A Guide to Raising Capital for Small Businesses in Canada Through Preferred Shares
By Gabriela Guauta, Connect4Commerce Guest Columnist
For numerous small business owners, securing capital is an essential component of fostering growth. Traditional approaches for raising capital often involve obtaining debt or giving away equity in the company. Typical business loans require that the company has the appropriate debt to equity ratio for the debt financing needed. This may lead companies to seek investments from family, friends, or angel investors which may involve giving up some control in the company. This is because they typically raise more equity by issuing additional common shares in the company which have voting rights. However, many entrepreneurs in Canada may be unaware of the alternative and typically less common strategy of issuing preferred shares to achieve their funding objectives.
This article delves into the concept of issuing preferred shares vs. common shares in Canada. The article outlines the advantages of preferred shares, and the steps small businesses can follow to raise capital through this avenue. By the conclusion, readers will gain a deeper comprehension of the significance of raising capital for small businesses and how preferred shares can play a pivotal role in promoting accelerated growth.
What are Preferred Shares?
There are several notable advantages to issuing preferred shares vs. common shares for small businesses:
- No voting rights: Preferred shares typically do not grant voting rights to shareholders, which allows the original owners to retain control over the company’s strategic direction and decision-making process. This can be particularly important for small business owners who wish to maintain their vision and management style without external interference.
- Fixed dividend payments: Unlike common shares, which often pay variable dividends based on company performance, preferred shares provide regular, fixed dividend payments. This creates a stable and predictable income stream for investors, making preferred shares an appealing investment option for those seeking consistent returns.
- Priority in receiving dividends and in the event of liquidation: Preferred shareholders enjoy a higher priority than common shareholders when it comes to receiving dividends and payouts during times of financial hardship. In the event of a company’s liquidation, preferred shareholders are compensated before common shareholders, offering an additional layer of security for their investments.
- Flexibility in structuring the terms of the preferred shares: One of the key benefits of preferred shares is the ability for businesses to tailor the terms of their offerings. Companies can customize features such as dividend rates, redemption terms, and conversion options to attract a specific investor demographic or to meet their unique financial needs.
- Preferred shares do not dilute ownership: When issuing preferred shares, existing shareholders’ control over the company is not diluted, as opposed to issuing common shares. This allows the original owners to maintain their ownership stake while still raising capital, which can be an attractive proposition for small business owners.
- Lower debt-to-equity ratio: Issuing preferred shares can contribute to a lower debt-to-equity ratio compared to issuing debt bonds. A lower debt-to-equity ratio is often considered a sign of financial stability and can make a company more appealing to investors and lenders. By opting for preferred shares, small businesses can potentially improve their financial standing and access to capital.
Considerations and Risks of Issuing Preferred Stock
- Increased financial obligations: When a company issues preferred stock, it commits to making regular dividend payments to its preferred shareholders. This added financial responsibility can put a strain on a company’s cash flow, especially during economic downturns or when facing unexpected expenses. Businesses should carefully evaluate their ability to fulfill these obligations before issuing preferred stock.
- Limited market for preferred shares: The market for preferred shares is generally smaller than that for common shares or other types of securities. This can make it more difficult for small businesses to find interested investors, potentially limiting the effectiveness of preferred shares as a capital-raising strategy. Companies should consider the potential challenges of attracting investors to their preferred stock offerings and develop a solid marketing plan to overcome these obstacles.
- Canadian investors are more familiar with common shares vs. preferred shares; therefore, there can be more difficulty in attracting investors unfamiliar with preferred shares. However, with additional investor education about preferred shares, which share characteristics of both stocks and bonds, potential investors may become more comfortable with preferred shares. Thus, small businesses looking to issue preferred shares may need to spend additional time and resources educating potential investors about the structure and benefits of these securities. Moreover, as many small businesses are not publicly traded, it can be challenging to find investors willing to buy preferred shares in a private company in Canada. Companies should be prepared to engage in extensive networking and marketing efforts to reach a broader audience of potential investors.
- Demonstrating a history of consistent dividend payments: Investors considering purchasing preferred shares will likely want to see a history of consistent dividend payments from the issuing company. This demonstrates the company’s ability to generate steady earnings and fulfill its dividend obligations. Businesses with cyclical or fluctuating earnings, such as those in the oil or real estate sectors, may find it more challenging to attract investors to their preferred share offerings. To address this concern, companies should work to establish a track record of predictable earnings and consistent dividend payments, which can help build investor confidence in their preferred share offerings.
Case Study: Small Business Successfully Raising Capital through Preferred Shares
To better understand how issuing preferred shares in Canada can help raise capital, let’s examine the case of HealthMax Physiotherapy – Scarborough, a small rehabilitation clinic based in Scarborough, Ontario Canada. The clinic offers a range of services, including physiotherapy, chiropractic, and massage therapy. Once established, rehabilitation businesses tend to generate predictable revenue streams and are often considered recession-proof. This made HealthMax an ideal candidate for raising capital through the issuance of preferred shares.
The founders of HealthMax sought to expand their practice but were hesitant to take on debt because the banks required a personal guarantee. To navigate this challenge, they enlisted the help of Roberts & Obradovic Law, a business law firm located in Toronto, Canada. The law firm facilitated a business restructuring and assisted in finding investors for the preferred shares.
Through the successful issuance of preferred shares, HealthMax raised the necessary capital to fuel its growth. The company meticulously determined the terms of their preferred share offering to ensure it met both their needs and the needs of potential investors. As a result, HealthMax Physiotherapy Scarborough experienced significant growth and expansion, demonstrating the potential of preferred shares as a capital-raising strategy.
It is important for small businesses considering this approach to consult with a business lawyer before issuing preferred shares. This will help ensure compliance with relevant regulations and legal requirements, mitigating potential risks and complications.
Final Thoughts
In conclusion, issuing preferred shares vs. common shares can be a viable alternative for small businesses in Canada seeking to raise capital without relinquishing control or taking on excessive debt. Preferred shares offer a range of benefits, including fixed dividends, priority in payouts, and flexibility in structuring terms. However, businesses should be mindful of the associated risks, such as increased financial obligations, limited market size, and the need to educate potential investors. By carefully weighing these factors and consulting with a business lawyer, Canadian small business owners can determine if preferred shares are the right capital-raising strategy for their unique needs and goals, fostering growth and long-term success.
About the Author:
Gabriela Guauta is part of Roberts & Obradovic Law Firm, a law firm focused on providing prompt expert legal advice and representation on various corporate, privacy, employment, and litigation matters for businesses and individuals. For more information about the services offered at Roberts & Obradovic Law, visit their website at https://robertsobradovic.com
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