Volatility in the equity markets and frustrating yields are causing clients to demand alternative ways to boost returns. At the same time, businesses are searching for alternatives to traditional markets to raise capital.
“This creates a perfect storm for the rising popularity of exempt-market products,” says Marcin Drozdz, managing partner with Blueprint Global Partners Inc. in Calgary.
Providing suitable clients with these investments, which are generally securities offered without prospectuses, can be a way to differentiate yourself, he says.
The type of client most likely to benefit from exempt market products has a stable personal and financial life, says Yvonne Martin-Morrison, a principal advisor with Purpose Inspired Solutions in Calgary.
That’s important, because liquidity is not guaranteed. “There are some private investments where the funds may be inaccessible for a number of years,” she says.
So investors who have run businesses, or significant understanding as to how businesses work, are often good potential candidates. “They have experience [with] how a business moves through its cycles of operation and can evaluate the exempt-market product from that perspective.”
William McNarland, chief investment officer at Pinnacle Wealth Brokers Inc. in Calgary, says it’s important clients understand exempt market products are not reporting issuers. In the case of a public company, investors can go to sedar.com to get a company’s financial statements, letters of material change, and news releases.
In contrast, “an exempt market company offering a private debt product has no obligation to report,” he says, “so I would caution advisors or retail clients to make sure a reporting structure has been negotiated for them or they have negotiated it themselves.”
You also need to tell clients “an offering memorandum is not reviewed by securities commissions, so more due diligence is required,” he adds.
What’s next for the exempt market?
Advisor.ca readers will need to keep a sharp eye on possible changes affecting clients’ abilities to purchase exempt market products.
Ontario, in particular, could experience significant changes. In 2011, the total amount of capital raised in Ontario and reported to the OSC through exempt distributions was approximately $87 billion.
In June 2012, the regulator broadened its exempt-market review to consider whether it “should introduce new prospectus exemptions that may assist capital raising for business enterprises, while protecting the interests of investors.”
Issuers may start releasing more products with liquidity built in, says Drozdz. As example, “a mortgage investment corporation in the exempt market might create a liquidity buffer of 10% redemption every year.” But this feature could cost an investor part of the return, which advisors would need to clearly explain, he adds.
Currently, the “most popular category among investors is private fixed income, rather than private equity,” says McNarland. Real estate investments are popular, but he says client interest is shifting toward other categories. He’s seeing growth in the number of opportunities in small-business lending, asset-backed lending (factoring and account receivables) and oil and gas (production or oil field service lending).
In the past few months, he’s finding “increased interest among issuers in obtaining funding for new technologies, including for mobile applications.”
Darren M. Smits, a partner with Miller Thomson LLP in Calgary, agrees the range of sectors looking to raise capital is expanding. “Ten years ago, when I began to practice in the exempt-market industry, funds were primarily being raised in Western Canada for either mining, oil and gas or real estate projects,” he says.
Then came the tough economy. “Since 2007-2008 when the traditional banks tightened up their lending requirements it became more difficult for some clients to access capital requirements,” says Smits. “A borrower needs to have a history of significant uninterrupted cash flow, with very little uncollected accounts receivable. For instance, start up companies, land development companies, etc., do not have the operating history necessary to obtain a loan from a traditional bank.”
In addition, “we have often seen that banks are unwilling to increase a credit facility for a current customer when the customer requires capital to expand or grow its business because its credit [is] based on past cash flow, not potential cash flow.”
However, says Smits, “our clients’ needs remained unchanged as they continued to require access to capital. Accordingly, we have witnessed a significant increase in clients utilizing the exempt-market industry as a way to expand and to grow their business,” he says. Examples include clients involved in restaurants, franchising, fabrication, technology, oil-field services and home-care facilities.
Drozdz says any concept relatively new to the public, including the exempt market, has a cycle: “First it’s ridiculed, then it’s denied and then, it is accepted as normal.” In the case of the exempt market, it’s in the third stage. “In three-to-five years investing in private placements will be commonplace.”
Fortunately, there are “more resources available today than ever before for advisors who want to bring these investments to clients,” says Martin-Morrison, who has used private investments in the exempt market since 1997. “There is high quality due diligence and assistance with compliance, registration and licensing, and more potential to discern suitable options for your clients.”
Drozdz, Martin-Morrison and McNarland will be speaking at WEMA’s Exempt Market Advisor Education Forum on November 7.