The Canadian Venture Capital and Private Equity Association announced a record total of venture financings in 2021 — $14.7 billion. However, excluding the venture financings related to the public listings of eight large tech companies, the total was in line with the steady, modest annual financings in the past four years. And private company deals totalled $18.1 billion last year, well below annual private financings from 2017 to 2019.
The domestic private equity markets have failed to keep pace with the financing needs of existing and new businesses amid a steadily growing economy and the transition to digitalization. Further, the large and growing institutional fund sector accounts for a declining share of domestic private investment. Few large investment funds have established specialized private equity funds to meet early-stage funding demand.
In contrast, the domestic angel investor network continues to be an important and stable source of equity financing for Canadian private business, particularly small-sized regional companies.
In addition to revamping the angel investor network (more on this below), new initiatives to vitalize capital flows to domestic private markets can be achieved by harnessing small regulated financial institutions, including managed investment funds and investment dealers focused on providing intermediate private capital to small private and public companies.
The Ontario Capital Markets Modernization Taskforce in 2019–20 made path-breaking initiatives for more efficient securities regulations, new proxy rules and structural reforms. Steps like consolidating the self-regulatory system, and concepts like open access to the product shelves of large financial institutions will improve the effectiveness of regulated small financial institutions.
The task force is now well positioned, with vigorous leadership and an experienced team, to see through and build on its proposals and resume its work to strengthen small-cap markets by embracing fiscal measures.
However, the task force should be reformed to be national in scope, expanding membership to all regions and widening accountability to provincial governments and the federal government.
Here are specific initiatives to consider:
- As the task force resumes its work nearly two years after its initial proposals, the status of, and possible changes to, the original recommendations should be assessed.
- Small financial institutions, many with limited research capability, need access to quality financial information on private companies for investment. A regulatory framework to facilitate the exchange of information among individual angel investors through not-for-profit angel investor groups is a way forward. Further, the task force could consider a version of the Curated Capital platform developed and implemented by the Enterprise Investment Scheme (EIS) Association in the United Kingdom, which advises the government on private investment. Curated Capital matches participating investment firms to eligible startup and small companies through a rating system, enabling small dealers and funds to invest in and build diversified investments of private companies.
- A personal tax credit on individual purchases of small company shares would compensate for risk and encourage investment. Some provinces already provide a dividend tax credit for small business investment. The task force could consider recommending a version of tax relief like the twenty-year-old EIS.
- The United Kingdom found that the EIS created a clustering or ecosystem of local and regional investment firms, accounting and law firms, information and trading platforms and small companies to exchange information and strengthen the capital-raising process. A similar result would happen in Canada.
- There has been a proliferation of private equity platforms catering to private companies and sophisticated investors. The task force could consider measures to improve these platforms by adopting more accommodating rules recognizing evolving investor participation.
Constructive action is needed to renovate the private and public marketplace to improve the capital formation process for small and mid-sized companies in Canada. The solution must be multi-dimensional — not just securities regulation but fiscal and competition initiatives. Immediate action is critical given the significant contribution of small business to economic growth and employment. The seriously indebted small business sector, with an estimated $135 billion in debt, combined with the need to transition ownership to a younger generation, means government cannot afford to ignore remedial action.
Ian Russell is a partner with Russell Deacon and Co. and past president of the Investment Industry Association of Canada.