By: Abdur Sharjeel, CA, CPA
As public accountants who work closely with a number of Exempt Market Dealers (EMDs) and Exempt Market Issuers, we are often questioned by our clients (and their advisors) about the minimum amount they should be looking to raise for one issue on the exempt market. While we cannot advise on a specific amount, there are general guidelines to understand how much it might cost for our clients to go this route, and try to raise money in the exempt market.
Volume of Exempt Market & Issuers Expectations:
In 2014, $6.7 billion was raised in the exempt market in Alberta, according to the ASC 2015 Capital Market Review. The exempt market is a valuable resource for small businesses that want to expand their business by raising capital from investors but are not large enough to justify the expense and complexity of a public offering.
The securities commissions recognize that it is very expensive and complex to take a company public and that it is not cost effective for many small businesses that need capital to become public companies. To accommodate small businesses in raising capital, the securities commission provides exemptions from some (but not all) of its requirements so that small businesses can raise capital from investors in a cost effective manner.
With this in mind, general perception of the issuers in the exempt market is that they expect that for every dollar raised there would be minimal costs and they would expect more than 90% of the money collected flowing to them. This expectation is not completely true as there are still costs associated with raising money in the exempt market and we consider it is important to educate the issuers with the costs they would expect so they can do their due diligence before making a decision of going down this path. This article discusses the costs associated with preparing an Offering Memorandum (OM) under the OM exemptions of National Instrument 45-106 Prospectus and Registration Exemptions
Cost of raising funds for Exempt Market Issuers:
- The costs related to an OM are dependent on several factors, some of which are listed below:
o Is the company already operating or is it a brand new start-up, for example, costs for a well-established company with a complicated business structure and, operating around the world, would be significantly higher than a company doing business only in the Canadian market, or having plans only for the Canadian market, or a company newly started;
o The industry the company is operating in or intending to operate in. For example, if the industry the company is operating in, or intending to operate in, is regulated then the expected costs would be higher than otherwise;
o The risk profile of the business the company is operating or intending to operate. The higher the risk, the more disclosures required in OM and higher would be the cost of issuing an offering memorandum.
Costs related, directly and indirectly, to preparing an OM and related documents in Canada can be broken down as in the table, as follows: Legal fees, Assurance fees, Agent fees, Sale commissions, Regulatory fees, Marketing fees, and Other Expenses.
For a small to medium enterprise, legal fees can cost between $5,500 to $50,000 plus taxes and disbursements. This is a wide range and depends on a number of factors including the sophistication and involvement of management of an issuer and professional advisors. If management is able to provide full support to the lawyer in preparation of the document, the legal costs are expected to be lower.
Assurance fees can cost between $5,000 to $30,000 plus taxes and disbursements depending on the scope i.e. if review is required then the expected cost is lower than the audit. Under the OM Exemption, you need IFRS audited financial statements while under the OM Exemption Lite you need unaudited financial statements reviewed under ASPE-GAAP or IFRS.
Agent fees are fees payable to an intermediary, such as an exempt market dealer or investment dealer, and are for the work performed by the intermediary in getting an issuer ready for financing. These fees can cost between $5,000 to $50,000 plus taxes and disbursements.
Agent commissions and finder’s fees:
Sales commissions are payable to a registered dealer, such as an exempt market dealer and/or investment dealer who are involved in selling securities to investors and/or unregistered finders who are referring (a) issuers to dealers or, (b) investors to issuers and/or dealers, in return for a fee. Sales commissions are generally 7% to 15% of the total aggregate amount raised by an issuer, depending on a number of factors, and typically would include any finder’s fees.
Regulatory filing fees:
Regulatory filing fees in each Canadian province or territory where capital is raised ranges from $0 to a percentage of the total aggregate amount raised in a particular jurisdiction.
These include sales and travel costs associated with entertaining or pitching potential dealers and/or investors (fees are indeterminate).
Other expenses include printing costs associated with printing the OM and any related market materials.
With the above costs in mind the following table gives an overview of comparison between the net proceeds and gross proceeds an entity should expect when it is raising funds:
It is clear from the table above that a significant portion of funds raised are used in paying the related issuance costs. Many of the issuers do not expect the costs of issuance to be so high and are disappointed when they see low net cash coming to them.
Working backwards from the above table, the following table shows the amount of gross proceeds the entity should be raising if the entity needs a net cash of $150,000, $400,000 and $650,000:
So if an entity wants to receive a net cash of $150,000 it should raise funds of $193,500.
How to reduce related costs?
- Entities can take a number of steps to reduce the cost of audit and legal fees. Some of these are listed below: For legal due diligence organize your due diligence documents properly before the work starts;
- Obtain the steps document from the law firm and ensure that you are fully ready with all the items mentioned there before the lawyers start investing any time;
- Get the financial records ready for the auditors and invest some time to prepare a comprehensive audit binder, this will keep the cost controlled as well as disruptions to your staff low;
- Get your third party documents for example bank statements and valuations in hand before you let the auditors/lawyers look at these;
- Avoid ‘scope creeps.’ They occur when the scope of a project and roles and responsibilities are not either clearly defined or management does not fulfill its responsibilities and the professionals have to step in to ensure the work is done and timelines are met. Consequently, project grows beyond its originally anticipated size resulting in higher cost;
- Respond promptly and reasonably to the inquiries of the lawyers and auditors.
Timeliness of the information provision is a key to keeping the costs low. Normally the tight time targets are set for these types of transactions, therefore, it is crucial that management provides full support and all the information to the professionals on timely basis. This will help to keep the cost low.
Abdur Sharjeel is a Partner with Calvista LLP Chartered Professional Accountants. He has 16 years of experience in Assurance, Accounting Advisory and Corporate Finance Advisory. His portfolio of clients comprises companies in public and private sector and in various industries. He is an active speaker on the financial reporting requirements for public and private companies in Canada.