Mark talked some time ago about taking companies public and detailed some of the bottom feeders that operate in this space. If you haven’t read the post it may both enlighten, and scare you.
It’s why we always say – management, management, management…
Earlier this week when discussing a company’s growing pains, I mentioned that we have found investing in the private equity space to be “easily the most high octane, lucrative area we’ve ever been involved in.”
This is absolutely true, and today I thought I’d discuss one very popular method of taking a company public on the Canadian TSX Venture Exchange.
Canada’s Capital Pool Company (CPC) Structure
First let me say this: The CPC structure itself is fantastic, but remember it safeguards investors from fraud, ethically bankrupt individuals and Vancouver’s serially “helpful” brokers (apologies to OUR broker buddies, who we know are part of the good guys!), in much the same way the SEC safeguards investors from the likes of Bernie Madoff and John Corzine!
In other words, just because it’s a decent structure, it does not mean you can’t or won’t lose money getting involved in one.
The following information comes directly from the TSX website:
Phase 1 – The Capital Pool Company
Creating the CPC:
- Three to six individuals with an appropriate combination of business and public company experience put up a minimum of the greater of $100,000 and 5% of total funds raised.
- These founders incorporate a shell company – the Capital Pool Company (CPC) – and issue shares in exchange for seed capital at a minimum price between the greater of $0.05 and 50% of the price at which subsequent shares are to be sold via prospectus. (Chris note: Think about that for a second)
- The CPC and its advisors prepare a prospectus that outlines management’s intention to raise between $200,000 and $4,750,000 by selling CPC shares at typically twice the issuance price of the seed shares, and to use the proceeds to identify and evaluate potential acquisitions.
Selling the shares:
- The CPC files the prospectus with the appropriate securities commission(s), and applies for listing on TSX Venture Exchange.
- The broker sells the CPC shares, pursuant to the prospectus, to at least 200 arm’s length shareholders, each of whom buys at least 1,000 shares. No one purchaser can purchase more than 2% of the offering, and no one purchaser together with his, her, or its associates or affiliates can purchase more than 4% of the offering.
- Once the distribution has been completed and closed, the CPC is listed for trading on TSX Venture Exchange. The symbol includes a .P to identify the company as a CPC.
Phase 2 – The Qualifying Transaction
Announcing the acquisition:
- Within 24 months, the CPC identifies an appropriate business as its “qualifying transaction” (QT) and issues a news release to announce that it has entered an agreement in principle to acquire the business.
- The CPC prepares a draft filing statement or information circular providing prospectus-level disclosure on the business that is to be acquired.
- TSX Venture reviews the disclosure document and evaluates the business to ensure it meets minimum listing requirements.
Closing the deal:
- As shareholder approval is typically not required, the filing statement is posted on SEDAR for at least seven business days, after which the qualifying transaction closes and the business is acquired.
- Additional components of the deal often include the following: name change and private placement coinciding with the closing of the qualifying transaction.
- The .P from the ticker symbol is removed and the company now trades as a regular TSX Venture listed company.
Poof, new publicly-traded company!
By the way, what typically happens is that the acquisition of the business (QT) takes place through a Reverse Takeover (RTO), whereby instead of paying cash for the asset, the CPC issues new shares to the owners of the company/asset.
Now I’ll tell you why this marriage can work.
For the founders of the CPC they get to issue themselves stupidly-cheap stock. Sure it’s only a shell, but worst-case this shell can be a saleable asset, attractive to a business which is in search of raising capital and a public listing.
Engaging in an RTO with a CPC is often a means of obtaining a public listing, liquidity, and access to the capital markets at a level not available to private companies.
For a largely unknown target company, an IPO can be a very costly and difficult option for obtaining these advantages. On the other hand, a CPC “shell” with well-known founders provides the perception (sometimes valid, sometimes not) of being less risky than a stand alone IPO.
As you can imagine, there are founders who have made crazy money by forming CPC’s and building a good track record of acquiring solid projects.
How it ISN’T supposed to work, but often DOES.
Ok, now that you’ve got the exchange-sanctioned and sanitized version, here’s what often actually happens.
Suppose you have a fantastic asset which you’d love to raise capital for in the public markets… Oh, say a large coal deposit for example, or a nickel deposit… whatever. Suppose further that you’ve spent a little money proving up and maintaining your deposit and have a pretty darn good idea of what you’ve got. Conservative valuations are say… $15M.
Wouldn’t it be easy to use a CPC to take this baby public?
Sure it would, and that’s what often happens. When you know exactly what the asset is that is going to go into the CPC shell you’re staring at what is possibly the easiest money you’ll ever make.
What’s that you ask? Oh, of course that isn’t the way it’s supposed to happen… The CPC is not allowed to identify a QT until after it’s been created. It’s just a bunch of really smart guys that are “hoping” they find a great project. Come on…
Look, it happens the way it is supposed to much of the time; for evidence of that one need only look at the CPC listings on the TSX website here. However sometimes you’ll find that these transactions seem just a wee-bit convenient.
That handy-dandy report linked above lists the status of all of the CPC’s that are currently listed on the TSX Venture Exchange as of the date of the report (April 27 for the current one). You can see that there are quite a few that have yet to find that elusive QT!
As we always say – management is the key!
Coming full-circle back to my first paragraph. Beware some of those “helpful” Canadian Brokers who can easily put that Nigerian prince to shame. You know the one, he just emailed you to borrow $1,000 so he can release his $50M fortune, some of which he’ll gladly share with you. The Nigerian prince is easy to pick, but we’ve seen many fall victim to the Canadian prince, as they’re far more slick.
We love CPC deals when we can find serially-successful guys behind the deals. But, it’s just one example of the types of structures available to accredited, and/or sophisticated investors.
Mark and I routinely look at dozens of deals a year where we can get in at the very earliest stages. This is where the biggest bang for your buck can occur.
Now you may ask yourself the question, why would founders let just any “Joe” into a deal which is essentially a no-brainer? Well, part of the answer is that they won’t, and the other part of the answer is because they still need to meet certain criteria to stay within the guidelines. You can’t sell ALL the stock to you and your buddies. This is where it pays to have intelligent, well-connected friends.
These investments aren’t available to everyone, as I mentioned previously. While we don’t necessarily agree with restrictions being imposed on intelligent, consenting adults (this goes for a lot of other things too!), we certainly understand the rationale behind wanting to protect people from fraud, misconduct, etc.
That’s why were so excited about, and have been dissecting crowdfunding, for our non-accredited readers lately. We’ll write more about that next week.
The following quote I hesitate to use since the character epitomizes cockroaches like Madoff and Corzine, but since it’s accurate, I include it for your pleasure:
“The most valuable commodity I know of is information.” – Gordon Gekko (Wall Street)