Edge-ucation / Market Commentary

The Wolves of Howe Street

  • Edge Editorial Team

    At Edge Investments, we make investing in small cap stocks enjoyable and edge-ucational. We are here to teach you about investing, keep you up to date on news, and help connect you with companies that you may have a desire to invest in.

    View all posts

Believe it or not, the west coast of Canada has a bit of a shady history. 

British Columbia accounts for a fairly sizable chunk of money laundering activity within the country and its biggest city, Vancouver, carries a globally recognized reputation for illicit gains. 

The money laundering problem has been around since the 1980s, however, the roots of Vancouver’s shadowy past may stem even earlier. 

Criminals intend to launder money in order to hide the origin of funds obtained illegally, through black market economies such as the drug trade. This involved using large sums of cash to purchase real assets such as property, cars, and luxury assets. 

As criminals became more advanced, multiple layers were added to transaction of these purchases, making it increasingly harder to track and ultimately prove the origin of these illegally obtained funds. 

Although assets like inflated real estate and casinos tend to be at the forefront of money laundering today, there was once a time when such concerns were being raised over something even less obvious. 

Banks and brokerage firms. 

Enter the Vancouver Stock Exchange (VSE) 

The VSE is a now-defunct stock exchange that was located in Vancouver, B.C. Incorporated in 1907, the VSE was the third-largest stock exchange in Canada, right behind the Toronto Stock Exchange (TSX) and the Montreal Stock Exchange (MSE). 

Inherently, the exchange focused on early-stage, speculative stocks that carried higher levels of risk than normal. As we know, with higher risk potential, comes higher reward potential. 

Resource exploration companies were the most commonly traded within the VSE. These companies utilized a structure (which we will get into shortly) that involved raising money to fund the expensive and revenue-less journey of exploration.  

Should the exploration prove successful, the returns were often very lucrative. Should the journey prove unsuccessful, there’s a silver lining. Public markets allow you to liquidate shares quickly and easily, meaning you often don’t have to risk losing your position in entirety. 

The companies that listed on the VSE tended to have very few assets other than the land they owned the rights to and occasionally, the companies aimed to raise capital simply to carry out the exploration itself (with little to no guarantee of success). 

High-tech companies also found a home on this speculative exchange. They tended to raise venture capital directly from retail investors, a method that is unconventional compared to the usual practice; early-stage companies raising money in the private markets before going public. 

While it meant that you didn’t have to already control a war chest of wealth to gain exposure to these opportunities, it also meant that silver-tongued salesmen could find investors who were less savvy and get them to commit their funds to projects with very little hope of success. 

The way around this problem? Education. 

Public Venture Capital 

The industry of Venture Capital within the public equities markets can be somewhat of a god send for certain companies. 

Take junior exploration stocks for example. 

When you think a plot of land has the potential to bear large amounts of precious metals (such as gold, silver, or nowadays, lithium), you need to go through very extensive measures to deploy a drilling program. 

Putting the right team in place and setting up drilling can cost millions of dollars off the bat. And when you are just beginning to explore a big ol’ piece of dirt in the hopes of striking gold, there is ZERO revenue to be made. 

This is why we need venture capital. Companies who go public early now have hundreds of investors who can sell their shares on the secondary market to other excited traders and brokers, who believe in the prospects of a mining/exploration stock. These initial investors had paid the company for equity in the form of shares. 

In an ideal world, the process for your typical exploration stock goes like this: 

  • Company finds a promising piece of land 
  • Company needs capital to fund exploration of said land 
  • Company raises money from investors, who accept shares for their capital 
  • Company files a prospectus and lists on the exchange, begins to explore and issues news releases 
  • Shareholders now have a liquid market in which they can trade their shares, ideally for a profit 
  • Company successfully finds the precious metal they have been looking for, increasing the price of their shares substantially 
  • Company eventually becomes a producer due to the abundance of resources within their site, turning them into a stable, long-term stock 

Of course, some companies don’t successfully find what they are looking for. Some of them may just take a lot longer to ‘strike gold’. When this happens, the stock price typically won’t see any exciting movements. Sometimes, the price may even sink following poor results. 

However, the beauty of the venture capital market is that you can still sell your shares! 

Even if the company is underperforming and you’re exiting your position at a small loss, it’s better than having your money tied up in a private company that didn’t get the results they wished for. In these cases, it’s extremely difficult to liquidate your position, and it is more likely you will face the ultimate drawback: the 100% loss. 

It’s not always over when a public exploration company doesn’t find what they wish to that year. 

Promising upcoming drills, resource usefulness, and overall market sentiment can influence any stock’s price, no matter if they’re worth $10m or $10b. Due to the nature of private placements (where you often receive discounted shares and warrants in exchange for your capital), you may even be able to sell your shares at a small profit before the company even strikes gold, IF they do. 

Why Is Vancouver’s Stock Exchange Legacy Still Significant? 

While initially taking advantage of British Columbia’s resource-rich landscape, the formula for early-stage companies to receive adequate financing is still used today. 

It only makes sense that VSE would facilitate more speculative companies. After all, the alternatives of debt financing or private equity can be extremely restrictive. 

Debt financing would be difficult as there is little to no collateral. Junior mining companies tend to have little cash or assets on their financial statements, and the land value is assessed at face value – without the consideration that there could be precious metals hiding underneath. 

