If you consider yourself a savvy investor with the stomach for significant risks, you’re far from alone. The exempt market, a higher-risk alternative to public markets, is big and burgeoning. The Ontario Securities Commission (OSC) estimates exempt-market issuers across Canada raised $143 billion in 2011, up by almost 10% over 2010.
This market offers access to deals unavailable elsewhere and the potential for higher rewards in return for higher risks. And entrepreneurs are more likely than most people to be eligible to make such investments. So, should you join the club?
Only if you don’t mind working without a net. Issuers are exempt from the rigorous disclosure demands of a prospectus, so exempt market dealers (EMDs) and investors must perform their own due diligence. As well, exempt-market securities—equity, debt or both—are often illiquid. If you get a bad feeling about an investment, you may be stuck with it until it matures, sometimes for two years or longer.
That’s why securities regulators have imposed rules governing who can play in this market. Ontario’s are the strictest: you must have at least $200,000 in income, $1 million in net financial assets or $5 million in net total assets. The OSC estimates just 352,000 Ontarians were eligible in 2011.
The other provinces have looser rules. The most permissive is B.C., where—given an offering memorandum (OM), which discloses fewer details than a prospectus—anyone can invest any amount in anything.
The exempt market doesn’t provide the reams of data that regulators require public market issuers to report. You can’t find out average returns across the exempt market or the share of deals that yielded stellar returns versus those that lost money.
Your best bet for navigating this market is to review EMD websites, then interview dealers to find one with a sectoral focus and risk/return profile that suits you. For instance, asset-backed investments such as in mortgage investment corporations are generally at the lower end of the risk/return spectrum. “If you’re content with 8% to 9% per year, you’ll find that’s going to be very consistent,” says Darvin Zurfluh, executive chair of Pinnacle Wealth Brokers in Calgary, an EMD specializing in such investments.
Contrast that with EMDs specializing in oil and gas exploration plays not available on public markets. Craig Skauge, president of the National Exempt Market Association, says these can deliver returns topping 25%. But, in this highly cyclical sector, you also may lose a bundle.
No national numbers exist on deals by sector. But of the 3,701 Ontario-based deals issuers reported to the OSC in 2011, the top three sectors by capital raised were: financial services (investment companies and funds) at 23%, mining at 14% and tech at 5%. That year, reports the Alberta Securities Commission (ASC), more than 80% of the 2,184 Alberta-based deals were in oil and gas.
But you’re free to invest outside your province. And investors do: ASC data for 2011 show that Albertans made 60% of their exempt-market contributions to entities in financial services and just 14% to ones in oil and gas. (The OSC doesn’t provide comparable data.)
Investors have access to a growing deal flow in part because many issuers have turned to the exempt market as capital has become scarcer since the 2008 crunch. “There are three Hilton hotels being built near the Calgary airport that have access to the exempt market through an OM, with $10,000 cheques from Ma and Pa,” says Skauge. “Pre-2008, the banks would have given the hotels what they need.”
Putting money into deals like this isn’t for everyone. But if you scrutinize them closely and limit them to a minority of your portfolio, you may find the exempt market just the thing to boost your overall returns.