Rude VC: Euronext’s SME Marketplace

May 7, 2013
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imagesLast week NYSE Euronext announced the imminent launch of an “SME Marketplace.” Managed by a dedicated subsidiary set up in France, it will have its own brand, operating budget and team.

It is hard to understand exactly what this means. Judging from the Euronext press release, the initiative appears to represent more of a hierarchical restructuring of reporting lines than a new dedicated exchange.

Apparently, the Marketplace will encompass companies that are listed on the B & C compartments of Euronext, as well as the Alternext listed companies in Paris, Amsterdam, and Brussels, a total of 800 public companies, essentially small and mid-caps. It does not appear, however, to involve any kind of merger or aggregation of the three exchanges.

If this move merely represents an administrative reshuffling, that would be a pity. However, to the extent that this launch represents a concerted effort to improve accountability, visibility, and by consequence, trading volumes, there may well be some benefits in this.

I’ve long been a skeptic of small French tech companies going public too early. The Alternext tends to be the market of choice for such companies: it is lightly regulated (technically ‘unregulated’); there are a handful of local investment banks that will serve as listing sponsor for a modest fee; and raising capital in the range of 10M€ is fairly straightforward (albeit still requires a formal filing process and a successful sales effort of securities to the public market).

My beef with small firms going IPO is that after the initial capital injection occurs, many companies fall into some sort of purgatory. The trading volumes, and hence liquidity, are low. Two detrimental consquences ensue. First, low trading volumes often handicap a company’s stock price, resulting in a market cap that sits below the intrinsic value of the firm. The danger of a consistent situation of undervaluation is its demotivating effect on management, employees, and shareholders. It also taints any discussion with potential strategic acquirers with whom hypothetical negotiations would inevitably anchor toward the low market cap.

The dirty little secret of French VCs

The second consequence is a dirty little secret in the French retail VC world. It is not uncommon for French VC funds to push their venture-backed companies toward an IPO. The ostensible justification is the quest for an exit. However, barring a few limited exceptions, an IPO on these smaller markets is not an exit. Far from it. The trading volumes are simply not sufficient to enable a significant shareholder like a VC to sell its block of shares, even over the course of several years. Yet, this is where the dirty little secret comes in: VC’s that IPO a portfolio company while remaining a shareholder can still assess management fees to the funds’ investors. Furthermore, since management fees are calculated on the net asset value of assets under management, a VC can effectively increase its take in management fees if the IPO valuation of the company is higher than its initial investment cost (which is almost always the case). It’s the best of both worlds for a VC management company: boast about an exit while still milking high management fees.

A re-branding effort of the Alternext and its lightly traded counterparts B & C of the Euronext, with a veritable commitment to provide resources to and to promote the exchanges’ listed SMEs, would be a welcome boon to the investors and the companies who are floundering today on the public market.