Exempt Capital Markets Critical for Small Business in Canada

Next wave, crowdfunding, a new task for already challenged regulators in fragmented system
May 22, 2015 Updated: May 23, 2015

By definition, the average Canadian hears very little about the country’s exempt or private capital markets. Not much is typically known about the raising of capital to fund the operations of small business as opposed to that of public companies that issue stock or bonds.

But private capital is critical for financing small business and entrepreneurship, and it ultimately leads to job creation. It also provides unique opportunities for wealthy investors.

The exempt capital markets feature higher-risk securities being sold to eligible investors without extensive public disclosure documentation. The investors, such as venture capitalists or private equity funds, among others, will often work closely with the small business or start-up providing advice with the aim of improving the investment’s chance of success.

Small businesses and entrepreneurs cannot afford the cost of public disclosures, aren’t typically seeking the greater amount of funding sought in public markets, and don’t have the time or personnel to deal with the duties of being a public company. Their focus has to be on developing the business itself.

This new way to raise capital [crowdfunding] is taking the world by storm.
— Joe Oliver, Finance Minister

Growth in private market financing continues to exceed $100 billion a year, although consistent supporting data is lacking. This is an additional challenge in Canada, which doesn’t have a single national-level capital markets regulator like the U.S.’s Securities and Exchange Commission. Canada instead has separate provincial securities regulators.

As the exempt market continues to broaden, regulators face the difficult task of ensuring an efficient market (transparency and pricing), providing investor protection, and cutting out misrepresentation.

Next Wave: Crowdfunding

Crowdfunding is a way of raising capital that makes use of advances in technology (Internet) and social media. Using online platforms such as Kickstarter and Indiegogo, small businesses can connect with a theoretically unlimited set of investors.

Canada’s finance minister Joe Oliver referred to new cooperation among several provincial regulators in his keynote address at the fourth annual PCMA Private Capital Markets Conference held May 19, at the Toronto Board of Trade.

“Just last week, six commissions [provincial securities regulators] agreed to a common set of rules for crowdfunding. This new way to raise capital is taking the world by storm,” Oliver said.

Especially the good start-up firms, they have to indicate they’re going to be better than the bad ones.
— Jack Mintz, School of Public Policy, University of Calgary

The change in the six provinces—British Columbia, Saskatchewan, Manitoba, Quebec, New Brunswick, and Nova Scotia—will be to allow equity crowdfunding so that early-stage investors can gain a share in the company. Previously, the rules only allowed crowdfunding investors to make donations or to receive rewards from the company such as its products.

Now it can be likened to a retail investor having the same opportunity as a sophisticated institutional investor.

But with reward comes greater risk, and regulators are acting to protect investors, such as by requiring the company to make some disclosures about itself including how it intends to use the funds. But these requirements are a far cry from a full prospectus in public capital markets.

Lack of Information

“The current state of data and information available on the exempt market is inadequate for informing any significant policy debate or for imposing new regulations,” writes Professor Vijay Jog in a University of Calgary School of Public Policy research paper.

Given this challenge, it is very difficult for regulators to get a handle on this market for the sake of investors. High net worth investors may be able to tolerate greater financial risks, but that doesn’t mean they have the sophistication to understand the risks in exempt markets. And while progress is being made to broaden the applicability of crowdfunding, the overarching problem with regulating exempt capital markets in general is the lack of data.

“It’s not clear that some of these rules are appropriate; they may not be addressing the right problem,” Dr. Jack Mintz told Epoch Times. Mintz, from the School of Public Policy at the University of Calgary, along with Jog have been doing extensive work on examining private capital markets in Canada.

For example, one rule that Mintz feels doesn’t achieve the right objective is Ontario’s annual limit of $30,000 for eligible individual investors on purchases of exempt securities.

“We’re making it more difficult for larger firms than smaller firms with that kind of rule—too focused on the investor instead of the issuer,” said Mintz.

The $30,000 cap rule may not hamper small business, but it makes the costs of raising capital onerous for slightly larger firms.

Mintz argues that the focus of regulation should be on the issuers and that focusing on the investor is not the correct approach for regulation.

“Regulations should make it harder for poor-quality firms to operate in the market so that investors will have more confidence,” said Dr. Mintz at the PCMA conference.

However, the good news is that with the broadening in private capital markets, small business and entrepreneurs have a greater likelihood of finding necessary funding in Canada than before.

But the onus is on the issuer to obtain funding. “Especially the good start-up firms, they have to indicate they’re going to be better than the bad ones,” said Dr. Mintz.


Follow Rahul on Twitter @RV_ETBiz

Follow Rahul on Twitter: @RV_ETBiz