The article “Soon You Will Be Able to Invest Like the Very Rich, With All The Rewards — and Risks” was originally published on The Financial Post on December 7, 2015.
If you have wanted to put money into the private investment markets and been denied, your options might be about to open up.
Starting early next year, changes are coming to the investment industry and new options will be available to residents of Alberta, Saskatchewan, Ontario, Quebec, New Brunswick and Nova Scotia that were previously only open to high-net-worth investors.
Until now, only wealthy investors were able to make certain types of investments — ranging from private real estate limited partnerships to mortgage funds to solar panels to accounts receivable that were sold through the private (non-public) markets.
But, starting in 2016, these six provinces will join the rest of the country with plans to enact the offering memorandum prospectus exemption found in section 2.9 of National Instrument 45-106 – Prospectus Exemptions (the OM exemption). This means that small and medium-sized private businesses will be able to raise money more easily, while the restrictions that prevented smaller investors from investing in these companies will be loosened considerably.
Currently in Ontario, for example, companies looking to raise money would have to issue an expensive prospectus to potential investors, unless the investor met one of only four exceptions:
- Investor has a net worth of over $5 million (including real estate)
- Investor has financial assets (net of debt) of over $1 million
- Investor has income over $200,000 in the past two years or $300,000 when combined with a spouse
- Investor invests a minimum of $150,000 (this exception was removed in May 2015)
These existing rules seem to presume that accredited investors with higher incomes and more to invest are somehow more financially savvy than their lower income, lower net worth counterparts — which I can say, from experience, is a poor generalization. “Rich” people as a whole are equally uneducated when it comes to investing, especially as the financial markets become more complex.
Private markets have grown considerably in recent years, despite the fact that only a small percentage of the population meets the accredited investor rules based on income or assets.
Some of this growth has come from non-accredited investors scraping together enough money to make the $150,000 minimum investment, even though this may have represented an irresponsibly high proportion of their assets being placed into a single investment. This has been happening all too frequently, according to regulators. And that’s why the Canadian Securities Administrators abolished the $150,000 minimum investment exemption earlier this year.
In a recent investigation of Ontario exempt market professionals who are licensed to sell private investments, the OSC found that nearly one in five was selling investments to people who did not qualify. Three quarters of them fell short on collecting and documenting important information about clients, including their risk tolerance.
On that basis, it may be that the six provinces making charges are simply making it OK to do what many exempt market professionals are doing already. I can get my head around lowering the bar on the thresholds to invest, but I hope that does not mean a further lowering of the bar on simple “know your client” responsibilities — like a discussion about risk tolerance — when that already seems to be an issue for the private market sector.
Changes are slated to be implemented in Ontario as of January 13 and on April 30 in the other five provinces. These changes include:
- Any investor can invest up to $10,000 within any 12-month period without restriction into private market investments.
- Eligible investors* can invest up to $30,000 annually without suitability advice from a licensed investment professional (an exempt market professional).
- Eligible investors* can invest up to $100,000 annually with suitability advice from an exempt market professional. That advice may not cost the investor directly – it will appear free – but the dealer will receive a commission from the issuer that will otherwise reduce the investment’s potential return.
(*In this context, “eligible investors” must have had a minimum of $75,000 of income personally in the past two years; income of $125,000 when combined with a spouse; or $400,000 of total net assets either alone or with a spouse.)
Instead of a prospectus, companies will need to issue investors an offering memorandum, which is a legal document that is not pre-cleared with the regulators like a prospectus would be. The memorandum does, however, need to contain standard disclosures, such as information about the management or promoters of a company raising money, the risks involved with investing and how exactly the company will use the money. As you can well imagine, these disclosures are more art than science.
You generally cannot buy private market investment through your local bank. In Canada, only exempt market professionals working for a licensed firm can deal in private market investments. These investments do not trade on public markets like stocks or other securities. Whether you can invest directly or need to invest through an exempt market professional depends on the dollar limits indicated above, unless you meet the accredited investor income or asset limits.
The lure of the private markets is that higher, uncorrelated investment returns may be available. Large pension plans like CPP, OMERs and Ontario Teacher’s Pension Plan all allocate funds to private market investments — a vote in favour of considering such an allocation in your own personal portfolio. But higher returns come with higher risk, including the risk of fraud that has taken down private market issuers in the past, like the First Leaside real estate limited partnership and New Solutions Group’s receivables factoring business.
One benefit of removing the $150,000 minimum is that non-accredited investors who want to invest in the private markets can do so in a smaller, more reasonable, and more diversified way. Small companies will also have more access to capital than they have had up to this point, which is good for Canadian small businesses.
But just like any investment, buyers should beware. The benefit of more options may be offset by the drawback of more risk. Even though anyone can invest up to $10,000 a year without restriction or advice, and eligible investors will be able to invest up to $30,000, it might not be bad idea to solicit input from an exempt market professional, even though they will get paid a commission. At least that way you will have a little more insight into what you’re getting yourself into. Otherwise, you might just be better off staying put in the public markets.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.