The proposed MTI financial plan, in time sequential order, may be summarized as follows:
The costs associated with an LP, especially the legal and accounting costs, can run up to $75,000 regardless of the size of the LP. Hence, the LP fund should be sufficiently large to justify this fixed overhead. An LP in the $500,000 to $1,000,000 range would be appropriate. However, the funds raised by the LP must be expended in accordance with GAAP (Generally Accepted Accounting Principles) prior to the current calendar year-end. Therefore, even if more than $500K could be raised, the LP could likely only spend this amount for reasonable and justifiable marketing related purposes. If successful, MTI would be well positioned to offer MTI LP II in the following year and would be able to raise a larger amount at a lower cost (percentage-wise) since most of the legal structures would already be in place.
Conceptually, the LP serves two purposes: for the investor it combines an investment with a tax deferral and for the company it is essentially a deferred private placement. The LP would appeal to an investor who is both interested in MTI and who is in a position to benefit tax-wise. The LP allows the investor to write-off over 90% of his investment in the current year, giving a high-tax bracket British Columbian approximately half of his investment back within a few months as a tax saving. In the following year, the LP investor is bought-out by the company at a premium. The premium is approximately 25%. This is an arbitrary limit put on the value of the LP. In fact, in order for the buy-out to take place, MTI when it is public would make a takeover bid for the LP. This bid would have to be supported by a business valuation opinion and it is expected that this valuation would be greater than 125% of the original LP investment - hence limiting the return to 25%. The investor would then receive shares in the public company, at share prices prevailing at that time, for 125% of his original investment. Premiums are based on market conditions (i.e. supply of and demand for tax shelters) and generally run in the 25% to 50% range. At the time of the buy-out, the company would experience an equity dilution, but likely at higher market prices (because the company is then reporting high earnings due to the reduced expenses that were incurred by the LP).
The buy-out of the LP, and the timing thereof, is at the sole option of MTI. MTI's Board would exercise this option so as to be most favorable to its shareholders. In the event that the LP is not successful, the Board would not be able to justify a buy-out based on a proper valuation opinion on the LP. One could regard the extra legal and accounting costs associated with the structuring of an LP as a form of "insurance" cost to the public company, i.e. to ensure that any pubco dilution occurs only if the LP is successful and at such a time that pubco's shares are trading at reasonable prices.
In summary then, a successful LP has the same outcome as a private placement except that the investor has enjoyed a tax benefit and the public company has deferred and decreased an equity dilution.
The process can be summarized as follows:
a)MTI sets up the LP (i.e. lawyers obtain the tax shelter number and structure the legal entity)
b)MTI solicits interest using a preliminary "Term Sheet"
c)MTI recruits a GP to manage the LP
d)MTI sells the LP to investors using an Offering Memorandum
e)the LP spends the funds on behalf of MTI for marketing purposes before 1995 year end
f)in the following year, MTI makes a take-over bid for the LP
g)LP investors receive shares (they get 125% of their investment in shares at market price)
h)LP is wound up (i.e. dissolved)
A "Term Sheet" (investment summary and highlights) which is used to sell the LP to prospective investors can also be used to solicit expressions of interest before any significant sums are expended on the legal set-up and offering memorandum costs. The terms are set out such that the company will offer to buy-out the LP investors in the following year based on the unit value as determined by an independent valuator. The LP's revenue sharing agreement is set forth in such a way that the valuation will produce a value greater than the pre-defined buy- out limit of 125% of the original LP investment. This serves the purpose of reducing the risk to investors.
A formal "Offering Memorandum" must be prepared before LP units can be sold to investors. Securities regulations require that a formal document known as an Offering Memorandum be prepared in order to fully inform potential investors about the LP and the opportunity. An Offering Memorandum is not required if the LP offers its units only to insiders of MTI or to "sophisticated" investors. The latter would save considerable legal expense. The Offering Memorandum approach is being suggested herein, with the understanding that one of the Offering Memorandum could be abandoned by relying on one of the securities exemptions in the event that sophisticated investors are identified.
Use of proceeds of a $500,000 LP (based on the Offering Memorandum approach):
Overhead Costs: Legal Set-Up costs $20,000 to $25,000 Accounting Fees 5,000 to 10,000 GP Fees (6 months) 15,000 to 30,000 (over 6 months) Printing, mailing,etc 2,000 to 5,000 Legal Take-Over Bid 10,000 to 15,000 Valuation Opinion 15,000 to 20,000 Total Overhead Costs: $67,000 to $95,000 Broker's Commission:(10%) $30,000 Marketing Program: Trade Shows $125,000 *Marketing Fees/Wages 100,000 US Marketing plan 150,000 Advertising, brochures 25,000 Marketing Expenses: 200,000 TOTAL: $500,000(approximately)(*MTI could charge marketing fees for services to the LP which MTI would take into general revenues, effectively increasing MTI's working capital by the amount taken in.)
