Headnote NP 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Approval of proposed current labour sponsored funds amalgamation under the approval requirements in NI 81-102 – Proposed current merger approval required because mergers do not meet certain criteria for pre-approved reorganizations and transfers in National Instrument 81-102. Approval of the continuing fund paying performance fees that is not calculated with reference to a benchmark or index that reflects the market sector the mutual fund invests in, as required under Part 7 of NI 81-102 – The proposed performance fees is similar to existing performance fees each of the merging funds has received prior regulatory exemption.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 5.5(1)(b) and ss. 7.1
September 10, 2010
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (THE “JURISDICTION”)
AND
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS IN MULTIPLE JURISDICTIONS
AND
IN THE MATTER OF
VENTURELINK FINANCIAL SERVICES INNOVATION FUND INC., VENTURELINK BRIGHTER FUTURE FUND INC., VENTURELINK DIVERSIFIED INCOME FUND INC. AND VENTURELINK BALANCED FUND INC. (COLLECTIVELY, THE “FUNDS”)
AND
VENTURELINK LP
(THE “FILER” OR THE “MANAGER”)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Funds and the Filer for a decision under the securities legislation of the Jurisdiction (the “Legislation”) for
i) approval pursuant to subsection 5.5(1)(b) of National Instrument 81-102 Mutual Funds (“NI 81-102”) for the amalgamation of the Funds (the “Amalgamation Approval”)
ii) exemption from section 7.1 of NI 81-102 for the amalgamated fund to adopt a performance bonus plan that incorporates the features of the existing performance bonus plans of the Funds (the “Performance Bonus Exemption”).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102”) is intended to be relied upon in the provinces of British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland and Labrador (collectively with Ontario, the “Jurisdictions”).
Interpretation
Defined terms contained in National Instrument 14-101 Definitions and MI 11-102 have the same meaning in this decision unless they are otherwise defined in this decision.
Representations
The decision is based on the following facts represented by the Filer:
The Amalgamation
1Details of the proposed amalgamation of the Funds (the “Amalgamation”) under the Canada Business Corporations Act (“CBCA”), were contained in an information circular dated July 22, 2010 (the “Circular”) which was sent to the shareholders of each of the Funds in connection with shareholder meetings held on July 22, 2010 (the “Shareholder Meetings”). The disclosure included the income tax considerations associated with the Amalgamation.
2The shareholders of each of the Funds approved the special resolution approving the Amalgamation by a margin well in excess of the required 66 2/3% approval.
3Each of VentureLink Diversified Income Fund Inc. (the “DI Fund”) and VentureLink Balanced Fund Inc. (the “Balanced Fund”) are required to continue under the CBCA as a precondition to participating in the Amalgamation. Details of the proposed continuance of the DI Fund and the Balanced Fund under the CBCA were contained in the Circular.
4The shareholders of each of DI Fund and the Balanced Fund approved the special resolution approving their continuance under the CBCA by a margin well in excess of the required 66 2/3% approval. The DI Fund and the Balanced Fund have applied to the Ontario Securities Commission for their continuance pursuant to clause 4(b) of the Ontario Regulation 289/00 made under the Business Corporations Act (Ontario).
5The Manager is the manager of each of the Funds. The Manager, or an affiliate of the Manager will be the manager of the amalgamated fund (the “Innovation Fund”), the continuing fund, following the Amalgamation.
6The Amalgamation will result in the securityholders of a mutual fund becoming securityholders of another mutual fund thereby requiring the approval of the Regulators pursuant to section 5.5(1)(b) of NI 81-102.
7The Manager shall bear the costs and expenses associated with the reorganization of the Funds resulting in the Amalgamation.
8It is anticipated that the Amalgamation will be effective on or about September 10, 2010 (the “Effective Date”).
