Launched in 1995, the Alternative Investment Market (AIM) of the London Stock Exchange is one of the most popular junior markets in the world. In its 15 years, it supported the growth of 3,100 small and mid-sized companies, which together raised a total of £ 68 billion (R$ 183 billion). Another listing reference for low-capitalization companies is the TSX Venture of the Toronto Stock Exchange (TSX). One out of five companies currently participating in the main Canadian stock index, the S&P/TSX, performed its first funding in the junior market, which houses over 2,300 issuers. These successful initiatives provide good lessons for the development of the Bovespa Mais. This listing tier for small and mid-sized companies was created in 2005 by the Brazilian stock exchange, but still has only one member, Nutriplant. Behind the foreign examples there is much more than the good will of the local stock exchange. It is expensive and burdensome to create a structure that encourages a junior market.

According to the study Economic Impact of AIM and the Role of Fiscal Incentives, published in September this year by the consultancy Grant Thornton, the granting of tax incentives to investors was crucial to the development of the London junior market. The incentives vary according to various criteria, such as the type of investor and time of ownership of the shares. However, in general, they include deductions for the rate paid on capital gains, dividend tax exemption (a benefit that investors already have in Brazil, regardless of the companies in which they invest) and a 100% discount on the fee payable in the case of inheritance.

Such motives significantly contribute to increasing the liquidity of AIM. In 2009, daily average turnover was £ 133.10 million (R$ 304.68 million). “That makes companies return to AIM multiple times for new funding”, the London Stock Exchange’s press relations office told CAPITAL ABERTO. Last year, initial public offerings (IPOs) in AIM raised £ 740 million (R$ 2 billion), and follow-ons amounted to £ 4.7 billion (R$ 12.66 billion). In October 2010, the size of IPOs ranged between £ 2.75 million (R$ 7.40 million) and £ 76 million (R$ 204.52 million). Today, four Brazilian companies trade stocks in the London junior market: Serabi Mining, Clean Energy Brazil, Itacare Capital Investments and Squarestone Brasil.

Grant Thornton emphasizes that market inefficiencies, such as the higher difficulty for investors to obtain information regarding smaller companies and the reduced liquidity of these assets, make fundraising by companies with offers of up to £ 25 million (R$ 67.3 million) scarce, hence the importance of government intervention to correct those imperfections. "Tax incentives would be very welcome in the Bovespa Mais. Investors who bought these shares could, for example, obtain an income tax rebate", suggests Marcos Sanchez, a partner at Grant Thornton Brazil.

According to Cristiana Pereira, the BM&F Bovespa’s director of business development, the institution is examining the types of tax incentives that could be granted to investors. Recently, she traveled to England and Canada for the purpose of learning how these countries’ markets work and seeking inspiration on how to leverage the Bovespa Mais. BM&FBovespa has the goal of bringing 200 companies to the trading floor in the next five years. It is unlikely, however, that the São Paulo Stock Exchange will obtain tax incentives from the Brazilian government, at least not in the medium term. It is known that the government of the “PT” (Workers’ Party), which will continue for another four years under the command of Dilma Rousseff, has a tough fiscal agenda ahead. Waiving taxes to strengthen the capital market would not initially be a trend.

"The best way to increase the interest of small investors is to share some risk with them", says the president of the MAB

Tax incentives offered to investors did not come cheap for the UK Treasury. According to Grant Thornton’s study, between 2004 and 2008, they reached £ 1.52 billion (R$ 4.05 billion), considering only tax deductions and exemptions granted to individual investors who participate in small companies’ IPOs and in Venture Capital Trust (VCTs), investment vehicles listed on the London Stock Exchange which have been popular among British investors. VCTs collect funds from private investors through the stock exchange and use at least 70% of the value to acquire additional shares of smaller companies, including those listed on the AIM. In the same period, VCTs have raised £ 2 billion (R$ 5.3 billion), more than the double the cost to the government treasury.

Even smaller access markets, such as the Bursátil Alternative Market (“MAB”), inaugurated in 2006 by the Madrid Stock Exchange, offer tax incentives to investors. In the regions of Catalonia and Madrid, individuals can deduct a percentage of the total invested in shares traded on the MAB from their income tax. "The best way to increase small investors’ interest is to share some risk with them," says Antonio Giralt, president of the MAB.

