RSPs may be the key in helping small businesses in Canada get back on track when the COVID-19 crisis is over.
Funding a small business in Canada, whether from scratch or after the doors were open for business, was a challenge before the international outbreak of COVID-19...and things won’t be getting easier anytime soon. Banks were hesitant to lend to small businesses before and the personal lines of credit that many entrepreneurs relied on in the past may be just that - a thing of the past. While the federal government has done a generally good job of supporting businesses during the crisis, much assistance will be needed when society returns to the new normal.
Simultaneously, many Canadians have seen a large portion of their RSP and/or TFSA holdings reduced in value significantly over the past month. Whether the trigger has been pulled and losses crystalized or not, the long-term effect of the wild swings in the markets will remain for the foreseeable future. That’s the nature of investing in public companies. With liquidity comes volatility.
What do these two things have in common?
Canadians could have used some of that same RSP money to invest in the small businesses in their community. It’s a little-known secret in the business community that the Income Tax Act generally allows for shares in Canadian controlled private companies to be held inside a registered plan (RSP/TFSA/RRIF/etc.). One requirement for private company shares to qualify as an investment for registered plans is that the company has to be engaged in an “active business,” that’s carried out primarily in Canada. The good news is that most businesses, be they a brewery, manufacturer, restaurant, retailer, etc. will meet the active business test.
How does this all work?
The first question an entrepreneur has to ask is what opportunity they want to give to the investor. An actual piece of the underlying business (common equity/shares) or something that closer resembles a debt obligation.
Many entrepreneurs will not want to give up a piece of their underlying business or common equity, especially if it’s an established business that generally has good cash flow.
If you’re not giving up equity, you’re going to take on debt. The problem is that private companies cannot issue, for example, a six per cent bond to someone’s RRSP because debt from private companies is not eligible for registered plans.
Thankfully, there is another way that Canadian private companies can borrow money from registered plans; by issuing preferred shares. The share, for example, could be redeemable by the company (bought back for the original purchase price) at any time after three years with a 90-day notice period. The share could also be retractable after three years (that means the purchaser could demand the money back) upon 90 days’ notice after three years. Normally preferred shares are not entitled to vote and do not fluctuate in value. The preferred share issued by the private company could pay dividends either monthly, quarterly or annually.
But can a private company just go and raise money legally?
Yes! Complex as they may be, Canadian securities’ laws are relatively friendly to the small business community.
Canadian securities laws vary moderately from province to province but generally speaking, you’re able to accept investments into your small business from your friends, relatives, business associates, and employees. In addition, you’re able to accept investments from Canadians that earn more than $200,000 per year or who has investable net assets in excess of $1,000,000.
Before you go talk to prospective investors you need to be prepared. Write out your business plan. Have a balance sheet and income statement for your business (if it’s an existing operating business). Be prepared to tell investors why you want the money and what you’ll use it for. And have a subscription form made out so that they know you are serious. There are of course rules as to what you can and can’t say to prospective investors but legal advice in that area is relatively easy to come by.
Now there’s one more problem. The money you are looking to get from investors is held in existing RRSPs.
If you manage to get 20 RSP investors, the funds designated for your company may currently be held at 10 different banks/financial institutions across Canada. Most of these institutions don’t like private securities and will have significant costs/barriers to entry for the business owner to have their shares held in their accounts. Others will outright refuse to deal with private company securities.
For example, let’s say your first investor has their RRSP with a bank. You get the customer to sign the subscription and the letter of direction authorizing the bank to purchase a preferred share in your company. But the bank is not particularly interested in dealing with private company shares. The first thing they are going to ask for is a letter from an accounting firm stating that the preferred share is an eligible investment for registered plans. So now you, the business owner, have to pay an accountant for the letter which may take some time to get back. Let’s say your next customer deals with another bank. They may not even accept private company shares in their RRSPs. If they do, they will also need an accountant’s letter stating the preferred share is eligible. Now it’s not impossible to go through all this and get your money from the registered plans, but what happens a year later is they want another letter from the accountant stating the shares are still eligible. And who pays for that letter?
From your point of view, you would be much better off to choose one financial institution to deal with and have all your investors who want to make the investment open a new self-directed account for the purpose of investing in your preferred shares. Only a few companies in Canada accept private company shares into RSPs without an abundance of red tape for the business owner.
Olympia Trust Company is the leader in Canada for administering registered plans where the primary investment is a private security. So, if you decide to use Olympia Trust, once your purchaser has opened an Olympia account, they can transfer the amount of cash they want to invest over to their Olympia account.
Olympia Trust is an expert and leader in this field. For more information, visit https://rsp.olympiatrust.com
For inquiries, contact them here: https://rsp.olympiatrust.com/contact.html
About the authors:
Rick Skauge is a seasoned entrepreneur who has raised money for multiple private oil and gas offerings and has a background in insurance and financial planning. He founded Olympia Trust Company nearly 25 years ago and is President/CEO of Olympia Financial Group (TSX: OLY). In addition he owns/operates Apple Creek Golf Course located in Airdrie, Alberta.
A 2019 recipient of Canada’s Top 40 Under 40, Craig Skauge is the President and Chief Executive Officer of Olympia Trust Company. In addition, Craig is a founder and the President of Exempt Edge Inc., a company providing cloud based regulatory compliance solutions for participants in the Private Capital Markets. Craig is a founder, director, and Vice Chair of the Private Capital Market Association of Canada and is a member of the Alberta Securities Commission’s Exempt Market Dealer Advisory Committee.