Not all businesses or investment funds are created equal. Often, one must dig well beyond the surface of a business or offering to separate the good from the bad. Proper due diligence programs are not one size fits all and often require significant experience and professional judgement throughout the process. Summarized below are the “Coles Notes” of effective due diligence that exempt market dealers (EMDs) should follow when listing a private issuer on their shelf.
Financial Due Diligence
While not as in-depth as a formal quality of earnings review, the level of financial due diligence should be sufficient to determine the financial well-being of a private issuer. EMDs should review a prospective issuer’s financial statements and filings, business model and, on certain occasions, high-level tax review. EMDs should seek to obtain and understand audited annual financial statements, financial models, forecasts, assumptions, and any other financial information included within an offering document. Beyond the financial information, reviewing and assessing the economic data supporting the overall investment thesis is important to ensure that the prospective investment is viable and that the overall capital raise is sufficient.
Legal Due Diligence
Legal due diligence covers a broad spectrum from review of offering documents and partnership agreements to critical background searches on the issuer and their management team. It is important to ask for any communications (written or verbal) issuers have had with their principal regulator or with any Canadian Securities Administrators member and whether any side letters have been entered into with any party who has superior rights or preferences than those presented in an offering. An EMD should be completing bankruptcy searches, bank act searches, business and corporate name searches, litigation searches, certificates of good standing and personal property security searches. These are all completed to make sure prospective issuers are in good standing.
Good governance can be a single differentiator between the good and the bad. EMDs should review the ability of investors to remove a director, the trustees, general partner, administrator, manager, or other issuer group entities involved in an offering, more specifically, in the event of a failed offering. It includes whether investors have such rights and for which entities, meeting quorum requirements, investor voting threshold requirements and related matters. Further, EMDs must review an issuer’s governance to determine if a conflict-of-interest policy is in place and standing orders are being followed. Conflicts of interest are often a major cause, partly, of failed offerings. Further, the composition of an issuer’s Board of Directors should be reviewed and scrutinized, especially when considering the independence of directors.
People are the heartbeat of a private issuer. Transparency, responsiveness, and honesty are core characteristics that exemplify standout issuers. EMDs should be evaluating the general partners or management teams to understand their experience within their investment mandate, how are they being compensated, have they invested their own money creating alignment with prospective shareholders, the length of their tenure and whether they have executed similar strategies in the past.
Pinnacle Wealth Brokers Advantage
It takes experts with deep knowledge of investment products, private issuers, and the risks that go along with both, to conduct due diligence properly. We at Pinnacle have been handling complex and thorough due diligence processes for almost two decades and have specialists who understand how to evaluate prospective investments. As due diligence occurs at a point in time, we aim to critically assess the impact of major macro events such as inflation, rising interest rates, COVID-19 and the 2008 credit crisis, all with the goal of keeping our representatives informed when helping clients achieve their desired portfolios.