9It is proposed that on the Effective Date, the Funds will amalgamate pursuant to section 178 of the CBCA and continue thereafter as a registered LSVCC pursuant to the Tax Act and as a LSIF pursuant to the CSBIF Act under the name the “VentureLink Innovation Fund Inc.” or such other name that is decided by the Board of Directors. On the Effective Date shareholders of:
(a) FinServ Fund (defined herein) Class A Shares, Series I, Class A Shares, Series II, Class A Shares, Series III, Class A Shares, Series IV and Class A Shares, Series VI will be entitled to receive, in exchange for those shares, Class A Shares of the same series in the capital of Innovation Fund equal to the number of FinServ Fund Class A Shares of the series so held multiplied by the net asset value per Class A Share of the series held of FinServ Fund divided by the net asset value per Class A Share of the same series of Innovation Fund all as determined on the Effective Date;
(b) BF Fund (defined herein) Class A Shares, Series I, Class A Shares, Series II, Class A Shares, Series III, Class A Shares, Series IV, and Class A Shares, Series VI will be entitled to receive, in exchange for those shares, Class A Shares of the same series in the capital of Innovation Fund equal to the number of BF Fund Class A Shares of the series so held multiplied by the net asset value per Class A Share of the series held of BF Fund divided by the net asset value per Class A Share of the same series of Innovation Fund all as determined on the Effective Date;
(c) BF Fund Class A Shares, Series V will be entitled to receive, in exchange for those shares, Class A Shares, Series II in the capital of Innovation Fund equal to the number of BF Fund Class A Shares, Series V so held multiplied by the net asset value per Class A Share, Series V held of BF Fund divided by the net asset value per Class A Share, Series II of Innovation Fund all as determined on the Effective Date;
(d) DI Fund Class A Shares, Series I, Class A Shares, Series II, Class A Shares, Series III, Class A Shares, Series IV and Class A Shares, Series VI will be entitled to receive, in exchange for those shares, Class A Shares of the same series in the capital of Innovation Fund equal to the number of DI Fund Class A Shares of the series so held multiplied by the net asset value per Class A Share of the series held of DI Fund divided by the net asset value per Class A Share of the same series of Innovation Fund all as determined on the Effective Date;
(e) Balanced Fund Class A Shares, Series I will be entitled to receive Class A Shares, Series II in the capital of Innovation Fund equal to the number of Balanced Fund Class A Shares, Series I multiplied by the net asset value per Class A Share, Series I of Balanced Fund divided by the net asset value per Class A Share, Series II of Innovation Fund all as determined on the Effective Date;
(f) FinServ, BF Fund, DI Fund and Balanced Fund Class B Shares will be entitled to receive, in exchange for those shares, one Class B Share in the capital of Innovation Fund for each Class B Share of a Fund held; and
(g) FinServ, BF Fund, DI Fund and Balanced Fund Class P Shares will be entitled to receive, in exchange for those shares, one Class P Share in the capital of Innovation Fund for each Class P Share of a Fund held.
10The investment objective of Innovation Fund is to realize long-term capital appreciation by making debt and equity investments in a diversified portfolio of securities of eligible Canadian businesses and by investing in reserves. The boards of directors of the Funds concluded that a reasonable person would consider each of the Funds to have substantially similar fundamental investment objectives and valuation procedures as Innovation Fund.
11The management fees for Innovation Fund are consistent with those of the existing Funds and the performance fee for Innovation Fund was designed to replicate the performance fees of the existing Funds and eliminate, to the extent possible, a change in performance fees going forward. The Innovation Fund will track investment pools for existing performance fees for each of FinServ Fund, DI Fund and BF Fund to retain those performance fee entitlements without change. For the Balanced Fund, the existing performance fee on venture investments is contained within the Community Small Business Investment Funds in which the Balanced Fund has invested, which will not change as a result of the Amalgamation. The performance fee from the date of the Amalgamation forward is substantially similar to the performance fees in each of the Funds. The boards of directors of the Funds concluded that a reasonable person would consider each of the Funds to have substantially similar fee structure as Innovation Fund, including performance fees.
12The Amalgamation is a tax-deferred transaction under subsection 87(1) of the Income Tax Act (Canada).
13Shareholders of the Funds were permitted to dissent from the Amalgamation pursuant to the dissent rights contained in the OBCA or the CBCA, as applicable. A shareholder who dissents will be entitled, in the event the Amalgamation becomes effective, to be paid by the amalgamated fund, the fair market value of the Class A Shares of a Fund held by such shareholder determined as at the close of business on the day before the Amalgamation resolution was passed. Where a shareholder dissents from an amalgamation and receives a cash payment for his shares from the amalgamated corporation, the shareholder is considered to have realized proceeds of disposition equal to the amount of the payment received by the shareholder. The proceeds of disposition will be reduced by the amount withheld and paid to the Receiver General for Canada as a return of the federal tax credit, the amount withheld from the proceeds and paid by the amalgamated fund to the Ministry of Finance (Ontario) as a return of the Ontario tax credit and applicable early redemption fees.
14Each of the Funds will cease to exist as separate entities upon the Amalgamation and there will be no discontinued funds to be wound up.
15The Amalgamation meets all of the conditions contained in Section 5.6(1) of NI 81-102 for the pre-approval of the reorganization resulting in the Amalgamation except for the requirement that the Innovation Fund have a current prospectus in the Jurisdictions as contemplated in subsection 5.6(1)(a) and the requirement that a prospectus and the most recent annual and interim financial statements of Innovation Fund be provided to securityholders as contemplated in subsection 5.6(1)(f)(ii) of NI 81-102, because such documents do not yet exist.
16The Circular dated July 22, 2010 provided prospectus level disclosure of the Innovation Fund. The Innovation Fund intends to continue distributing securities by filing a prospectus.
