By Paul Ghezzi
It is common for both public and private issuers to paint each other with broad generalizations and to highlight the other’s respective flaws. In a competitive world of raising capital such narratives can be useful as a marketing tool but the reality is that ‘both worlds’ of capital have their advantages and disadvantages. More importantly, the combination of the best attributes of each offers a compelling opportunity for advisors and investors.
Having spent seven years in the exempt markets and two years in the public markets, raising and managing capital, I have often pondered the question: “What is the ideal investment structure for retail investors?” I have come to the personal conclusion that combining the transparency, rigor and the regulation requirements of the public markets with the more sophisticated capital formation and structures found in the exempt markets is the ideal solution.
Public Market Leadership in Ongoing Disclosure
Up until the recently announced regulatory changes for the exempt markets, public issuers have been held to a much higher standard of ongoing disclosure and reporting than private issuers. In fact, other than preparing annual audited financial statements, private issuers have not been required to provide any ongoing disclosure. While this has been a win for private issuers in terms of lower regulatory costs, investors and advisors are often in the unenviable position of chasing private issuers for information. In my experience, a common complaint from advisors and investors is that they have little to no power to get the information they require to properly analyze their investment performance or the performance of the management team to which they have entrusted their capital.
Over the years there has been a vigorous debate as to the cost versus benefit of having private issuers held to a higher standard of care in terms of ongoing disclosure. The most recent regulations for the exempt market are an attempt to bridge the divide and strike a balance. Private issuers using the OM exemption will now be responsible, on an annual basis, for: auditedfinancial statements, details of the use of proceeds raised through an offering, notice of discontinuing the business, changing industries or change in control of a company ownership.
Overall, the intent of these new regulations is: (a) to protect investors from fraudulent behaviour (b) when disclosure is required, that the offering documents must contain all material information with respect to the issuer and the exempt securities being offered.
While this is a move in the right direction, public issuers continue to be held to a higher standard of ongoing disclosure with detailed quarterly financial statement reporting and detailed quarterly and annual management discussion & analysis. Public issuers also face severe penalties for non-compliance with ongoing disclosure regulation on a quarterly reporting basis. In Canada, for example, not filing quarterly financial statements on SEDAR within the timelines required can result in various penalties, sanctions and a potential cease trade.
Why does the rigor and regulation of ongoing disclosure matter so much?
The only way for advisors and investors to make a determination about the quality of their investment and the quality of the executive team managing their capital is to have access to straightforward information in a timely manner. The public markets operate on the principle of full disclosure at all times. While the public markets are not perfect and have their own challenges with non-compliant issuers, they do offer the exempt markets a standard which better serves the ongoing disclosure needs of advisors and investors. In simple greater transparency allows advisors and investors to make more informed decisions.
Private Market Leadership in Capital Structuring
The public markets for small capitalized companies in Canada have generally focused on commodity companies in mining, oil and gas. Public issuers have traditionally been exploration based and have used the public markets as a vehicle to raise early stage capital that is equity in nature. This approach to raising capital to fund growth has lagged the sophistication in the exempt markets. Further, public markets can be volatile, and raising equity capital, is not always a good option.
Private issuers, through entrepreneurship, have typically led the way in terms of more sophisticated structuring of various forms of financing and have relied less on equity issuances. Common structures include the Offering Memorandum with limited partnership units, mutual fund units, and various forms of debenture offerings.
The sophistication in private issuer structures has been driven by the demand from advisors and clients for more income and less volatility. Income products with some growth and lower volatility have flourished in terms of capital accumulation and have filled a void that the public markets do not seem capable of addressing.
There is no doubt that the innovation in the exempt markets for financial structuring has led to hundreds of billions of dollars in capital formation which has benefited the capital ecosystem of Canada. I don’t see this changing any time soon and believe the exempt markets will continue to innovate and deliver creative forms of financing and investment.
If we summarize the retail investor experience in the public markets, we can make the generalization that transparency and ongoing disclosure are important advantages while lack of structured income offerings and high volatility are disadvantages. Conversely, in the exempt markets structured income offerings are abundant but private issuers are not held to the same standards of ongoing disclosure which investors require to make informed decisions.
As opposed to focusing on the flaws in either the public or exempt markets, respective issuers could benefit from integrating the best of what the other has to offer. In practical terms, I see a shift in both markets where public issuers will raise capital through the exempt market and private issuers will move towards implementing greater ongoing disclosure and reporting. Strong operators and management teams will separate themselves from the rest and be able to raise capital more efficiently and effectively.
Ultimately the best of both worlds approach is a win for advisors and investors.
Mr. Ghezzi is the CEO of Kontrol Energy, a Canadian company focused on the acquisition of operating businesses and/or technologies in the energy efficiency sector. Mr. Ghezzi is a leader in clean tech, renewable energy policy, renewable energy financing, and distributed electricity generation. He has global experience in power generation projects under Feed-in Tariff programs and Power Purchase Agreement programs for both commercial and utility-scale projects. In 2008 Mr. Ghezzi created Canada's first securitized Renewable Energyfund. A trusted and sought after industry advisor, Mr. Ghezzi continues to be involved with various renewable energy programs in North America and Africa. Most recently he has led the formation of Kontrol Energy through the acquisitions of NUVO Energy Grid and Kontrol Technologies Inc. via a Reverse Take-Over transaction with a CSE listed company. Mr. Ghezzi is passionate about building a sustainable future and helping Canada achieve its GHG emission targets through market-based energy solutions and technology.