Can Local Stock Exchanges Overcome the Valley of Death?

Posted on November 10, 2011


Whenever you see a venture capital or investment banking presentation on the development of a company, it starts with two guys working on their smart idea in a garage, progresses to funding from angel, venture capital, private equity groups before reaching the utopia of listing on a public stock exchange, preferably either the NYSE or NASDAQ.  This trajectory was always the exception as most companies either failed somewhere along the way or were too small to list.  Over the past decade or so, things have become tougher for potential IPO candidates; investment banks merged and consolidated their efforts on larger clients and meeting regulations – especially those under Sarbanes Oxley – has become expensive.  Then the recession came along and made listing even harder.  All of a sudden, your shot at listing is pretty slim if you expect a market capitalization of under $1bn.

In lieu of traditional stock exchanges, a slew of private market networks have sprung up, which offer a kind of for companies to meet investors.  The models diverge from there; some are registered as broker / dealers so they can transact investments, others just match the two parties and leave them to figure out the rest themselves.  Here are some examples:

Company Focus Website URL
AngelSoft (now Gust) Early Stage
Axial Market Mid Market
Equity Net Multi Stage
Indie GoGo Early Stage
Kickstarter Early Stage
Prosper Peer to Peer Credit
SecondMarket Multi Stage
SharesPost Growth
Xpert Financial Growth

The sites are growing fast – SecondMarket’s volume evidently quadrupled last year over 2009 – but there’s no clear leader in the ‘crowd-funding’ business as yet, and there’s still room for additional business models.  For the past couple of years, a group – now called the Focus Local Finance Association – has been working on reintroducing the local stock exchanges that used to dot the country.  The game plan is for companies to list on a local stock exchange, with due diligence conducted by the stock exchange and companies able to raise either debt or equity as they see fit.  Exchanges would have a local flavor; the planned Lancaster PA one, for instance, is likely to be heavy on the food- based businesses for which the farming region is famous.

The North American test case will most likely be Toronto’s Social Venture Exchange, which has recently obtained regulatory approval to move forward, a process that took just over a year.  A couple of other localities are also working on exchanges, the barriers being in regulatory approvals and logistics.  To date, planners assume that they will be governed by state regulators owing to exemptions under SEC legislation; some state regulators encourage the exchanges, others are leery of potential fraud amongst other risks. To minimize expenses, there are plans afoot to share listing and exchange software across regions, and to ‘bundle’ listing services from local accountants and lawyers to minimize initial listing costs, but this is some way off.

The movement’s founders focus on the opportunity for local businesses to raise capital without exposing their stock to “speculators”, but there are other societal benefits, such as the deepening of capital markets and more efficient allocation of capital.  As banks have pulled back from lending, it’s become difficult for even the best of small businesses to raise sufficient growth capital, while venture capital is an option for very few.  Further out, it’s conceivable that indices of local stock exchanges could be used as proxies for regional or industry growth.

The toughest challenges may well be establishing trust between buyer and seller on an untested exchange, and attracting sufficient listings to create a liquid market.  The financial advisors to whom many potential investors will likely turn for help are notoriously conservative, and may well balk at investments in small local companies.  That said, there’s a decent chance that the ability for investors to back their favorite local coffee shop or their neighbor’s engineering endeavor will trump such concerns.