Nowadays, the Bursátil Alternative Market trades shares from nine companies. They all debuted on the tier between 2009 and 2010, the period in which MAB began to grant tax incentives. However, not only investors receive benefits from the MAB. Companies that want to be listed on this market are supported by the Ministry of Industry when paying expenses related to their preparation for the IPO. Through the Spanish National Innovation Enterprise (“ENISA”) – a development agency established in 1982 to help small and mid-sized Spanish companies to finance themselves in the long run - the companies are able to receive a credit of up to € 1.5 million (R$ 3.39 million ), repayable over two years. There are no interest rates or fees on this amount.

Companies in specific regions of Spain, such as Madrid, Galicia and Murcia, can also obtain financial subsidies from local development agencies. The Development Institute of Madrid offers, for example, up to € 80,000 (R$ 180,800) to help future members of the MAB to pay the costs of hiring attorneys, brokers and registered directors. "Small and mid-sized companies represent 99% of Spanish companies. It is expected that 5,000 of them will be financed through the MAB in the medium and long term”, says Giralt.

TSX Venture does not offer any tax incentives. However, the president of that market, John McCoach, believes the benefit is not necessary, since Canadians have already consolidated a culture of investing in mid-sized companies, mainly in the natural resources sector (mining, oil and gas). A study published by PricewaterhouseCoopers shows that mining companies account for approximately 61% of the TSX Venture’s market capitalization.

TOO STRICT? - Another aspect in which the Bovespa Mais differs greatly from the AIM and the MAB is regarding corporate governance rules applicable to listed companies. Neither of these markets requires practices to be followed by companies in this area. In the AIM, the "Nomad" (nominated advisor), a type of consultant in charge of preparing companies for listing and accompanying them during their stay in the junior market, is responsible for deciding, along with the company, the governance practices that match their development stage. In the MAB, the registered director figure plays a similar role. The TSX Venture has a position more similar to the Brazilian stock exchange. It publishes a standard governance rules “package” to be followed. "Giving up this practice is a double-edged sword. The risk of lowering the requirements is to have companies coming to Bovespa Mais with few governance practices and weak controls", says PwC partner Ivan Clark.

"We have already built this tier adapted for smaller companies. It is proven that when you raise the level of corporate governance, the shares are better priced and asset liquidity increases ", argues Pereira, from the BM&F Bovespa. "I believe more important than changing the rules is creating a culture of investing in smaller companies, because Bovespa Mais was not extensively tested."

There are those who disagree with this view. Carlos Augusto Junqueira, partner at Souza, Cescon, Barrieu & Flesch Advogados, believes that the regulation of Bovespa Mais establishes requirements significantly more stringent than those provided for trading in the traditional market and in Niveis 1 and 2, which creates a conceptual conflict. By being a junior market, the attorney argues, Bovespa Mais should have simple rules that create incentives and regulatory "discounts" in comparison to the traditional tier for companies in a development phase. "The fact that the formalities of the Novo Mercado are very similar to the Bovespa Mais discourages companies from engaging in the junior market" says Martin Marcelo Araujo, from the investment company AF Invest, from Minas Gerais.

Regarding this concern, Souza Cescon submitted a few proposals for reviewing the Bovespa Mais regulations to the BM&FBovespa. In the governance area, the office suggests that the Brazilian stock exchange extend the term of office of members of the board of directors, which currently is two years, or even remove this limitation. Another suggestion is to relieve the controlling shareholder from having to make an OPA (takeover bid) for securities issued in companies that migrate to another special listing tier. Currently, this exemption applies only if the company migrates to the Novo Mercado.

"We considered performing a concentrated IPO of the companies", says Cristiana Pereira, director of the BM&F Bovespa

Some ideas depend on the Brazilian Securities and Exchange Commission (CVM) promoting changes in its rules. Souza Cescon proposes that midsize businesses (total assets of less than R$ 240 million and annual gross revenue smaller than R$ 300 million), that wish to be listed on the Bovespa Mais, can be excused from registering for a public offer, as established in Section 400, and be permitted to register as category B listed companies, even though they issue shares and debentures convertible into shares. According to the current rules, companies of any trading tier must register as class A to negotiate these types of securities. The completion of the reference form is required in both categories, but there are optional fields for category B issuers. One such field is the chapter on managers' remuneration, which provides, among others, fields for the description of the remuneration policy and information on the largest, smallest and average salaries paid individually.

"It is not uncommon for entrepreneurs of mid-sized companies to be startled after seeing see the amount of rules that they must meet to list their company, and choosing to seek the BNDES," says Junqueira.

Charles Aboulafia, a partner of Banco de Negócios CAinvest, has been working to structure initial public offerings in the Bovespa Mais, and therefore is aware of the difficulty of adapting companies to the tier’s requirements. For months, he has tried to improve the management and control levels of a company that he wanted to bring into the junior market this year. "When we entered, we found the need to change many things. The company would release the accounting report 60 days after closing, and the process was manual", said Aboulafia. Henrique Campos, an associate of BDO and partner of CAinvest remembers that, due to their quick development, companies targeted by the Bovespa Mais face difficulties in developing controls at the same rate as their expansion.

