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Practices and Patterns of Informal Investors

Summary and Conclusions

The work described here provides information with respect to the characteristics, practices, patterns and perspectives of Canadian informal investors. The work draws on empirical data to update profiles of typical individual investors. Breakdowns are presented of:

• investors' personal characteristics (education, experience, financial attributes, and occupation);
• investors' investment patterns including their expectations and investment patterns (investment size, sector, stage, frequency of investments, location of businesses);
• investors' experiences regarding the availability of investment opportunities;

It is found that private equity investors (also known as informal investors or angels) are well educated and report considerable experience as investors. They tend to hold other full time jobs, limiting the time they can devote to their direct investments; however, they account for a considerable amount of investment in new growth-oriented businesses. The 41 investors contacted in the short time frame of this study had made 121 investments involving more than $82 million of direct investments over the last two years. Moreover, these investors hold in excess of $40 million available for further investment in growing SMEs. These investments are usually at the earliest stages of business development, stages where it is often most difficult for growing firms to raise capital from other sources. These private equity investors would argue that a problem lies in the shortage of investment-ready businesses in which the principals are willing to partner with experienced investor-mentors.

The work describes the nature of informal investments and identifies key parameters of the investment process, focussing on investors' investment behaviour. In particular, the work addresses:

• how investors learn about and locate potential investments;
• how investors evaluate potential investments (including the due diligence process);
• investors' exit strategies;
• formal and informal networking and syndication patterns of Canadian informal investors;
• essential factors prompting investors to make an investment;
• investors' experience with the level of preparedness of small and medium-sized enterprises (SMEs) with respect to private investment.

Investors learn about potential opportunities mostly from business associates. Evaluation tends to be conducted informally, although some investors have developed extensive sets of due diligence materials. The key dimensions of investable business opportunities are the market potential of the business and the capability of the principals to commercialize and market the service or product. Investors also seek the opportunity to make a substantive contribution to the success of the firm. Investors ideally exit through sale of their shares to third parties through acquisitions, buy-backs, and, occasionally, IPOs. Investors frequently exit because the business in which they have invested has failed.

The report documents private equity investors' perceptions of the investment climate in Canada and its regions. These include comments about the effects of recent tax changes (the tax-free rollover of, and reduction in, capital gains taxes on small business investments). The work also documents investors' ideas about how equity financing of SMEs might be facilitated. Overall, respondents expressed the view that what is really needed is a generalized reduction of tax rates across the board. In their view, this would have the effect of both helping to attract managerial and technical talent (human capital) to Canadian businesses and increase the availability of financial capital.

Finally, the study took some first steps towards establishing a national panel of informal investors. The idea here is that through such a panel, governments can more readily monitor private investment activity on an ongoing basis and enter into dialogue with the panel with respect to public policy proposals and related matters. Private investors generally viewed this concept positively, with at least two-thirds of the participants signaling a willingness to take part, subject to suitable protection of their anonymity and that the panel would be an authentic and valued source of commentary.

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