‘Walking dead’ on the TSX Venture Exchange: How are ‘zombie’ companies surviving?

BEN NELMS for National Post Tony Simon, co-founder of the Venture Capital Markets Association is pictured in their offices in Vancouver.

Management at the TSX Venture Exchange would probably appreciate it if Tony Simon just shut his mouth for a while.

As the co-founder of the Venture Capital Markets Association, Mr. Simon is an unlikely torchbearer for the theory that Canada’s market for junior resource stocks is broken and the Venture Exchange is part of the problem. But he has assumed that role with gusto in the past few weeks as his thoughts have reached an increasing number of ears. It is hard to imagine that anyone else is causing more headaches for the Venture Exchange these days.

Mr. Simon, for his part, thinks he is just stating the obvious.

“This is not something that’s an unknown problem,” the Vancouver-based entrepreneur said.

The Venture management team has fired back, completely denying his claims that they are not doing their jobs properly.

However one feels about the debate, all would agree that Mr. Simon’s research paints a frightening portrait of Canada’s junior exploration sector. It raises questions about how hundreds of tiny resource companies can continue to exist. Sources said that auditors are offering these companies cut-rate fees to maintain their viability.

The controversy started in February, when Mr. Simon published research suggesting there are about 600 “zombie” resource companies on the TSX Venture Exchange that are not meeting listing requirements and should be de-listed. His report has spread around, even getting picked up by Zero Hedge, the influential U.S. financial blog.

The big numbers are grim: by Mr. Simon’s calculation, these “zombies” have combined negative working capital of greater than $2 billion. Raising money has become impossible for many of these junior firms as market conditions have deteriorated over the past few years. Now they are just “walking dead” companies with no serious prospects that pose a threat to investors looking at the sector, he said.

So why are they still around? Mr. Simon noted that TMX Group Inc. is a profitable corporation that relies on listing fees for revenue. He believes the exchange is failing to enforce its own rules, and also blames auditors and securities regulators for not doing enough to crack down on these companies and protect investors.

There are plenty of others who believe the Venture should purge these weaker firms.

“It tarnishes the viability of the [stronger] companies there, and it turns the exchange into a laughingstock where very few people will go to invest,” said Bill Sheriff, the opinionated chief executive of Till Capital Ltd.

Mr. Simon’s research points out numerous companies that are in appalling financial positions. For example, Bluenose Gold Corp.’s latest statements show the company had $3,491 of cash and receivables at the end of December, compared to $2.6 million of accounts payable and accrued liabilities. Xiana Mining Inc. had $6,954 of current assets as of Oct. 31, compared to $1.7 million of current liabilities.

In some cases, the accounts payable in these tiny companies are owed largely to insiders, which shows they are putting their own money in to keep the firms going.

There is a legitimate debate to be had on whether it is in the interests of investors to have companies such as these on the public markets. But in the Venture Exchange’s view, there is no debate that it is upholding its standards. In an interview, Venture president John McCoach defended his company’s practices and accused Mr. Simon of selectively choosing data for his study.

“The one thing that jumped out at me is his allegation that we were intentionally turning a blind eye [to non-compliant companies] or changing our practices. Which is totally without any basis, and in fact it’s absurd,” he said.

“Our continuing listing standards have been applied the same way as long as anybody here can remember in at least 10 years.”

For example, on the issue of negative working capital, Mr. McCoach noted the rules give the exchange some discretion to keep companies listed if their capital position is weak because of seasonal or temporary conditions. And he said working capital is not necessarily the best tool to judge these companies, since the nature of mineral exploration is that you spend your money on drilling and then go raise more of it (if you can).

Mr. McCoach said 27 of Mr. Simon’s 600 companies were previously bounced to the NEX board, which is for Venture companies with little-to-no corporate activity (Bluenose Gold is one of those). The Venture Exchange then took a sample of 135 of the other weakest companies on Mr. Simon’s list, and determined that 30 may not be meeting listing requirements. “Extrapolating that out, we would end up with a number far less [than Mr. Simon],” Mr. McCoach said.

For the past few years, numerous experts have predicted there will be a purging of these companies. They are seen by some as a relic of the mining bull market from last decade that no longer have a reason to exist. But despite their struggles to raise capital, they have shown an ability to hang in, and Mr. McCoach thinks the vast majority of them will continue to do so.

THE CANADIAN PRESS/Aaron Vincent ElkaimThe Toronto Stock Exchange Broadcast Centre is pictured in Toronto.

The question becomes: How are they doing that? Auditing fees alone can cost upwards of $25,000 a year for a small junior mining company, experts said, while listing fees are a minimum of $5,000 to $6,000. And that does not even account for legal fees and transfer agent fees.

By law, an auditor cannot start a new audit for a company until it has been paid for the prior one. Companies with minimal cash and negative working capital should not be able to pay that money. Company insiders won’t foot the bills forever.

But sources said some auditors are offering very low rates to keep these companies from folding — in some cases less than $10,000. One source said he knew of a case in which an auditor settled up with a company at a lower-than-expected-rate, just to ensure it got paid quickly.

“A lot of the auditors have given them a lot of slack,” said Mr. Sheriff.

The miners themselves are always trying to find ways to ease the burden. Tony Drescher, an entrepreneur involved in many small mining companies (including Xiana), said he does as much of the administrative work as possible in-house to control fees. “It would be very difficult if we had to contract this stuff out,” he said, adding companies are always finding creative ways to lighten their fee load.

But insiders wonder how long the survival can last. Junior exploration companies have, for the most part, been in a bear market since 2007. They have managed to defy the doubters and keep the lights on year after year as they hope and pray for better market conditions. It is not a scenario that can go on indefinitely. However one feels about the listing debate, at some point it may make more sense for a lot of companies to just die than to be part of Tony Simon’s Walking Dead.

‘Walking dead’ on the TSX Venture Exchange: How are ‘zombie’ companies surviving?