(January 11) – “Times are good. Inflation, interest rates and unemployment are low. The economy is booming and a large number of Canadians have a great deal to be thankful for economically. Governments, regulators, stock exchanges and financial institutions are all, of course, taking credit for our boom conditions and indeed, in times like these, there is glory enough for all,” writes Thomas Caldwell in today’s Globe and Mail.

The danger of pointing out concerns in good times is the potential of being treated like the prophets of old. Despite that concern, let me begin by stating in non-prophet-like language that Canada is getting one on the house. The house providing the free drinks in this case is the United States, with its roaring economy. Canada’s economy is being pulled along in its wake, in spite of itself.

This is fine as far as it goes. In stock markets, the difference between being good and being lucky doesn’t matter if you are winning, and right now we are benefiting from boom times.
Strong economies, however, should not simply be enjoyed or used for self-aggrandizement, but to improve what exists and build for the future. This is where I fear we are lacking as a nation.

Much has been written about the need for lower taxes, debt reduction and our lack of 21st-century leadership and policies. A key point for future prosperity that has been missed in this debate, however, is the flawed structure of our Canadian capital markets. In particular, the markets are not providing adequate financing opportunities for smaller companies. This hurts not only the prospects for these firms but also the growth potential of the country’s economy.

Let me begin with a historic view. Canada has historically been a resource-based economy. Capital markets were geared for financing large mineral, oil and timber enterprises as well as bringing smaller prospects to fruition through an array of financial institutions. Pools of capital existed first in Montreal, then in Toronto and later — to a lesser extent — Vancouver.

As Canada’s economic scope widened to include real estate, heavy industry and secondary manufacturing, the existing capital market structure continued to raise the funds needed to finance development.

Despite the occasional innovative enterprise outside of the resource and industrial sectors, market mechanisms were still focused on fundraising for these basic enterprises. As has been said of armies, we were preparing for a war that had already been fought.

@page_break@The next step to occur was the consolidation of the Canadian financial sector into a few massive investment and fundraising enterprises. This, of course, was the logical offshoot of the old economic model we were working on. It all sounded great, with phrases like: one-stop shopping; bringing stock trading to the hinterlands; “we like to handle all your financial needs,” and so on.

The problem, however, is now evident as several things have occurred.

The minimum threshold for financing has been substantially increased to approximately $100-million per deal, in order to feed the massive underwriting and distribution operations of our major institutions. There is nothing wrong with this; indeed, it is positive, so long as mechanisms exist elsewhere to raise smaller amounts.

As investment firms have been bought up, the remainder have tended to specialize in sectors other than financing, such as wealth management, institutional trading and research.
As a result, there are only a few firms that can consider public financings in the $5-million to $20-million range. Their capital structure not only limits the number of deals these enterprises can accommodate, but also curtails their ability to maintain reasonable after-issue trading in the companies financed. Those companies often become orphans.

Regulators and eastern stock exchanges have added to the problem with their total focus on fraudulent and unscrupulous operators, who in fact have become the real policy makers. Rules are made for the many because of the few. Their desire to be seen as legitimate host environments for the trading of senior companies overwhelmed the need for growth in smaller enterprises and indeed their responsibilities in this regard. In the end, the liquidity of small enterprise shares has declined dramatically, and as a consequence, capital formation has been impaired.

The final step to keep in mind is the fact that venture capital has to be raised where the pools of capital reside. New enterprise financing is a face-to-face business, as entrepreneurs must seek and gain the trust of financiers and individual investors.

Thomas Caldwell is chairman of Caldwell Securities Ltd., an investment management firm and brokerage in Toronto.