years to set up an anticipated 20 regional facilities, with Ottawa providing two-thirds of each facility's funding, and the local community coming up with the rest. Each regional facility is to act as a broker between entrepreneurs and investors who are not traditional financial institutions.

Each facility follows it own path to meet the need for investment capital among small, high-growth businesses. Some use mentoring and an informal network of local investors, or have programs to classify investors according to industry, philosophy and spending limits, while others help with developing business plans and presentation skills, or arrange introductions of entrepreneurs to potential investors at forums and in private meetings. Some emphasize a particular industry. For example, the facility covering the Kitchener, Waterloo, Guelph and Cambridge region is called "Canada's Technology Triangle Accelerator Network".

Venture Capitalists

While angels are generally individuals who invest their own personal funds, venture capital firms are often professional fund managers who invest other people's money. Usually they are institutional, or act for institutional investors. Many, but not all, are members of the Canadian Venture Capital Association.

Some are private independent funds, which raise the capital they need from institutions like pension funds and insurance companies, and in turn, invest in more entrepreneurial companies. Others are corporate affiliates, obtaining their investment capital from their corporate parent and investing in companies having some connection to their parent's current or proposed lines of business. Still others are public sector funds, established by the federal or provincial governments. And the best known of them all may be the labour-sponsored funds which derive their capital from public solicitation, particularly during the winter "RRSP season" since individuals investing their capital in these funds get certain tax benefits.

Venture capitalists may invest as little as $50,000 and as much as $20 million, but most deals they do are in the $500,000 to $5 million range. Most venture capitalists set minimum thresholds for the size of deals they are prepared to consider, not only to account for the high evaluation and monitoring costs they incur, but also to encourage larger deals overall, since they can make more actual dollars on a larger deal.

While there may be more venture capital around than there used to be, not many venture capitalists are throwing their money at needy companies. They continue to invest in fewer than three out of every 100 potential opportunities they're given. By one rule of thumb in the industry, the 2-6-2 rule, for every 10 companies receiving venture capital financing, two of the companies will fail, in six the venture capitalists will get their money back, and the remaining two will sell out at great multiples.

As with angel investments, high risk venture capital deals demand high rewards. Venture capitalists look for high rates of return, often 25% to 40% on an annualized basis. But this is not the quick buck that most venture capitalists are accused of getting, since their return isn't realized until they exit via a buyout or an IPO. And the return they want often depends on which stage the company is at when they invest, since higher rates of return are expected for riskier, early stage deals, and lower rates for later stages when expansion or even a buyout is more likely.

Most venture capital firms don't do start-ups and prefer to invest only when there is a prospect of real capital gains. They like businesses capable of reaching $30 to $50 million in sustaining revenues within five years, with a clear potential for a big payout when the businesses go public or are sold to larger concerns. They also like businesses with low fixed cost structures, brand name recognition, throw-away or repeat-use goods, products with no-substitutes, or a large and rich customer base. But some will back troubled or no- growth businesses with a clear rescue potential, if the turnaround promises to be lucrative.

Venture capitalists also look for an experienced and involved board of directors with good connections, and a strong management team comprised of individuals not only having the required technical expertise but also having previously made money for themselves or others in a similar business. While some venture capitalists may be as active and "hands on" as angel investors, many are more passive and prefer to leave business operations to capable managers. However, some have access to a "stable" of professional managers, and may even support an "executive in residence", who can be called upon to go into a company and provide managerial help when the need arises.

Individual venture capital firms usually specialize according to particular stages of development or industry sector. For example, some will only do technology deals, or will not invest in real estate, retail or natural resource companies.

Once they invest, venture capitalists don't want to be involved in a company's day to day operations, but they usually want a say in significant decisions. They often want at least one seat on the company's board, and expect to be consulted on major strategic or financial matters, with a right to veto certain types of proposed transactions. But they don't look for control, and hold on average less than a third of an investee company's outstanding equity.

Venture Capital tends to be patient capital, with a five to seven year time-line. Venture capitalists make their investments incrementally over time, often in two or three rounds, depending upon certain milestones being met. However, while they may not want control, they generally insist on a commitment from management to work with them to bring about an exit, such as an IPO, within a shorter period. Furthermore, if the IPO doesn't happen, they may then require that the founders buy back their shares plus any unpaid dividends.

Corporate Investment Programmes

A number of larger corporations, often well-established and publicly traded, have decided to invest in people and ideas and keep them outside of their corporations, instead of acquiring them to bring them inside. Some believe that their respective corporate cultures and bureaucracies may not be conducive to maximizing the value which these ideas possess should efforts be made to commercialize them completely in-house.

Often referred to as "incubators" and sometimes called "skunkworks", such corporate sponsored projects are housed in separate companies, with different shareholders and directors than those of the corporations. The sponsoring corporations provide both financial and logistical support for these new companies, whose business is often but not always complementary to their own existing businesses.

Some of these new companies are started up by former employees of the sponsoring corporations. Instead of losing valuable employees hoping to commercialize their own innovations, the corporations benefit by helping their employees move on, since the corporations can retain the benefits of their creativity.

The sponsoring corporations make their investment in these new companies with a view to getting a return at least equal to their own cost of capital, as opposed to the return they might expect if they were making a pure venture capital investment. The flow of ideas and other synergies between the company and the sponsoring corporation presumably justify a lower return.