Whereas an LP is attractive to investors and the company for the affore-mentioned reasons, it should also be noted that, in the fiscal period during which the LP funds are expended, the company enjoys an abnormally high profit because its expenses have been substantially reduced. The higher earnings should yield a higher share price. However, it must also be noted that in the period when the LP is bought out by the company, the company will have an asset on its books (valued at 125% of the original LP investment) which it will have to write off in one to five years. This is often referred to as the "hang-over" effect. This write-off will be mitigated by the increased sales and profits arising from the LP investment.
The B.C. Government makes an annual allocation to this program early each calendar year. Investments are typically approved in the January/February period until the provincial allocation is used up. Therefore, a VCC investment in MTI should be planned almost immediately.
The VCC program guidelines are summarized as follows:
The VCC money can be raised throughout the calendar year. Hence, some form of staging couId be permitted, e.g. use a minimum-maximum range. If the VCC sells well early in the year, a minimum sum could be raised immediately and the VCC it could be kept open with additional funds to be raised later in the year. If successful, this form of financing could preclude some of the other vehicles. However, due to the competitive nature of the VCC program, the registration application should be prepared and submitted to the BC Government as early as possible.
One might question if it is possible to obtain direct investment into MTI if MTI remains as a private firm, i.e. with no immediate intention of becoming a publicly traded company. In this example, we will assume that such financing took place at the earlier, start-up stages in the life of MTI by angels and well-heeled technology financiers.
In general, investments made into privately-held firms are done at valuations far lower than those for comparable public companies. Also, for any investor to make a private, minority investment into MTI, that investor would basically be backing the MTI team and become a part of that team. Usually the management team consists of the founding shareholders which is a main criterion for an investor.
Private placements are very straightforward and rely on regulatory exemptions from having to prepare complete disclosure documents such as a Prospectus or Offering Memorandum. This is one of the main advantages to being a public company - the ability to raise new capital efficiently through private placements. The cost of doing a private placement is minimal, consisting mainly of legal and filing fees. A private placement in the range of $500,000 can be completed for less than $10,000 in costs. However, if the placement is made by an underwriter, a commission of at least 10% would be charged by said underwriter. Additionally, the underwriter may request broker's warrants as an additional bonus. Private placements generally consist of units in which a unit is equivalent to a common share plus one common share purchase warrant (or some fraction or multiple of a share purchase warrant).
After a company is listed and is trading publicly, the only way in which it may sell its securities (issue new shares), by law, is through an Exchange Offering Prospectus or through a private placement relying on one of the Securities Act's exemptions from having to issue a prospectus. The Exchange Offering Prospectus (EOP) has recently replaced the "Statement of Material Facts (SMF)" form of offering which was popular on the VSE. EOPs (formerly SMF's) must be used when a listed company wishes to distribute new securities to the general public.
A reverse take-over involves the use of an existing publicly traded company which is inactive, i.e. a "shell". Reverse takeovers have been popular because they can be used to take a company public without having to simultaneously sell shares to the public. A good example of a company that went public in this manner is Magna International. This method is also popular because it can be done more quickly. Reverse takeovers fall under the jurisdiction of the VSE, whereas IPOs require both VSE and BC Securities Commission approvals. Reverse take-over disclosure requirements are similar to those of an IPO. Legal and other expenses would run in the $75,000 to $125,000 range. An additional cost consists of the actual price paid to the current majority owners of the shell. Clean VSE shells cost between $125,000 and $150,000 to purchase a large control block of shares around 75%. However, the purchase price is offset by the fact that a shell usually has some net assets in it - cash, properties, shares etc. Then, there is also the "cost", or dilution associated with the other 25%. Once a take-over has been completed, this 25% is reduced to less than 10% by way of dilution of the public shareholders of the shell.
It appears that, regardless of the route chosen to become public, the total costs, excluding any financing commissions, are all in the $100,000 to $200,000 range. It is not possible to directly compare these approaches since there are so many unique factors and considerations pertaining to each case (e.g. how "clean" is the shell? what roadblocks might the regulators impose?).
To become public on the VSE, a company must meet the following listing criteria:
Hopefully, this real-life example has illustrated some ways for a company to raise money. Some of these ways are simple and straightforward. Others are more esoteric and complex. Such is Life!
Copyright 1996, All Rights Reserved, M.C.Volker.