T-Net Investor Section Column #11     29Mar99

Tech Futures by Michael Volker

VCP Companies Offer Excellent "Ground Floor" Opportunities

Last year, the Vancouver Stock Exchange (VSE) paved the way to allow for the listing and trading of Venture Capital Pool (VCP) companies in B.C. This is a special category of public company investing which is available only to residents of British Columbia. They are particularly good for high tech companies and I suspect that many tech firms will use these as a means for raising their early stage capital.

These VCPs have been so popular that the average appreciation on the first wave of listings has indeed been 272%.  Furthermore, when companies make their first acquisition such as FVC First Venture Capital Corp did in its takeover of Lasik Vision, the returns can be over 1500%. FVC was the first VCP to hit the market. Its IPO was done last August at 20 cents and the stock has been trading in the $3.00 range.

So what is a VCP and how does it work? Back in the late 80's, the Alberta Stock Exchange (ASE) introduced its Junior Capital Pool (JCP) program. These were affectionately called "blind pools" or "nickel deals" because companies would raise funds by selling shares to the public at very low prices - yes, as low as 5 cents - without having any specific business plan in mind. These companies would then be used as clean "shells" into which real, active private operating companies could be vended in a typical reverse takeover type of transaction. In fact, the sole purpose of a JCP was to seek out and acquire an interesting business with real potential.

The JCP program was very popular in Alberta and each year about 100 new companies began life in this manner, each providing healthy returns to both the initial and subsequent investors investors while contributing to the growth of the ASE.

Because the trading of securities in Canada is regulated provincially, JCP shares could only be sold to Albertans (although Ontarians and others could start JCPs provided they had at least one Albertan director on board). But they worked and many were used by junior industrial and technology companies as a means to grow.

Such a program could easily have been offered by the VSE but it had to first convince the B.C. Securities Commission, the regulatory watchdog. In view of the bad press the VSE was getting in the mid-90's and the resulting Matkin Commission report on the operation of the VSE, the Commission only recently became convinced - thanks to internal changes and new controls -  that the VSE was ready to launch is own version of the JCP offering. The VSE announced that, as of June 1, 1998, it was ready to accept IPO filings for its own brand of JCP - the Venture Capital Pool (VCP).

In concept, a VCP is identical to a JCP. The main difference is that VCPs can be offered only to B.C. residents (sorry - Manitobans and Quebecers!) although, as in the case of JCPs, a VCP can be started by a resident of any province. (When I lived in Ontario, I started two JCPs in Alberta.) VCPs can also raise slightly more capital (up to $700,000 max initially) on the IPO and most importantly - VCPs must not, under any circumstances, have a takeover deal ready in their back pockets. Although Alberta started off this way, it was widely known that JCPs were set up by financiers and investors who already had specific takeover targets lined up but found the JCP route to public life to be more convenient than the IPO way. The B.C. Commission insists that, if this is the case, the target company should go public via the traditional IPO route.

This being the case why, then, bother with a VCP? That is, why doesn't the company being taken over simply do its own public offering? Furthermore, how can a VCP with so little cash take over a real company?
 
In my opinion, there are some compelling reasons why VCPs are useful. Companies seeking to do an IPO on a junior exchange need to have a sponsoring broker. This broker, like a venture capitalist, is supposed to do the due diligence on the company on behalf of the investing public. This takes time and knowledge. Before even approaching a broker, companies must have raised a certain amount of seed capital, have a good management team in place and have an exciting opportunity. But, even for companies that satisfy these requirements, the overhead cost and time taken to do an IPO is still somewhat intimidating. Junior IPOs are not attractive to brokers. A broker can make more money by trading and doing financings for already-listed companies than by investing tons of time and effort in an IPO. Enter the VCP. The VCP is already a trading entity. As such, it has some cash on hand, the potential to raise more cash, and a board of directors that knows something about public markets, finance, and building successful companies. By putting a VCP together with a technology company, even if it doesn't meet all the IPO criteria on its own, presto - you've got the makings of a better deal. The VCP directors effectively off-load the brokers by doing the legwork and putting their own reputations on the line to ensure that good deals get done.