Merchant Banks

Merchant banks provide term debt financing and equity financing to clients, often using their own funds to buy equity in a client. Although some are affiliated with the banks, they are not deposit-taking institutions. They provide advisory services as well as financing, and are ordinarily active in mergers and acquisitions, restructurings and management buy-outs. While they occasionally work with new companies, merchant banks normally assist larger, more established companies. Their average deals fall within the $3 million to $12 million range.

Like venture capital financing, merchant banks represent patient capital, and generally don't expect to exit for five to seven years. They may invest in a company after venture capital has been invested, but before an initial public offering. Their intended exit is often through an IPO, buyout or refinancing through senior debt.

Merchants banks often provide subordinated debt financing, which ranks behind any existing "senior" debt and ranks ahead of the equity investors. This subordinated debt, sometimes referred to as "mezzanine financing", may be accompanied by an "equity kicker", either by containing conversion rights into equity, or including warrants or options to acquire equity.

Institutional Investors

Institutional investors such as pension funds, mutual funds and insurance companies don't generally provide financing directly to new companies, and instead invest indirectly through various venture capital funds as mentioned above. When institutional investors invest directly, their deals are for at least $1 million, an amount which exceeds what many companies need in their early stages. Direct investments by institutions in new companies tend to be made during the companies' expansion stages, before they go public, and sometimes with the undertaking that such companies will try to go public within a certain time. Institutional investors make their direct investments as exempt purchasers within the private placement market.

However, if available, direct investment by an institutional investor in a new company may be better for the company than an investment by an angel or venture capitalist. Since such investments are a relatively small amount of money for most of them, institutional investors ordinarily don't want any day-to-day involvement in the company's business. Furthermore, getting an institution familiar with a company early on by way of investment may make the institution more likely to participate as a purchaser in the company's eventual IPO.

Private placements with institutional investors are arranged either directly between the company and the institution, or through an investment dealer who acts as the company's agent. Dealer commissions and overall expenses for a private placement are relatively low compared to a public offering since no prospectus needs to be prepared and filed and the transaction can be completed more quickly.

Initial Public Offerings

Once a new company has tapped into some or all of the foregoing sources of equity capital, it may decide to sell further equity through investment dealers to the public. Of the many advantages to doing so, the company acquires enhanced visibility and prestige, it becomes able to raise capital on the public markets, it is looked on more favourably by its institutional lenders who prefer dealing with public companies, and its founders, employee shareholders and any angel and venture capitalist investors it's picked up on the way get to convert some shares into cash.

Of the many disadvantages, the confidentiality of the company's affairs as a private company disappears, its managers and directors give up a degree of personal privacy, the company gets to be investigated by research analysts who try to second guess its decisions, and the company is required to bear the expense of going public and staying public.

And these expenses are significant. Going public can amount to between $200,000 and $400,000, excluding the dealer's commission. For offerings over $15 million, the total costs for the offering can add up to 10 per cent of the value of shares sold because the process involves lawyers, accountants, printers, investor relations and other professionals as well as the dealers who have to be paid. Once the company is public, it must spend substantial sums not only to remain listed but also to be in compliance with the continuous disclosure requirements imposed on public companies under the securities legislation. It has to pay the fees of auditors, investor relations counsel, lawyers and others retained to assist in preparing regular financial statements, reports and circulars, as well as the sustaining fees of those exchanges it may be listed on.

Many new companies wanting to go public may not qualify to do so. At the outset, they need to have a product or service that can capture the investor's mind, as well as a real need for the money they are about to raise. And they have to be big enough. Even though they can meet the basic tests of marketability, they still have to engage an underwriter who may demand a minimum level of capitalization to ensure profitable trading activity on the offered shares. Many underwriters won't consider offerings in Canada of less than $20 million.

There are other monetary thresholds to meet imposed by the stock exchanges on which the company may want to be listed. For example, to get listed on the Toronto Stock Exchange, a company must have, among other things, net tangible assets of $2 million, and pre-tax earnings of $200,000 and pre-tax cash flow of $500,000 in the prior year.

Conclusion

Whether new companies are being well served by these existing sources of financing continues to be debated. As the federal government moves closer to finalizing its current round of financial services legislative reforms, some of this debate may be closed off, at least for the short term. But whatever reform package is eventually presented by the federal government, and whether it is supported by complimentary reforms from the provincial governments, there no doubt will continue to be demands for government initiatives to facilitate the availability of risk capital for small and medium sized enterprises within Canada, especially those in the technology sector.

While some may advocate the need for a transparent and comprehensive angel and venture capital infrastructure, others may stress the benefits of providing smaller companies with some relief from the expensive and time-consuming prospectus and registration requirements of provincial securities legislation.

Yet if there is any consensus at all, it's in the desire of those who try to raise money for new companies to remove the randomness and fragmentation from the current process. Searching for equity these days still entails a tremendous amount of hard work and disappointment. There often seems to be little positive correlation between effort and result. Those on the receiving end of financing proposals admit to proceeding with just one or two for every 100 they see.

Maybe these odds will be better when the sequel to today's programme is eventually held.

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A. Paul Mahaffy practises business law with Bennett Best Burn LLP of Toronto, with particular emphasis on purchase and sale agreements, technology transfers, joint ventures, strategic alliances and financing, and can be reached by e-mail at pmahaffy@bbburn.com

Copyright 1998, A. Paul Mahaffy. Reproduction by any means in whole or in part without the author's written consent is strictly prohibited.