One of the biggest challenges in running a MIC is when you first realize that the investors who were once your private lenders are now expecting the equivalent of their monthly interest cheques however in the form of a dividend. With a mortgage, a private lender is accustomed to receiving a monthly cheque of interest only (usually). The formula is simple, the private lender is expecting the equivalent of the monthly interest rate applied to the principal outstanding on the loan they funded. With a MIC however, there is no direct attribution of the investor’s investment, through the purchase of MIC shares, with any of the investments the MIC makes, such as mortgage loans. Hence your once private lender, now turned investor/subscriber in the MIC, has no way of knowing what they will earn except for the expectations you leave them with.
The challenge as a newly started MIC should mean no such expectations at all. Securities law and regulations require that you provide information only based on actual facts and not on a forward looking basis. For example a MIC can use historic data, however a new MIC would have none. Although the founders of the MIC may have historic performance data based on the many years of private mortgage lending, this has nothing to do with the MIC, for the MIC is newly formed and it now would take every passing year to build this so-called historic data to illustrate performance and investment returns earned over time. Thus there is tremendous pressure for the managers of the MIC to payout dividends substantially the same rates of return their former private lenders earned on the money they invested.
However, the bigger challenge then becomes how to take in enough investor/subscriber money into the MIC so that it can immediately place the money into investments such as mortgages. It takes time for a MIC to building up enough of a book of business including deal flow, a broker and agent network and borrower base to ensure it can always place the monies raised. Because the managers of the MIC are most likely raising monies from the same private lenders it worked with prior to moving into a MIC structure, the moment it takes investment money these subscribers expect to earn a return almost immediately with a payment of some kind to start within a month or so. Logistically it is extremely difficult to balance the intake of money from investors and the immediate placement of it into an interest earning mortgage loan. This is especially difficult at the beginning where the primary motivation to take investment money is to make sure to meet the 20 shareholder and 25% capitalization limitation rules to qualify as a MIC within its first fiscal year.
So what is a MIC to do? First of all, its important that a MIC maintain transparency with its investors, in that its crucial that the managers of the MIC manage their investors’ expectations. Disclosing to the investors that there will be lag time from when they raise enough money to invest in mortgages and paying them a dividend. Explain to the investors that paying dividends at the beginning from the capital raised and not retained earnings is cannibalizing at the ability for the MIC to earn higher returns in the future with less money to invest, doing so would mean in theory returning an investor’s capital in the form of a dividend (remember dividends paid out by a MIC is taxed as interest income in the hands of the investor). Hence a slap in the face to the smart investor where they now have to pay tax at the higher marginal rates when they could have simply asked for their money back tax free. Also under the Business Corporation Act a company should only pay out dividends to its shareholders if it can demonstrate that by doing so it is still meeting all of its obligations and liquidity needs while maintaining solvency. The MIC should launch at the beginning of their first fiscal period in a manner where they have their investors lined up with just enough money to invest in mortgages already vetted so as to allow for returns to be earned immediately all while qualifying as a MIC.
It is also important for MIC managers to remember that a MIC must payout all of its net income in the form of dividends by the end of its fiscal year or within 90 days of its end. That being said, investors should be educated to expect lower more manageable returns throughout the year to balance the MIC’s cash flow needs, and a more aggressive top-up dividend within 90 days of the MIC’s fiscal year end. A healthy and normal dividend cycle for a newly formed MIC should have little to no dividends within the first few months to progressively increasing dividends topping up within 90 days of its first fiscal year end. Following which usually after its first or second fiscal year a MIC’s dividends will stabilize to more consistent and manageable levels thereby shaping your investors expectations thereon.
This article is for information purposes and not intended to provide legal or business advice or any form of opinions. For any questions please contact the lawyers at Levy Zavet.