1. What is the right balance between capital formation and investor protection?
The right balance between capital formation and investor protection for non-sophisticated investors in the Canadian Private Markets should prioritize investor protection without completely restricting access to investment opportunities.
The risks for non-sophisticated investors in private capital markets include limited information and disclosure, illiquidity, and potential for higher volatility compared to public markets. Non-sophisticated investors may lack the experience or knowledge to adequately assess the risks associated with private investments, which can lead to poor investment decisions and significant losses. Additionally, they might not be aware of the long-term commitment often required in private investments, as these assets can be harder to sell or transfer compared to publicly traded securities.
2. When is a company too big to be private and too small to be public?
For a large company to stay private, there are several risks and challenges. First, access to capital might be limited compared to going public, as private companies rely on private equity, venture capital, or other private funding sources that may not be as abundant as the public markets. Second, staying private can limit liquidity for shareholders and employees, as there is no public market to sell or trade shares easily. This could make it challenging to attract and retain top talent that may be seeking stock-based compensation. Finally, private companies may face less external scrutiny and regulatory oversight, which could lead to less disciplined financial management and weaker corporate governance, potentially affecting the long-term health of the company.
On the other hand, small companies that decide to go public face their own set of risks. First, the costs of going public can be substantial, including underwriting fees, legal expenses, and ongoing costs related to regulatory compliance, auditing, and financial reporting. These expenses might disproportionately affect smaller companies with limited resources. Second, small public companies may struggle to gain visibility and attention from investors, leading to lower trading volumes and stock price volatility. Lastly, going public exposes companies to the pressures of short-term performance expectations from shareholders, which could force management to focus on immediate results rather than long-term growth and stability. This pressure can be particularly challenging for small companies that require more time to develop and execute their growth strategies.
3. What affect do you see greater interest rates having on capital raising in the Private Markets?
As interest rates rise, a ripple effect is seen across the private markets with far-reaching implications for capital raising. Of particular concern is the potential for either overvalued or undervalued company valuations. This is due to increased capital costs, which can reduce the present value of future cash flows, leading to lower valuation multiples. Furthermore, the upward movement in interest rates could lead to inaccuracies in Discounted Cash Flow (DCF) analysis, a staple method for company valuation, ultimately leading to incorrect valuation estimates.
Ignoring the change in interest rates also runs the risk of misallocating capital. Companies may end up investing in less profitable projects or overlook potentially profitable opportunities due to inaccuracies in valuation multiples. There's also a risk of suboptimal capital structure decisions. Ignoring the upward trend in interest rates could mean businesses carry more debt than advisable or fail to effectively leverage their capital structure.
Rising interest rates also mean an increased cost of borrowing for companies. Failure to consider these changes when setting valuation multiples might lead to higher borrowing costs, impacting profitability. This may also cause companies to curb investment in growth initiatives, leading to slower growth, loss of market share, and decreased competitiveness. These changes can even permeate into the realm of mergers and acquisitions, with misjudged valuation multiples potentially leading to overpayment or underpayment for target companies. In essence, rising interest rates are a significant factor that cannot be ignored in the private markets.