It was general knowledge that most small firms receive the equity capital they need in their businesses from family and friends, a source of capital that is not recorded anywhere. It is generally referred to as the non-institutional equity market. And if we really want to stimulate small business growth, we want to know more about it. Only then can we design tax measures that will encourage more private investments in small firms.
Our most important research project in 1972-73 at the Canadian Centre for Entrepreneurial Studies was funded by the Canadian Banker’s Institute, the research arm of the Canadian Bankers Association and designed to explore the nature of the non-institutional equity market.
We sent a researcher into three small communities from 5,000 to 50,000 population and over a period of six months, interviewed as many small business owners and professionals as we could. Much of what we learned was not a surprise; that most of the equity in small business came from the owners and the owner’s family and friends.
But the surprise was that in all three communities there were prosperous small business owners that invested in local companies because it was good for their own business and good for their communities. They are often called angel investors and bring management expertise along with their money.
The fun was trying to meet them because they kept themselves well hidden behind their accountants and lawyers. But we did root them out eventually and found them to be key people in the development of their communities and in the creation of jobs.
It was our conclusion at the time that 90 per cent of all the equity that builds small firms comes from this secret corner of the market. Although venture capitalists and government institutions like the BDC get a lot of public profile, during our study of three communities, we could not find one single institutional source of equity financing.
This research was the basis for an all-out effort to change the tax system over the next 20 years at the Canadian Federation of Independent Business to encourage investments in small corporations by individuals. The result was the Allowable Investment Loss Provision, referred to as the ABIL (Invest $50K and at worse lose only $25K) and the tax-free capital gains provision (Invest $50K and any gain over that is tax-free.)
Small firms in Canada at last, had access to sources of equity in small quantities, solving one of the fundamental problems facing small businesses everywhere.
In 2000 using the new tax provisions to encourage investments in small businesses, I raised $2 million from 20 individuals to fund a new e-learning company, Vubiz Ltd.(Virtual University for Business). And because the company was properly funded with equity, not once in the next 15 years did we have to borrow from our bank. The conclusion. The major financial problem facing small firms is not their working relationship with their banks, but being undercapitalized.