The unsung heroes — that's what PCMA co-founder and director David S. Brown calls exempt market dealers (EMD) and Angel Investors. While Angels and EMDs serve as energy for the private equity market engine, they are often subject to over-regulation which slowly leeches their life force out.
"Angels and EMDs, who are literally the lifeblood of the private capital ecosystem, are being regulated out of business. Angels, for the most part, don’t even know it and tend to invest regardless of the regulatory regime, but EMDs – who are regulated creatures of statute — must follow the rules, which are getting more complex and expensive to follow yearly," he said.
For Brown, this was apparent in the way EMDs and Angel Investors are regarded in the formation of the cannabis industry in Canada. He said despite the leap of faith EMDs had to take in the sector, they remain unappreciated and are even “rewarded” with a more complex sets of rules and regulations.
In this exclusive interview, Brown shares his insights and hopes for industry regulation. He also shares the significant changes he witnessed in the industry — from the early days of venture capital to the flourishing of the thriving private markets ecosystem.
Have you seen any significant changes in the industry during your career?
I have literally witnessed the development and segmentation of the private capital markets from the late ’80s to present. When I started out in the area, “Private Equity” did not even have a name. It was only named “Private Equity” in the mid-’90s.
Early on, Venture Capital consisted of “if you needed to expand and the bank won’t provide the capital financing, we will provide a secured loan with perhaps an equity kicker at an exorbitant cost of capital”, that is to say there really was no segmentation or specialized financing, especially in the earlier stage knowledge-based industries (aside from a few anomalies like Sir Terry Matthews, Michael Cowpland and Ben Webster at Helix Investments, who were all visionaries at the time, in a vein similar to Jock Whitney, the father of modern American venture capital).
The type of companies that typically got funded were, in the main, old school economy companies. That all changed with the introduction in the ‘90s by the Federal and Provincial Governments of Labour Sponsored Venture Capital Funds, which made Venture Capital investing somewhat tax efficient to the retail investing public. This, to Governments’ credit, primed the pump for Venture Capital (both formal funds and informal of the type EMD’s source) in knowledge-based (i.e., high tech, balance sheet light) companies, which led to an explosion of micro-cap public companies financings, which then resulted in the formal Angel Group formation and investing, and finally led to the Canadian pension funds allocating more of their investable assets to Private Equity/Private Capital (and the Canadian pension funds had always been laggards as compared to their U.S. pension funds counterparts).
Now we have our current situation of a literal smorgasbord of private capital availability and ecosystem, starting with the 3F’s (friend, family, and fools), angel, venture capital (both formal pools and informal of the type EMD’s typically source), venture loans (i.e., secured loans with an equity kicker) and bigger capital flows of what is commonly referred to as Private Equity and which we typically associate with the pension funds and large cap private funds such as Onex and the like, which also led to other government initiatives such as Queens Park’s MARS and Ottawa’s Venture Capital Catalyst Initiative.
What do you think are the most challenging issues facing the private capital markets space today?
These views are personal to me, and are not those of my Firm: Over regulation. Period. Full stop.
People tend to forget that EMDs are critical to the piece, in that they source the necessary “gas in the tank” when it is most needed and most risky. The IIROC dealers tend to get the glory in the media, but by the time an issuer gets to them and they raise funding, the deal is pretty much derisked. EMDs get involved with issuers when the deal is not derisked. They must make correct judgment calls on a whole host of issues: “Is this unproven management team capable?”, “Is this new industry or product something that will flourish in the future?”, to name a few. These are tough things to predict which only come with experience, yet EMDs are called upon to make those types of predictions all the time.
Look at the formation of the cannabis industry in Canada. EMDs were absolute pioneers in funding the space, arranging funding for them when IIROC dealers wouldn’t touch them with a 10-foot pole. Yet who gets the glory through the profile articles in the media once the cannabis companies succeed? Not the unsung heroes, the EMDs. These folks were literal pioneers providing funding for unproven industries which are now flourishing and creating hundreds of thousands of direct and spin-off jobs. The (non-independent) IIROC dealers in the main tend to be gatekeepers with no skin in the game (the independent IIROC dealers are still very entrepreneurial, yet are shrinking in number).
The EMDs put their risk and reputation on the line pretty much each and every deal they do. They literally cannot afford to have losers. And they are being ‘rewarded’ through increasingly complex rules and regulations, which the IIROC dealers can afford to spend hundreds of thousands, if not millions, of dollars in terms of compliance costs, but EMDs cannot.
Do you have any hopes for the industry moving forward?
Yes, that the Ford Government follows through on its promise to cut red-tape, especially so as it relates to the raising of private capital in the Province of Ontario, which ultimately results in the business expansion and the creation of jobs. Let us envisage a situation where the Province of Ontario is a leader in area of rules and regulations that encourage (and not inhibit) the formation of private capital for worthy and growing companies. And to be clear, this does not mean no regulation at all — simply responsible and balanced regulation.
If you had the power to change one thing about the private capital industry, what would you change?
Well, it would not be surprising for you the hear “deregulation” given the above. But I would also say more profile for the unsung heroes in the form of the Angels and EMDs who are not simply gatekeepers but who really have the skin in the game. The “Masters of the Universe” VCs and PE folks get toasted and heralded (mainly by toasting and heralding each other) in the social pages and at industry functions, which are profiled in the media, while Angels and EMDs quietly go about their business taking on the real early-stage risk. This needs to be heralded and rewarded, not snuffed out through senseless over-regulation.