News

February 28, 2005


Susan Copland
Manager, National Policy
TSX Venture Exchange
650 West Georgia St., Suite 2700
P.O. Box 11633
Vancouver, B.C.
V6B 4N9

Dear Ms. Copland

Re: Comments on Proposed Amendments to the CPC Program

YTW Growth Capital is a group that was put together last year for the purpose of pursuing a venture capital investment program utilizing the TSX Venture Exchange’s Capital Pool Company (“CPC”) program. The YTW Growth Capital group consists of:

A management company that provides on a professional, full-time basis the expertise and administrative resources to manage the investment program;
A fully funded Limited Partnership (with private, Accredited Investors with strong business backgrounds as limited partners) which has funded the operations of the management company and the seed financing of a series of CPCs envisioned over the life of the investment program; and
We are currently in the market with the Initial Public Offering of YTW Weslea Growth Capital Corporation (our first CPC vehicle).

We view the TSX Venture Exchange’s CPC program as a unique and valuable addition to the venture capital market, and over the course of our fund raising activities for the Limited Partnership and for our first CPC vehicle we have found a number of investors that enthusiastically agree with us. Our unique structure is designed to redistribute the economics and returns at the seed stage in a manner that provides a professional approach to the CPC program. In exchange for funding the Management Company’s operations during its pre-revenue phase (i.e. at least the period until some Qualifying Transactions have been completed), the Limited Partnership is provided with seed stage investing opportunities to which the limited partners would otherwise not have access.

The purpose of this letter is to provide our views and comments on the proposed amendments to the CPC program that were released in a TSX Venture Exchange Bulletin dated December 22, 2004. Our views and comments will be organized on the same basis as the December 22 Request for Comments.

1. Exclude agent’s commission from the category of expenditures subject to the 30% limit relating to the use of proceeds.
  We agree with this proposal. The problem lies not with the 30% limit, but with the $210,000 absolute limit which is unrealistic in the context of a CPC that raises the full $2,000,000. Such a CPC is faced with at least $150,000 of cash outlay in commissions and the balance leaves insufficient funds for even the most frugal of companies to pay the legal, audit, translation, printing and filing fees and costs necessary to complete its IPO, let alone the expenses required to keep it alive as a public company for the time required to complete a Qualifying Transaction.
2. Permit members of the Pro Group, including the agent and selling group members (“Pros”) to participate in the financing of CPCs at both the seed and IPO stages, subject to their compliance with any applicable client priority rule, and the following:
 
