A shortage of capital for early-stage companies has long been seen as a problem in Canada, but regulators may have to learn that sometimes they should take the long-term view when it comes to struggling startups.

Given that regulators are in the business of spotting, and correcting, market failures, one of the issues they’ve been facing recently is the lack of financing for early-stage companies. In response, regulators have considered measures such as easing the disclosure and governance requirements for public venture companies; now, regulators are looking at how to allow new funding models, such as equities “crowdfunding,” to operate in the exempt market.

However, a new report prepared for the B.C. Securities Commission (BCSC) highlights the fact that, sometimes, market droughts are simply a fact of life and that market regulation reform isn’t always the answer.

The BCSC’s report, which was put together by KPMG LLP, focuses on the struggling junior mining sector in British Columbia. The research found that although the sector is suffering, companies see this more as a function of natural market and economic cycles; they don’t see regulatory reform as the answer to their problems.

According to the report, junior mining firms say that market conditions have not been conducive to them attracting investors (either retail or institutional) over the past couple of years (from mid-2011 to mid-2013).

For one, the S&P/TSX Venture Exchange (TSXV) generally has underperformed the senior markets in Canada and the U.S. And within the venture market, miners have been particularly hard hit; data from the BCSC show that stock prices in the sector are down sharply and the aggregate market capitalization for junior miners on the TSXV has dropped to less than half its level in 2010.

At the same time, venture financing is slumping, with the level of capital raised by all companies on the TSXV dropping to around $6 billion in 2012 vs about $10 billion in 2011. Moreover, the vast majority of private capital raised over the past year has gone to the real estate sector; private capital for mining has virtually evaporated.

This environment also is certainly one of the reasons for the ongoing struggles of small investment dealers, too. A number of the small firms that have been consolidated or closed up shop altogether in the past year were involved in the venture-financing business, which has dried up.

In the past, junior miners could rely on institutional support from brokerage firms and portfolio managers that specialize in the sector. Yet, the market downturn has pushed many of these firms to focus their attention elsewhere, the BCSC report says. Now, these firms favour investments that are less volatile and more likely to generate positive, short-term returns.

At the same time, retail investors have been turned off by a combination of factors, including the lack of returns and no recent major mineral discoveries. Moreover, as firms seek to raise funds more cheaply in the exempt market, they end up excluding many potential investors who don’t qualify to participate in offerings under one of the existing prospectus exemptions.

Says the BCSC report: “With already reduced pools of investment capital and investors, the reduction in investment opportunities further slows the recovery of a market perceived as lacking investor confidence and excitement.”

In addition, the research found that there’s a sense among junior miners that traditional investors in the sector are aging and are not being replaced by younger investors. As the older investors shift their portfolios away from risky ventures and into more stable holdings, and new investors don’t fill the void those older investors leave, the retail investor base for junior miners is eroding: “Without younger investors to replenish venture capital from previous investors, capital becomes more scarce and difficult to attract.”

The report adds that the same is true of the people running junior mining firms – both the investor base and the junior mining sector’s personnel need rejuvenating “to sustain the [junior mining sector].”

There’s also some fear about the long-term effects of the disappearance of small, venture-focused investment dealers: “There is concern amongst the juniors that this loss of intermediaries could be a longer-term problem for the industry when it returns to more ‘normal’ markets.”

Yet, despite this gloom, junior miners aren’t looking to the market regulators to fix their problems for them. Although many of junior mining firms report being in “survival mode” – devoting greater portions of their operating funds to staying afloat (paying administrative expenses and maintaining stock exchange listings) rather than exploring for minerals – these firms don’t see a reduction in market regulatory costs as their route to salvation.

Rather, they say, what’s really needed is for the market to turn around and for the mining sector to undergo some creative destruction in the meantime. The junior mining firms believe that some of their peers will have to close their doors and that senior firms will have to get their balance sheets in order (because senior firms represent the exit strategy for many junior firms) before the sector will revive.

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