By Alan Lo
While stock markets are taking a beating since the beginning of the New Year, many Ontario investors do not realize that they can now more readily invest in the private markets. On January 13, 2016, the offering memorandum prospectus exemption became available in Ontario, this allows individual retail investors to more readily access private market investments.
Link Between World Events & Public Stock Market Prices
Like many of you, I did not realize that individual investors could access private market investments until only a few years ago. The private markets are not new, however, they became more commonly known in 2009 with the introduction of exempt market dealers across Canada. Exempt market dealers are intermediaries in the business of trading private market securities and are required to be registered in those jurisdictions where they carry on their business.
I remember the dog days of the 2008 financial crisis, when the value of many Ontario investors’ public market portfolios were experiencing extreme volatility, in some cases fluctuating almost 50% in value. It was a terrible time as some of these individuals were near retirement age and were relying on the value of their public investment portfolio to supplement their future income. I, like other investors in Ontario, was unable to identify a solution to reduce the volatility of my investment portfolio because I only had access to public market investments at the time. It was not until 2010, when I learned about private markets, that I developed an appreciation of how a combination of public and private market investments could achieve a more diversified portfolio. The idea is similar to the strategies employed by pension funds and other institutional investors where a portion of their portfolio is invested in private market securities.
A problem with the public markets, although a very important part of any investment portfolio, is that the way public securities are priced is too sensitive to short term investor sentiment. To elaborate, the world has become so integrated that any catastrophic event happening in one part of the world can have a negative impact to another part of the world’s economy and consequently the stock market. For instance, in 2008 stock prices around the world fell together in the face of the U.S. sub-prime mortgage meltdown.
The change in price of a public security is caused by many factors including investor sentiment, which may not necessarily be a true representation of the value of the underlying company. In contrast, private market securities are generally not valued based on investor sentiment but rather are priced based on a valuation metric to determine the intrinsic value of the operating business itself. Therefore, even if a large number of investors sell their shares in a private company, the share price will generally not be affected. This is the difference between public and private equity investments.
Do your homework before investing
Although private market investments have grown in popularity in the past few years, risks associated with private market investments can be quite high and some investments that failed in the past were the result of fraud. I cannot stress enough that it is important for investors to complete their due diligence prior to making any investment decisions. Securities regulators have done a tremendous job in tightening the regulations involving private placements and we are starting to see better-structured products. Even some that are RRSP-eligible. The key is to make sure a company has good management and governance in place prior to making these types of investments.
Access Private Market Investments Through Dealers
In the ‘private’ or ‘exempt’ market as it is called, there are dealers that promote their own investment products, investments of third party companies or a combination of both. Investors should work with a dealer when considering a private market investment since dealers and their dealing representatives generally have a wealth of industry knowledge and can assist investors with understanding their investment needs including, an investor’s investment objectives, risk tolerance, time horizon, and other matters with a view to matching a suitable investment with an investor’s investment profile.
Prior to 2016, Ontario Retail Investors Could not Access Private Market Investments
Prior to this year, accredited investors could invest in exempt market products under the accredited investor exemption. The private markets could not generally be accessed by retail investors other than under very select prospectus exemptions in Ontario such as the private issuer exemption. Accredited investors include, among others, individuals that are generally considered to be high net worth investors who (a) are making $200,000 per year individually or $300,000 including spousal income for the past two years and expect to continue making such income at the time of the investment, (b) have financial assets of cash, securities or the cash surrender value of an insurance policy in excess of $1,000,000, or (c) they have net financial assets of at least $5,000,000 which includes an investor’s real estate and other securities.
After January 12, 2016, Ontario Investors Can Now Access the Private Markets
On January 13, 2016 Ontario introduced the offering memorandum exemption which effectively allows (a) any qualified Ontario investor to invest up to $10,000, (b) any so called ‘eligible investor’ to invest in excess of $10,000 but up to and less than $30,000 without a registrant and (c) any eligible investor in invest more than $30,000 but up to and less than $100,000 in any 12-month period provided that the investor has received advice from a registrant, such as a registered dealing representative, that the trade is suitable.
An eligible investor, includes a person whose (i) net assets, alone or with a spouse, in the case of an individual, exceed $400 000, (ii) net income before taxes exceeded $75 000 in each of the 2 most recent calendar years and who reasonably expects to exceed that income level in the current calendar year, or (iii) net income before taxes, alone or with a spouse, in the case of an individual, exceeded $125 000 in each of the 2 most recent calendar years and who reasonably expects to exceed that income level in the current calendar year.
The offering memorandum exemption will provide new and different investment opportunities that were previously unavailable to Ontario investors but available to investors across Canada. Ontario has made some minor changes to the existing offering memorandum exemption model used by other provinces in order to allow it to be used by Ontario investors.
However, with any opportunities there will be associated risks. When capital becomes more accessible, generally the quality of investments and registrants may potentially be diluted. As such, it is very important for investors to complete a thorough due diligence on the person and dealer that is promoting a private placement.
Alan Lo is a Dealer Representative and a Branch Administrator of Pinnacle Wealth Brokers Inc., which is registered as an Exempt Market Dealer in provinces of BC, AB, SK, MB, ON, QC, NB, NS, and NL.
This information does not constitute a solicitation for sale or purchase of securities. This is not an offering of securities. Offerings are made pursuant to an offering memorandum and only available to qualified investors in jurisdictions of Canada who meet certain eligibility or minimum purchase requirements. The risks of investing are outlined and detailed in the applicable offering memorandum and you must review the offering memorandum in detail prior to investing. Investments are not guaranteed or insured and the value of the investments may fluctuate.