Breaking it down: The three most common questions from investors about the Exempt Market
By: Shannon Pineau
The private capital markets in Canada are not considered mainstream, and are still a mystery to most average investors. Even more sophisticated, or accredited, investors have had a lot of new information to take in over the last few years, as the market has been totally restructured. As an Exempt Market Dealing Representative, I have a wide range of clientele and a lot of new prospects that come to me for information about private investing. I get asked a lot of questions and I thought it might be helpful for both investors and other industry professionals to hear 3 of the most frequently asked questions about the Canadian private markets and my responses.
#1 – What is the Exempt Market Anyways?
When people ask what I do for a living, I rarely mention my true title, which is Exempt Market Dealing Representative. The majority of people look confused (or sorry they asked) when I say this so I have learned to change things up a little bit. Now I give a short overview of the market’s great advantages and use the words “private investment opportunities” and that always seems to make more sense to everyone.
That leads me to the question that I get asked, by far, the most often from investors, and that is: “What is the Exempt Market anyways?” It is a very fair question because it is a new term. Most investors, even those that have held private investments in the past, are not familiar with it. I generally tell investors:
The Exempt Market is where you can find private investment opportunities in Canada. These investments are not available in the public markets or stock exchanges, and they are very different than these types of conventional products. They are generally longer in duration, offer higher returns, have different risks, and have many different types of structures and terms.
The private investment market has always existed in some form, as people have always needed money to start or grow new companies or projects. The reason you have never heard the term Exempt Market before is, up until recently, the market didn’t really have a formal name and was usually referred to as the ‘private’ or ‘alternative’ market. Another reason you might not know the name or even know about the private investment market overall is that it is not that common or well known.
Even though it has existed for centuries, it has generally only been available to the wealthy or those ‘in the know’ such as business associates, friends or family. The mid 2000’s saw a boom in the industry with a red-hot economy and the increased use of the Offering Memorandum (OM) exemption. Up until then, the market was largely unavailable to average investors and so not well known at all.
To explain where the name ‘Exempt Market’ came from, let us first take a look at why and how people raise capital in the private markets.
When Canadian businesses or the government of Canada raise capital in the public markets, they issue stocks or bonds through a prospectus offering. A securities regulator reviews the prospectus for completeness including a full disclosure of risk and a full disclosure of material facts.
To sell securities under a prospectus is very costly and onerous process, and can deter smaller companies in their ability to raise capital. Many of these companies choose to stay in the private investment landscape and rely on exemptions from the prospectus requirements in order to raise capital for their projects.
Common exemptions include:
- Issuing an Offering Memorandum (not yet available in Ontario)
- Selling only to Accredited Investors
- Selling only to family friends and business associates
- Selling a minimum of $150,000.00 per transaction
So using an ‘exemption’ to prospectus was the first lead in to the name ‘Exempt Market.’ Then, the need to have the marketplace restructured, formalized and better regulated led to the formation of registrants called ‘Exempt Market Dealers.’ These EMD’s play a large role in the private marketplace and further cemented the name ‘Exempt Market.’
So there you have it. A market that has been around as long as time but has been restructured, rebirthed, in some cases newly introduced and given a whole new catchy name.
#2 – I’ve Lost Money in the Exempt Market, Why Should I Invest Here Again?
Another common question as there were many losses experienced during the recent recession. Just as investors were introduced to a whole new world of private investments and higher returns in the mid 2000’s, the tables turned and everything changed in the world economy. There were many losses experienced in the Exempt Market and many investors questioning their decision to invest there. As this was most people’s first exposure to this market, it did not leave a very good impression in most investor’s minds. Here is how I generally respond:
Losing money in an investment (or just losing money period) can be a devastating thing. You’ve worked hard, you’re doing the right thing trying to build for a great future and retirement, and investing should help with that, not cause you to lose money.
The truth is though, investing does come with risks and people frequently lose money, both in the private and public markets. You are never going to profit 100% of the time with investing; it is just not possible. Even the risk adverse that want the ‘guarantee’ and park their money in GIC’s can lose money through inflation risk. There is a very real chance that inflation will be higher than what they are making in a GIC and erode their returns away.
When we experience a large financial crisis like 2008/2009 where losses were enormous, it is easy to want to just throw in the towel and put your money under the mattress.
That is not the answer though and deep down most people know this. Life is a learning experience and failures often give us the opportunity to learn a lot. You might not see it at the time but later when you reflect back you will see many things that you will try to do differently in the future. And this time, with more knowledge and experience under your belt, you’re likely to do much better.
It’s easy to take that position with the Exempt Market overall too. It is considered a higher risk market and the risks really became apparent during the recession when some very high profile companies failed. But again, with great hardships come great changes and Canada’s private investment landscape has now become a well regulated, more controlled, place for investors to earn great returns on their money.
So my immediate answer would be – because it is completely reformed, offers great issuers with extensive experience and great track records. The returns are much higher and you will make your losses back much faster than you would with stocks or mutual funds.
And I will qualify that with – there are still no guarantees of course. Not in this market or any other market. Investments hold risk. But if you take a look at the changes that have taken place in the Exempt Market to protect you the investor – I think you will readily agree that it is a very investor friendly place to be.
#3 – Why would I invest here instead of in stocks or mutual funds?
The Exempt Market is not mainstream, and it is considered a higher risk environment – why would the average investor want to put some of their portfolio in the Exempt Market? This is the topic I love to talk about the most and here is my condensed response:
Because, when properly diversified, private investments can help you reach your financial goals and retirement dreams faster than conventional products. That is the market’s main draw for investors - the potential for higher and more consistent rates of return than stocks, mutual funds or bonds.
The reason for this is that lots of opportunities come with upside potential. Many of the issuers offer both income and profit sharing components to their structure and for investors this is where the potential is to really see some growth. It is also what sets this private investment landscape apart from the usual investment vehicles as a successful project could mean a much higher return on your money. For example, in a hotel development, there could be higher than average levels of occupancy and then a final sale of the hotel - all of which the investor shares in. Another draw to the Exempt Market is less volatility, as it does not closely mirror the ups and downs of the public stock markets.
For investors, this means that your capital can increase faster and you will have more capital to continue investing at higher rates.