Capital Pool Companies (on CDNX)Contact: Mike Volker, Tel:(604)644-1926 Fax:(604)925-5006 email@example.com
As part of the creation of the Canadian Venture Exchange (CDNX), the VCP program merged with Alberta's counterpart - the Junior Capital Pool (JCP) - to produce the Capital Pool Corporation (CPC). In the almost two years since VCPs were introduced, more than 100 VCP/CPC companies have been created.
I've been a big fan of these. Why? because they:
A CPC is a public company which has been established for the sole purpose of acquiring an active business enterprise. It allows a group of individuals to create a vehicle - i.e. an "empty" public company with no assets other than a little cash and an eager board of directors - which they can then use to finance and build an emerging venture. Unlike a dormant "shell" company, a CPC brings with it a wealth of experience through its directors. A CPC's sole purpose in life is to acquire a business and then trade as a normal venture company on the CDNX.
In the CDNX's own words, "The Exchange’s program was designed as a corporate finance vehicle to provide businesses with an opportunity to obtain financing earlier in their development than might be possible with a regular initial public offering (“IPO”).The CPC program permits an IPO to be conducted and an Exchange listing to be achieved by a newly created company which, other than cash, has no assets and has no business or operations.The CPC then uses this pool of funds to identify and evaluate assets or businesses which, when acquired, qualify the CPC for listing as a regular Tier 1 or Tier 2 Issuer on the Exchange (a “Qualifying Transaction”)."
A common misconception about CPCs, is that they are indeed a "capital pool" or a type of venture capital fund. As stated above by the Exchange, the pool of funds is used to find a target company - not invest in the company. In fact, the absolute maximum cash limit that can be raised is limited to $700,000. Very few CPCs raise the maximum.
The working capital needs of the active technology venture which will be acquired by the CPC will be met by having the principals of the CPC and/or the underwriting sponsor raise the capital via private placement or public offerings coincident with the completion of the acquisition.
In essence the process is very similar to that of an RTO, i.e. Reverse Take Over, because the principals of the CPC no longer control the merged entity. In fact, the principals of the target company end up in control. For example, a CPC with 3 million shares outstanding can acquire an active technology enterprise by issuing 7 million new treasury shares to the owners of the target company. Now, the CPC founders and all the public shareholders will own 30% of the company while the new shareholders (the former target company owners) will hold 70%.
The way this works is simple. Here's an example: The CPC team finds an exciting young company, call it BlueCo, in the internet telecoms sector. BlueCo has some unique IP (intellectual property - not internet protocol although it uses that, too) with patents, a dozen solid engineers, a good business plan and some enthusiastic prospective customers. The CPC folks and the BlueCo folks negotiate hard and finally agree that BlueCo is worth $7 million dollars. CPC shares happen to be trading around $1 per share. Hence, the CPC issues 7 million treasury shares to buy BlueCo. At the same time, the CPC team with its sponsor agrees to raise another $2 million at $1/share via private placements. New investors are more readily attracted at this stage because they are investing in a stronger company.
A couple of important points to note: the resulting merged company must still meet the minimum listing standards required by the CDNX, i.e. you can't acquire a flaky company with no substance. Also, the "majority of the minority", i.e. the arms-length public shareholders, must approve the acquisition of the target company. And there are guidelines as to what constitutes a "qualifying transaction" (e.g. CPC must issue at least 25% new shares, i.e. acquire significant assets).
How does a CPC get started in the first instance? A group of individuals, for example a small group of high tech business angels, decide to incorporate a CPC. Their first step is to find a sponsor - a stock broker who will sponsor them on the CDNX Exchange by agreeing to handle an IPO (Initial Public Offering). The founding group must invest a minimum of $100,000 (total) in "seed" capital in the company at a price of at least $0.075 per share. They then hire an accountant to produce a nice, fresh audited balance sheet (which shows the seed capital amount and the number of shares issued). They also sign up a transfer agent (all pubcos use a transfer agent to keep track of who owns shares). Finally, a corporate securities lawyer is engaged to prepare a prospectus document. This document is mainly "boiler plate" other than information about the CPC team members - who they are what they've done, etc. The document must state that: a) the CPC does not have business operations or assets other than cash; b) the CPC has not entered into an agreement in principle with any company; and c) the offering is suitable only for those investors who are willing to rely solely on the management of the CPC and who can afford to lose all of their investment. The prospectus also states how many shares are being offered to the public and the price per share.
Getting all this done takes little time and money. Total legal and accounting costs should not be much more than $10K. The prospectus is then filed with the CDNX for approval. Following what are usually minor revisions, the broker then gets a green light to sell shares in the CPC to the general public. Regarding approvals, what the CDNX looks for is the quality and expertise of the CPC's founders. They want to make sure that these people have some understanding of the public markets, will apply good corporate governance practices, and most importantly do not have tarnished reputations (no room for scam artists, here!).