All Pros participating in the seed round will be subject to 3 year escrow, regardless of any connection to the transaction or the price paid for the seed shares; and
Pros may purchase under the IPO subject to the 2% subscription restriction.
  We agree with this proposal. We see no reason for an absolute prohibition on investment in CPC companies by the Pro group although at the same time we understand the need for caution. The proposal provides a good middle ground in that it puts the Pro group on the same footing as founders for investment in the seed round, and limits their investment to small amounts in the IPO. It has been our experience that some retail investment executives have shied away from putting clients’ money into CPCs because, for this type of investment, they want to demonstrate to clients that they are prepared to invest their own money on the same terms as their clients, but are prevented from doing so by the current prohibition on Pro group participation. Furthermore, the possibility of Pro group participation at the seed stage may help with the existing reluctance of some dealers to form or join a selling group for the IPO of a CPC because the small size of the deal leaves too few broker warrants to spread around. Permitting Pro group members to participate in the seed round may encourage broader support for the selling effort in the IPO, while the escrow provision will ensure abusive behaviour does not take place.
3. Remove the $500,000 limit on the amount of seed capital that can be raised, but restrict the amount of seed capital that can be raised below the IPO price to $500,000. Allow the issuer to raise seed capital contributed at the IPO price subject only to the limits imposed by the distribution requirements under the CPC policy.
  We agree with this proposal. While it is our philosophy that financing of the CPC should be as widely spread and broadly based as possible to ensure the best possible following and market support, ours is not the only valid model and we believe that the CPC program should provide flexibility for a range of approaches to the program. Ultimately the market will decide what the best approach is and, even then, the best approach may vary from time to time based on prevailing market conditions. At the same time, we agree that it is desirable to limit the seed price participation to a quarter of the maximum amount that a CPC is permitted to raise.
4. Replace the requirement to cancel all Non Arm’s Length Parties’ discount seed shares for issuers moving to NEX with a requirement that there be, at a minimum, a partial cancellation of such shares. The number of shares that may be retained is the same as if the Non Arm’s Length Party had paid the IPO price for the shares. In order to retain any amount of discounted seed shares, disinterested shareholders approval must be obtained. Issuers that are delisting and not moving to NEX will continue to be required to cancel all discount seed shares held by Non Arms Length Parties.
  We agree with this proposal, although without great enthusiasm. We agree that where a CPC has been unable to find a Qualifying Transaction within the permitted time, a mechanism to give incentive to the founders to remain committed to creating value for shareholders has merit; however we would like to make sure the result is not just a postponement of the inevitable. We note the number of CPCs that get to the end of their permitted time without finding a Qualifying Transaction, and the desperate behaviour sometimes exhibited by these companies as they are nearing the end of the permitted time. In some cases, the situation arises because the CPC came to the market with a specific “back pocket” transaction in mind but for whatever reason that transaction fell away and the skill set does not exist within the CPC to find another suitable transaction. While the requirement for shareholder approval may result in the management group being required to justify to shareholders that they indeed have the ability to find a quality Qualifying Transaction, it is not clear that the shareholder approval process will focus on this issue to ensure that this is the case. Given that the proposal on balance represents an improvement from the status quo, we support the proposal as it stands.
5. Extend the 18 month timeline for completion of a QT to 24 months.
  We agree with this proposal. Inasmuch as this represents a codification of current practice, it is a positive step to make the ground rules clear for all parties. As noted in our comments on item 4 above, we have concerns about the number of CPCs that have little ability to find other suitable Qualifying Transactions if their initial transaction falls away, and extending the deadline from 18 to 24 months may just be delaying the inevitable. On the other hand, there may be market conditions where CPCs with good ability to find quality Qualifying Transactions legitimately chose not to do so within the 18 month period but may be able to do so within 24 months. On balance, however, given the inability to reliably and conclusively determine which of these two categories any particular CPC falls into, we support the proposal as it stands.
6. The prohibition on foreign non resource Qualifying Transactions should be removed for CPCs. Where a CPC that is a reporting issuer in Ontario undertakes a foreign non resource Qualifying Transaction, the issuer must file a prospectus with the OSC in connection with the transaction.
  We agree with most of this proposal; however we are perplexed by the requirement for a prospectus based on Ontario reporting status. The business environment is increasingly global in its scope and it is increasingly difficult to categorize many companies as foreign or North American. We have particular experience with a potential Qualifying Transaction candidate that currently has European and Asian operations. It was looking to finance the North American launch of its operations and would have nicely fit the profile of a desirable Qualifying Transaction candidate, however because of the rules of the program we would have had to segregate its North American operations and do the Qualifying Transaction based on those operations alone. The lack of existing operations in this model and the potential divergence of economic interests between the stand-alone North American operations and the current controlling shareholders’ position in the global operations led us to abandon this opportunity. While we agree that the elimination of the prohibition on foreign companies is a good idea we do not, however, understand the requirement for a prospectus based on Ontario reporting status. Investors understand the nature of the CPC program when they invest in a Capital Pool Company, and there is no basis to believe that the understanding will vary from province to province. We had understood Ontario to be a leading advocate of national standards for securities regulation and are perplexed by its apparent insistence on different standards for Ontario reporting issuers than for other reporting issuers. Indeed we note that in its recent Budget, the federal government has abandoned its long held discrimination against foreign securities held in various registered, tax deferred plans. If a transaction has sufficient merit to be accepted as a Qualifying Transaction, the national status of the issuer should not lead to a different disclosure standard for the transaction. Finally, we note that the cost of preparing such a prospectus is significant and may change the economics of the transaction such that some otherwise appealing Qualifying Transactions do not get done. This can only serve to reduce the value of Capital Pool Companies overall to the market. While we support the proposal to eliminate the prohibition, we believe the requirement for a prospectus is unnecessary and counter-productive.