17The Manager and the board of directors of each of the Funds believe that amalgamating the Funds to form Innovation Fund will be beneficial to shareholders of each Fund for a number of reasons including some that are unique to LSIFs. The Amalgamation is expected to generate the following benefits for shareholders of the Funds:
(a) Greater Venture Portfolio Diversification - The shareholders of Innovation Fund, will become shareholders of a fund which has a broader, more diversified venture portfolio which is composed of a greater number of portfolio companies than that held by each individual Fund. Diversification is the main tool available to reduce the high level of risk inherent in venture investing.
(b) Improved Liquidity - After the Amalgamation, Innovation Fund is expected to have a stronger overall liquidity position than each of the Funds would have had alone. Maintaining adequate liquidity is important for a number of reasons. Cash is needed to meet the follow-on investment requirements of investee companies and to meet the redemption requests of shareholders. Adequate liquidity avoids the need to sell portfolio positions at inopportune times to generate cash, which can result in lower values being realized.
(c) Ability to Provide Follow-on Financing - Adequate liquidity allows Innovation Fund to meet follow-on fundraising commitments to investee companies which prevents shareholders from suffering the dilutive effects of financings completed at significantly lower prices than previous financing. It also allows Innovation Fund greater flexibility in providing follow on capital to take advantage of opportunities than each of the existing Funds would enjoy.
(d) More economic portfolio size – Innovation Fund will be significantly larger than the existing Funds. This increased size will provide a more economic portfolio size over the remaining life of Innovation Fund.
(e) Reduced Costs - As compared to continuing each Fund as a single entity, shareholders of Innovation Fund can expect to bear a modestly reduced level of fixed, recurring fees and expenses post-Amalgamation such as those of professional services fees and shareholder communication expenses.
(f) Pacing benefit –four Community Small Business Investment Funds (“CSBIF’s”) with a cost of approximately $14 million are held by the Balanced Fund. These CSBIF’s are expected to be eligible investments for the purposes meeting LSIF investment targets and provide greater flexibility to management in meeting minimum investment thresholds through the life of Innovation Fund.
(g) Management of Reserves – Innovation Fund will have a larger pool of reserves to manage. This larger pool can be managed to meet redemptions and to provide incremental yield.
(h) Pooling of tax loss carry forwards – Innovation Fund will have large tax loss carryforwards available, sufficient to significantly reduce the risk that one of the Funds should become taxable.
Relevant Parties
18Information about the relevant parties involved in the Amalgamation consists of the following:
VentureLink Financial Services Innovation Fund Inc. (“FinServ Fund”)
(a) FinServ Fund was incorporated under the CBCA. FinServ Fund is a registered labour sponsored investment fund corporation (“LSIF”) under the Community Small Business Investment Funds Act (Ontario) (the “CSBIF Act”) and is a registered labour-sponsored venture capital corporation (“LSVCC”) under the Income Tax Act (Canada) (the “Tax Act”). FinServ’s investment activities are governed by the CSBIF Act and the Tax Act.
(b) FinServ Fund primarily invests in small and medium sized businesses and primarily financial services companies, with the objective of obtaining long term capital appreciation and must make “eligible investments” in “eligible businesses” as prescribed under the CSBIF Act and Tax Act.
VentureLink Brighter Future Fund Inc. (“BF Fund”)
(d) BF Fund was formed pursuant to the amalgamation of VentureLink Fund Inc. and VentureLink Brighter Future Equity Fund Inc. in July 2006 under the CBCA. BF Fund is registered as a LSIF under the CSBIF Act and is registered as a LSVCC under the Tax Act. BF Fund’s investment activities are governed by the CSBIF Act and the Tax Act.
(f) BF Fund primarily invests in a diversified portfolio of Canadian businesses developing products, services and technologies, including those engaged in software, broadband, Internet, fibre optic, telecommunication, wireless, hardware and biotechnology industries and companies involved in the essential services and infrastructure industries, such as energy, water and waste management. BF Fund’s objective is to obtain long term capital appreciation and it must make “eligible investments” in “eligible businesses” as prescribed under the CSBIF Act and the Tax Act.
VentureLink Diversified Income Fund Inc.
(g) DI Fund was incorporated under the Ontario Business Corporations Act (the “OBCA”). DI Fund is registered as a LSIF under the CSBIF Act and is a prescribed LSVCC under the Tax Act. DI Fund’s investment activities are governed by the CSBIF Act.
(i) DI Fund primarily invests in diversified portfolio of debt and equity securities of small and medium sized businesses with the objective of generating a superior level of income and must make “eligible investments” in “eligible businesses” as prescribed under the CSBIF Act.
VentureLink Balanced Fund Inc.