Paying back the interest on a regular basis would also be near impossible, as exploration companies don’t have any cash flow yet. 

While private equity is an option, the safety net is a lot lower than when compared to equity financing. As we mentioned above, public equity in a junior exploration company can be more easily liquidated than when private. Most people would rather lose some of their money if their bet went wrong, than all of it. If you’re a poker player, we’ll put it in a way that you’ll understand: not many people want to go all in on pocket sixes before seeing the flop. 

What about the tech companies that decided to go the public venture capital route? 

Like exploration issuers, early-stage tech companies often need capital to initialize development and cover expenses like coders, basic corporate costs, and more. They also have a lack of revenue until their idea actually hits the market. However, should the idea succeed in making a positive change in the world of consumerism, the payout tends to be astronomical. 

Such is the reason why the public venture capital markets remain a hot spot for such companies today. Every successful company once began as an idea. 

While larger, more initially profitable companies took their turn with the Toronto Stock Exchange (TSX), the little guys with big ideas needed a more plausible and reliable source of funding to propel their dream to the big leagues.  

This system for injecting capital and developing venture-stage companies into fully functioning businesses is the basis for many of the industries that we here at Edge Investments cover today. 

You’re happy we’re here… right? 

Why The VSE’s Reputation Was as Volatile as Its Stocks 

As every useful, new innovation that gets used in this world, it’s not uncommon for things to get abused and create unintended side effects. This phenomenon is often referred to as the Cobra Effect. 

Did you know?: The Cobra Effect was a term coined after an unintended systemic consequence in British-governed India in the early 1900s. The government tried to instate a bounty for every dead cobra reported to them, to curb a cobra infestation problem in Delhi. Instead of reducing the amount of snakes in the city, this birthed an industry of cobra farming, to be killed for profit, eventually resulting in the country having more cobras than before. 

While public venture capital was intended to link hopeful entrepreneurs with everyday investors, it allowed less savoury characters to abuse market optimism for their own gain. To crooked members of the finance world, the ability to raise money with a company with little to no existing business was music to their ears. 

All they had to do was promise retail shareholders that there was indeed a possibility for any given early-stage company to hit it big, and they could proceed to collect money at a valuation much higher than the valuation that they invested at. 

Crooked insiders with large amounts of cheap shares could then manipulate the stock price through aggressive promotion and sell their shares; turning their words and actions completely against each other. 

As such activities became more commonplace by blending into the world of high-risk, high-reward capital, many investors began to reduce confidence in new issuers. This led to good-hearted early-stage companies having to work even harder to ensure that their vision was not only possible, but even perceived as legitimate. 

Much to the dismay of the exchange, Vancouver started to establish a reputation as the money-laundering capital of the world. 

Brokerages would receive large amounts of illegally-obtained cash in exchange for stock certificates, with no questions asked. 

As regulators started investigating, they found out more than they anticipated. You may be surprised to hear that the RCMP even admitted to being aware of certain schemes involving washing dirty money with legitimate businesses. 

One of the first targets was the brokerage First Vancouver Securities. The firm had their license revoked for affiliation with the Filipino dictator Ferdinand Marcos. 

The notorious Marcos embezzled millions of dollars during his tenure as president. A vast majority of the dirty money was kept in storage overseas through a fairly complex laundering system. First Vancouver Securities was a prime suspect in the involvement of facilitating this washing of Marcos’ illicit fortune. 

In 1993, former regulators of the VSE made an announcement stating that the exchange was highly vulnerable to organized crime and money laundering. William Pedrutchny, former VP of Listings had suggested the B.C. government step in to run the exchange as a public entity. 

Where is the VSE Today? 

Fortunately, as time passed, most of the “dirty laundry” from VSE’s history was able to be washed away, leaving behind what the exchange was meant to be used for. 

Venture capital. A saving grace for early-stage companies that just needed someone to take a (calculated) risk on them. 

It started in the early 2000s, when the market turmoil of the dot-com bubble seemed to inevitably bring the VSE down to its knees. However, something happened.

Canada’s premier exchanges took matters into their own hands.  

In 1999, the VSE merged with the Alberta Stock Exchange and Bourse de Montreal to become of the Canadian Venture Exchange (CVE). This lasted two volatile years until 2001, when the TMX group (the parent company behind the TSX) acquired the CVE and promptly renamed it to the TSX Venture Exchange (TSX-V).  

The newly formed TSX-V is headquartered in Calgary, Alberta and executes all trades electronically, eliminating the need for a trading floor. 

The TSX-V remains a leader in global benchmarks and venture capital listings. Successfully preceding its previous unfavorable reputation, the TSX-V and the TSX, together, expand over C$3.2 trillion in consolidated market capitalization. C$45 billion and 1,673 companies within this belong to the TSX-V. 

Rules, regulations, and auditing processes have been created and implemented to make sure that the shady characters from the industry’s past are found out before they can create damage, but it will always be the job of industry leaders, participants, and investors to make sure they’re educated and forthright about what’s going on. 

We, at Edge, are committed to helping retail investors truly understand and feel confident within the world of public equities (especially at the venture level), so be sure to follow along, join our Discord, and ask us every question you’ve got. We can’t wait to learn more, together. 

  • Edge Editorial Team

    At Edge Investments, we make investing in small cap stocks enjoyable and edge-ucational. We are here to teach you about investing, keep you up to date on news, and help connect you with companies that you may have a desire to invest in.

    View all posts

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