Brokers' clients just love to buy shares like this on the IPO. This is because the maximum price that shares can be offered at is $0.30. And, there are usually only slightly more than 1 million shares offered, which is the minimum number of shares than can be offered to a minimum of 300 shareholders. Because of this, the price nearly always (I've seen no exceptions, yet) doubles or triples as soon as the stock starts to trade in the market.
Upon completion of the IPO, the CPC will typically have somewhere between $300K and $700K in the bank which it will then use to identify potential acquisitions, like BlueCo above.
In principal, CPCs should not have pre-determined deals in mind. Although Albertans have allowed JPCs (under the old Alberta Stock Exchange rules) to be formed by individuals as an alternative way of taking a company public (rather than doing an IPO directly for the target company), British Columbia has frowned on this practice.
To recap, the following table summarizes some of the basic features of a CPC:
|Seed Share Price:||$0.075 to $0.15 per share|
|Min. Seed Capital:||$100,000|
|IPO Share Price:||$.15 to $.30
(2X Seed Price max)
|Min. # Shareholders:||300|
|Min. # IPO shares:||1,000,000|
|Max. post-IPO capital:||$700,000|
|Founders shares:||1,000,000 to 2,000,000|
|Public float:||1,000,000 to 2,000,000|
|Total shares after IPO:||2,000,000 to 4,000,000|
One little quirk about our strange system of securities regulation in Canada is that presently, IPOs for CPCs can only be offered to B.C. and/or Alberta residents (aren't you glad you're a westerner?). Of course, once they start to trade, anyone anywhere can buy/sell.
When I lived in Ontario, I started two JCPs in Alberta. I had to have at least one Albertan on the board of each JCP. But when the IPO was done, only Albertans good buy it. None of my Ontario pals could. This is still the case today and typically when a CPC goes public its shares are offered in either Alberta or B.C. Ontarians -eat you hearts out. Soon, though, the CDNX will get the Ontario Securities Commission to go along with the program. If only we had a national, unified securities commission!!
In my opinion, there are some compelling reasons why CPCs 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 CPC. The CPC 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 CPC 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 CPC 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.
The process of finding a suitable acquisition candidate can take several months. The CDNX has put a time limit of 18 months on this process to ensure that the CPC directors are proactive. When a candidate acquisition has been identified a tentative deal, referred to as a "Qualifying Transaction", is negotiated and this is then submitted to the Exchange for approval.
To make sure that a CPC's insiders aren't in this for a quick flip, the founders have to escrow their shares for 3 years! (shares get released in 6 month intervals). And, the counting on the escrow releases doesn't even start until after the Qualifying Transaction has been completed.
It is worth mentioning that CPCs are reviewed and approved by the Exchange (not the B.C. or Alberta Securities Commissions as in the past) which has set strict performance standards for itself (e.g. getting CPC prospectuses approved within 25 days).
One problem with CPCs for investors 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.
Why would anyone invest in a company if it can't tell you what business its going to get into? The answer 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.
I've been keeping an eye on CPC activity on the CDNX (as well as VCPs before that) and in the following section you'll find a regularly updated table listing all CPCs. 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.
When you look at the chart you may wonder why there are so many (more than 100) CPC's in the works and relatively few consummated deals. Only 10 CPCs have made the transition. I can give you some insights into this. Firstly, I have found that CPC boards take their role seriously. They are less likely to do a quick and sloppy deal. They have to live with it and make it work. They get no fast pay cheques and capital gains. I'm presently involved in two CPCs and I've invested in several others and I can tell you that the task of finding just the right takeover target can be a very onerous job. Like a marriage, there's got to be a good fit. The parties have to be able to work together and most important of all, everyone has to believe that the business opportunity is real.
One of the most challenging an interesting aspects of the CPC process is that of determining the relative values of the CPC and its target company. What's a fair price to put on the target? How many shares of the CPC should be issued to the target's owners? In the case of the CPC, the valuation is straightforward: the market dictates. If you've got 3 million shares trading at $.50, your value is $1.5 million. But, because the target company is private, the value has to be negotiated.
Those who are familiar with RTOs will often be of the opinion that CPCs are overvalued. As per the above example, why should a company with only $500K in the bank, with no active business, be worth a few million dollars? Like a dot-com which is selling a future hope, the CPC is selling itself as a vehicle which has the potential of contributing substantially (expertise, contacts, mentoring, credibility, access to capital, etc) to the growth and development of the target company.
Finally, please note that there are many details which I have not mentioned here. And the rules do tend to change and get updated. For a thorough description of this program and to get a copy of the policy please go to the CDNX website at www.cdnx.ca and look up Policy 2.4: Capital Pool Companies. Have fun!
Check my Capital Pool Company chart for a complete updated list of the CDNX's CPC and VCP companies. (Thanks to David Ing of Pacific International Securities for providing updates)
Mike Volker is the Director of the University/Industry Liaison Office at Simon Fraser University, past-Chairman of the Vancouver Enterprise Forum, and a technology entrepreneur.