VCP founders are generally folks who have a track record in raising capital, are willing to risk some of their own funds, understand business and public markets. By forming a VCP, they create a vehicle for themselves to use for purposes of acquiring an active emerging company.  The money that a VCP raises from the public in its IPO is not intended to be used as the main investment capital for the target firm. Sound strange? This initial capital is used to find a suitable target and to cover the expenses associated with acquiring it. Some of this capital could be made available to the target but usually more capital will be raised after the target has been identified. When a VCP's directors take over a company they do so by issuing shares in the VCP to the owners of the target firm. This amounts to a reverse takeover giving the new owners the majority control while retaining the interest and assistance of the VCP's founders. New investors are more readily attracted at this stage because they are investing in a stronger company.

The process of finding a suitable acquisition candidate can take several months. The VSE has put a time limit of 18 months on this process to ensure that the VCP directors are proactive. When a candidate has been identified, a tentative deal, referred to as a "Qualifying Transaction" is negotiated and this is then submitted to the VSE for approval. At this juncture, a full disclosure document is prepared for approval by the VCP's shareholders. It is important to note that final approval is required by a "majority of the minority" shareholders. This means that the VCPs founders do not vote on the deal. Instead, the public investors vote on the deal to ensure some degree of objectivity.

To make sure that a VCP's insiders aren't in this for a quick flip, the founders (those who put the VCP together and got a bunch of relatively cheap stock, i.e. at half the public's price - but not pennies!) have to escrow their shares for 3 years! And, the counting on the escrow releases doesn't even start until after the Qualifying Transaction has been completed.

Will VCPs disappear as a result of the restructuring which is taking place in the Canadian stock markets? The proposed amalgamation of Canada's junior stock exchanges will likely be a plus for VCPs in that Alberta's JCP and B.C.'s VCP policies will become unified and increase in popularity.

It is worth mentioning that VCPs are reviewed and approved by the VSE (not the B.C. Securities Commission) which has set strict performance standards for itself (e.g. getting VCP prospectuses approved within 25 days). 

The only problem with VCPs is that it is difficult to get stock on the initial public offering (IPO). This is because the stock has to be widely distributed to at least 300 shareholders and the number of shares being offered is small, i.e. in the one to two million range. This means that a purchaser can only buy, on average, a few thousand shares. However, when the stock begins to trade, buyers of the IPO can buy more shares on the open market. Demand has been high.

So, how do you know which VCP to invest in if it can't tell you what business its going to get into? The best bet is to look at the board of directors. This will give you some hints. As for getting in at the IPO stage, the best bet is to call your broker(s). This is one case where you really do need a broker - internet trading won't help you here. You're going to have to cozy up to a real live person and get them to notify you when they have an IPO in the pipeline. For those of you who have used full service brokerage firms and have avoided the discounters, here's your chance to call them up and get some preferential treatment for the loyalty you've shown over the years.

On T-Net we'll be keeping an eye on those VCPs that are technology oriented. I believe that VCPs will help a great number of tech firms by offering them this financing alternative.

According to the VCP rules, and as can be seen in the table which follows, the IPO price has to be between $.15 and $.30 per share and the insider "seed" shares have to be priced at $.10 or greater. The maximum that can be raised is $700,000, including both seed and IPO rounds.

The following table (I hope your browser can handle it) summarizes all but the most recently filed VCPs for you. Note that a number of these have pending IPOs. To get a copy of the prospectus document for any of these ventures, just look up the company on the Canadian securities administrators' information repository - SEDAR - at http://www.sedar.com. This table will be updated periodically.
 

VCP Company Summary List - Courtesy Pacific International Securities Inc. (E.&O.E.)

Copyright, 1999.