Unlike when he began to structure deals for the tier, the associate of CAinvest does not risk any forecasts as to when the IPO he is preparing will take place. He says only that the issuance should be between R$ 40 million and R$ 50 million. "I believe the Bovespa Mais will really kick-off in about five years", he estimates. The prediction by Aboulafia matches the statistics gathered by a survey carried out by Amcham-Brazil, in partnership with Ernst & Young Terco and BM&FBovespa, with 106 companies located in Recife, Goiania, Porto Alegre, Curitiba and Campinas, with revenues from R$ 101 million to R$ 400 million, which is precisely the scope of the Bovespa Mais. Among the surveyed companies, of those considering an IPO (49%), only 2% are considering pursuing an IPO in the short term (up to one year). The majority (52%) intend to use the Brazilian stock exchange in the medium term between one and three years, and 42% expect to do so in the long term (i.e. over five years).

It is not only the companies that need to be interested in going public. There should also be an intermediary system that proposes to take them to the Brazilian stock exchange. Investment banks have already shown several times that they have no interest in coordinating the issuances of mid-sized companies. The work is almost as large, and commissions are much lower. Therefore, the BM&FBovespa is committed to bringing the potential issuers of the Bovespa Mais and intermediaries closer. A total of ten companies participated in workshops sponsored by the Brazilian stock exchange with the participation of banks, auditing and law firms.

NOW WE MUST EDUCATE - A survey by AmCham-Brazil found that among the companies that have no intention to go public, half of them admit the need for more information on the subject in order to make a decision. The Brazilian stock market is trying to correct this problem. Last month, it launched two programs for training and developing entrepreneurs in partnership with the Endeavor Institute and Babson College. The programs will introduce concepts and practices related to corporate governance, risk management and business financing. The purpose is to create favorable conditions for a greater connection between entrepreneurs and capital markets in Brazil.

Pereira notes at least five companies currently preparing to list their shares on the tier. "We considered performing a concentrated IPO of the companies, with a difference of a few months between the IPOs. We need to demystify the concept that the capital market is not for smaller companies", she says. Paulo Sérgio Dortas, partner of the IPO department at Ernst & Young Teco, says that he is currently working on the operations of three companies that have their eyes on the Bovespa Mais. The plan is to bring them to the market with previously determined buyers . "It provides more security to both sides. The entrepreneur knows that he will have demand for his supply, and the investor is guaranteed to acquire shares in a company with high governance standards.”

"Being a junior market, the Bovespa Mais should have simple rules that create incentives and regulatory 'discounts'”

The Brazilian stock exchange is confident that the next companies to be listed on the Bovespa Mais will not have trouble finding interest in their businesses. The expectation is that companies with very different backgrounds than Nutriplant will join the Brazilian junior market. The profitability of the fertilizer producer has disappointed all investors. The company ended the third quarter of 2010 with a net loss of R$ 1.85 million, a significant increase compared to the R$ 879,000 loss during the same period last year. Since its IPO on February 13, 2008, until November 25, 2010, it suffered a 72.9% share devaluation, while the Bovespa index increased 10.8%. The liquidity of the stock is almost negligible. In the twelve-month period ended in November 25, 2010, only 133 trades took place, totaling R$ 762,000.

AmCham-Brazil’s survey showed that over 70% of the consulted companies have recorded an improvement in gross revenue exceeding 10% annually over the past five years, 17% of them attained an increase between 25% and 50%; and 12% exceeded 50 % per year during this period. For the next five years, the vast majority (82%) foresees an increase in this indicator of over 10% per year, 17% plan to growth of 25% to 50%, and 17% expect to grow over 50%. "It's as if we were to find several Chinas within Brazil," says Dortas. "Funds dedicated to small caps, family offices and qualified investors interested in companies with high growth potential are the likely acquirers of these shares", says Marcio Pepin, director of capital markets at BESI Investimento do Brasil.

The Brazilian stock exchange hopes he is right. Investment banks often claim that one of the obstacles to the development of the Bovespa Mais is the lack of interested investors. Foreigners tend to like the big issuances, to give them room to acquire substantial slices. However, domestic investors, who are increasingly concerned about monetizing their portfolios after the reduction of interest rates in recent years, are out there, eager to find attractive investment options such as those identified by the survey. Hopefully, supply and demand will meet in this case.