7. Permit CPCs to be incorporated in non-Canadian jurisdictions other than those listed on the Financial Action Task Force on Money Laundering’s (FATFML) list of deficient countries/territories.
  We agree with this proposal. All of the commentary relevant to this proposal was made above under item 6, so we do not propose to repeat our comments here.
8. The provision regarding shareholder approval for arm’s length transactions should be amended so that it is clear that where shareholder approval is not required for an arm’s length QT, but is required under corporate or securities law for consequential transactions such as a share consolidation or change in auditor, the CPC is not required to obtain specific shareholder approval for the QT in addition to those transactions.
  We agree with this proposal. The whole point of a Capital Pool Program is to have shareholders vest a particular board of directors with the shareholders’ trust in their ability to complete a suitable Qualifying Transaction. This is pretty much the only decision a shareholder is able to make at the time that they invest in any particular CPC. This in turn enables the directors and the CPCs to obtain public company status and complete Qualifying Transactions in as economic and efficient a manner as possible. To start loading on those directors and CPCs an obligation to go back and reconfirm shareholders’ agreement with their investment decision is redundant, costly and time consuming and introduces further uncertainty. This will ultimately have a negative impact on the directors’ and CPCs’ ability to complete Qualifying Transactions in an economic and efficient manner and as a consequence may reduce the number of Qualifying Transactions that can be done.
9. Extend the cancellation provision applicable to stock options held by directors and officers of a CPC that do not continue with the Issuer after the Qualifying Transaction from 90 days to one year.
  We agree with this proposal. One of the most significant incentives that can be offered to a director or officer of a CPC to create value for shareholders is stock options. While it is a fact that once a Qualifying Transaction is in place the most constructive and helpful thing some of the directors and officers of the CPC can do is to step aside in favour of directors and officers affiliated with the target of the Qualifying Transaction, this can have a very negative impact on the value of the exiting director’s or officer’s stock options. This could conceivably lead to decisions being made that are not fully congruent with the interests of common shareholders. The proposal will take a large step towards alleviating this problem.
10. Revise the definition of Non Arm’s Length Qualifying Transaction so that it incorporates the concept of common Control Persons, which makes it clear that the threshold for control is material affect on control or a holding of at least 20% of the outstanding securities of the relevant parties, rather than a 50% threshold.
  We agree with the direction of this proposal, but not with its quantum. We agree that 50% is too high a threshold for the purposes of requiring a shareholder vote on Qualifying Transactions; however 20% appears to us to be too low a threshold. In this situation, 80% of the economic interest lies outside of the control of the party or group that is being used to determine whether or not a non arm’s length situation exists. It strikes us that a 33 1/3% / 66 2/3% situation is more reflective of where a party is likely to be able to exercise sufficient influence such that legitimate non arm’s length relationship concerns arise and the significant cost and uncertainty surrounding a shareholder vote becomes justified. If this threshold is set too low, it could result in this cost and uncertainty being triggered in inappropriate circumstances and could result in desirable Qualifying Transactions not being completed. This consideration is particularly important in the venture capital market where it is sometimes necessary to put investments into good companies to help them through the audit and other expenditures that they must undergo to prepare for a Qualifying Transaction. Similarly, some regard should be had as to whether the party that is a Non Arm’s Length Party to the CPC indeed exercises sufficient influence over the CPC’s decisions that a shareholder vote is warranted. There may be circumstances where a party is invited to become a board member or officer of the CPC because that party’s relationship with the Qualifying Transaction candidate will enhance the CPC’s ability to get that Qualifying Transaction done, but that party does not exert significant influence over the CPC or its decision making process and is not driving the deal process. Simply applying the proposed criteria to all parties that are caught up in the definition of Non Arm’s Length Parties will in all likelihood require shareholder votes in too many cases. It is not clear to us whether the wording of the proposed changes to Policy 2.4 reflect this consideration. While we support the proposal to reduce the threshold for determining non arm’s length transactions, we believe the threshold should be set at 33 1/3% rather than 20%, and regard should be had as to whether the Non Arm’s Length Party that is triggering the threshold test in fact exercises significant influence over the CPC.
11. Replace the representation in Form 3A that the CPC’s management satisfies enhanced management standards with a representation that management believes that the CPC has sufficient human and financial resources to identify, investigate and acquire a Significant Asset.
  We do not take a position on this proposal. We believe that management’s ability to identify, investigate and acquire a Significant Asset is the primary factor that will determine the success or failure of a CPC, and therefore its value to shareholders. This is not an issue that can be satisfactorily covered off by a simple representation, but is something that all parties involved in the process (i.e. management, the agent, the regulators, and ultimately the investors) need to focus on. It is not clear to us whether this proposal will help or hurt that focus.


We are pleased to make representatives of YTW Growth Capital available to discuss or amplify our views and comments on the proposed amendments to the CPC program if it would be of any assistance to your review process.

Yours very truly,



B. Andrus Wilson
President
YTW Growth Capital Management Corporation
(416) 350-5002