John Gabriel of Oculus Ventures. (Photo by Darren Brown, OBJ)

Risks the same as IPO but companies go public with less work and in less time, say proponents

These days, it's not just smaller companies feeling the venture capital pinch: even venture capitalists themselves are hurting from the countrywide lack of funding and are scrambling to find new investments to enrich their coffers.

So it's no wonder the capital pool company (CPC) vehicle is becoming increasingly popular, both as a way for companies that are slightly larger than startups to raise some much-needed capital and go public quickly, and for venture capitalists to get into some less risky investments and build strong public companies.

While CPCs have been around since 1988, when the TSX Venture Exchange launched the program primarily as a way for small mining companies to get medium-sized amounts of funding, the vehicle has also gained prominence in other industries in recent years, including a few local companies.

Some haven't exactly prospered – industrial technology company Tarquin Group, which bought Process Photonics and DIPIX Technologies but may now have to sell one of the firms after struggling to raise fresh private placement funds, is one example – but for savvy managers, analysts say the CPC could well be a gold mine.

"The CPC is a private placement powerhouse," says Raymond King, who is in charge of business development for the TSX. "What's setting the tone is the market's appetite for risk and new investment, and when there's a tough IPO marketplace, a built-in entity with capital behind it can be a good option."

That's what attracted venture capital firm BBG Equity, which just wrapped up a $400,000 IPO for its CPC shell Oculus Ventures. The VC firm started off as a provider of strategic management consulting, but has more recently begun more strategic implementations with various companies. The CPC vehicle is one way to get more involved, says Oculus CEO John Gabriel.

"It's a great vehicle to execute on our growth plan, because what happens in the VC market is that angels and founders get squeezed out by VC funds. This tool helps preserve a little more of that seed funding for the entrepreneurs," says Mr. Gabriel.

That's good news for companies who become the qualifying transactions (see sidebar), for whom the CPC is a form of public venture capital which can raise smaller and more realistic amounts of capital.

"For a true IPO in today's marketplace, on the senior exchange you don't tend to want to go smaller than $40 million to $50 million, and then on the (TSX Venture Exchange) you'd want to raise $15 million to $20 million. But the company might not need that much – they may only need $5 million to $10 million," says Mr. King.

What about doing a reverse takeover instead, or simply having venture capital firms buy small companies outright?

"A reverse takeover usually comes with invisible liabilities, because with fresh money coming into a dormant company, a lot of people think, 'Time to sue,'" says Sean Caulfeild of Perley-Robertson, Hill and McDougall, who is himself helping set up a CPC. "The CPC shell, on the other hand, is pure and ultra white."

Meanwhile, simply buying the company comes with its own problems because the company will still need capital, which it won't get if it's still private.

The other advantage of using the CPC vehicle is it's a relatively quick and painless way to go public, since venture capitalist directors will do legwork for the shell's IPO. "It's not unheard of" to have the shell go public in 100 days, says Mr. Caulfeild.

The statistics are promising: of about 1,900 companies listed using the CPC vehicle, just about 1,500 successfully completed a qualifying transaction, while 237 have graduated onto the senior TSX board.

One local success story is mining company Soltoro Ltd., which amalgamated with CPC shell Blue Fyre One Inc. in 2006. The company's original investors got in at around 12.5 cents per share, and Soltoro hit the public markets at roughly 30 cents, but the stock is now trading at 40 cents and had risen to as much as 83 cents per share.

However, there are still risks to this vehicle, although many are the same as with any other public company.

"The process is relatively simple and easy to understand, but the directors need to be willing to do a lot of work to find a qualifying transaction; it's not a passive thing," says Michael Gaffney, who was Blue Fyre One's CEO. "We talked to 50 or 60 companies before we found Soltoro."

There are three distinct groups within CPCs that fail, notes Mr. Caulfeild: "First, there are the directors that didn't get a qualifying transaction in 24 months, and financially it's a bad day and there's reputational risk for them; secondly, there are the shareholders with the hope and promise of an IPO that didn't pan out, and their shares are now in purgatory – although that's venture capital for you, so no-one was hoodwinked – and then there's the owner-managers of the target company who perhaps didn't find themselves comfortable in the public environment, or they were micromanagers."

But with VC at a low throughout the country, it could be well worth it to roll the dice on the public markets.

"For a small, close-to-profitable company, it's a good way to differentiate oneself from the VC crowd, since all the shareholders are in the common pool, as opposed to the VC model where investors have all sorts of rights over the principals," Mr. Gaffney adds.

--

FACT BOX:

How a CPC is created:

First, the shell of the company must be formed by a group of between five to eight directors who must have at least $100,000 in cash. The directors issue themselves shares typically at about 10 cents per share, and then put together an IPO on the TSX Venture Exchange at about 20 cents per share. After the public offering, they have 24 months to find a qualifying transaction (QT), which can either be a piece of mining property if the shell is targeted at the mining industry, or a private company looking to go public quickly. The target company should already have a product and be larger than a startup. Following that, the company relists at about 40 cents and usually changes its name, after which it is a fully fledged public company that can either choose to roll up a group of complementary companies, or concentrate on its qualifying transaction if it is strong enough.