(j) The Balanced Fund was formed pursuant to the amalgamation of VentureLink Diversified Balanced Fund and VentureLink Brighter Future (Equity) Balanced Fund Inc. in July 2006 under the OBCA. The Balanced Fund is registered as a LSIF under the CSBIF Act and is a prescribed LSVCC under the Tax Act. The Balanced Fund’s investing activities are governed by the CSBIF Act.
(l) The Balanced Fund primarily invests in diversified portfolio of debt and equity securities of small and medium sized businesses with the objective of generating a superior level of income and must make “eligible investments” in “eligible businesses” as prescribed under the CSBIF Act.
19VL Sponsor is the labour sponsor of each of the Funds and the Manager is the manager of each of the Funds.
The Proposed Performance Bonus
20Each of the Funds pays a performance bonus which does not satisfy the requirements of Section 7.1 of NI 81-102, for which relief has been granted.
21The performance bonus proposed for the Innovation Fund (the “Performance Bonus”) does not satisfy the requirements of Section 7.1 of NI 81-102. The Performance Bonus is based on realized gains and the cumulative performance of the venture portfolio (and not in relation to a benchmark). The Performance Bonus is not based on the total return of the Innovation Fund because reserves are not included in the venture portfolio and because the quantum of the Performance Bonus is calculated on an investment-by investment basis.
22The Performance Bonus consists of three parts:
(a) Part I – investments of VenturLink Financial Services Innovation Fund Inc. (“FinServ Fund”) and new investments of Innovation Fund (the “Continuing Plan”);
(b) Part II-Existing investments of DI Fund (the “DI Fund Plan”); and
(c) Part III-Existing investment of VentureLink Brighter Future Fund Inc. (“BF Fund”) ( the “BF Fund Plan”).
Part I
23The performance fee for the Continuing Plan will be based on performance from the FinServ Fund eligible investment portfolio since inception and performance of any investments made (new or follow-on) following the Effective Date. Investments of the FinServ Fund since inception and investments following the Effective Date are described as Continuing Plan Investments and the sum of Continuing Plan investments to be described as the Continuing Plan Portfolio.
24The Manager will be entitled to a performance fee under the Continuing Plan based on realized gains and cumulative performance of the Continuing Plan Investments. Before any performance fee is paid by the Innovation Fund on realization of a Continuing Plan Investment, the Continuing Plan Portfolio must have:
(a) earned sufficient income to generate a return on eligible investments in excess of a cumulative annualized threshold return of 6%. The income on eligible investments includes realized and unrealized investment gains and realized and unrealized losses earned and incurred since inception.
(b) earned income from the eligible investment which provides a cumulative investment return at an average annual rate in excess of 6% since the date of the investment; and
(c) fully recouped an amount equal to all principal invested in the eligible investment. The Innovation Fund will not pay the performance fee on any partial disposition of an eligible investment of the Continuing Plan unless and until the Innovation Fund receives, from all dispositions of that investment on a cumulative basis, an amount equal to at least the full amount of the principal invested in the eligible investment.
25Subject to all of the above, the performance fee under the Continuing Plan will be an amount equal to the lesser of (i) 20% of all income earned from the eligible investment, and (ii) the portion of that amount that does not reduce returns to shareholders on the Continuing Plan Portfolio below a Cumulative Annualized Threshold Return of 6%.
Part II
26The performance fee for the DI Fund Plan is based on the performance of eligible investments of the DI Fund held as at the Effective Date. Investments of the DI Fund as of the Effective Date are described as the DI Fund Investments and the sum of the DI Fund Investments are described as the DI Fund Portfolio.
27The Manager will be entitled to a performance fee based on realized gains and cumulative performance of the DI Fund Investments. Before any performance fee is paid by the Fund on realization of a DI Fund Investment, the DI Fund Portfolio must have:
(a) earned sufficient income to generate a return on eligible investments in excess of a cumulative annualized threshold return of 6%. The income on eligible investments includes realized and unrealized investment gains and realized and unrealized losses earned and incurred since inception.
(b) earned income from the eligible investment which provides a cumulative investment return at an average annual rate in excess of 6% since the date of the investment; and
(c) fully recouped an amount equal to all principal invested in the eligible investment.
28The Fund will not pay the performance fee on any partial disposition of an eligible investment of the DI Fund Plan unless and until the Fund receives, from all dispositions of that investment on a cumulative basis, an amount equal to at least the full amount of the principal invested in the eligible investment.
29Subject to all of the above, the performance fee under the DI Fund Plan will be an amount equal to the lesser of (i) 20% of all income earned from the eligible investment, and (ii) the portion of that amount that does not reduce returns on the DI Fund Portfolio below a Cumulative Annualized Threshold Return of 6%.
Part III
30The performance fee for the BF Fund Plan is based on the performance of eligible investments of the BF Fund held as at the Effective Date. Investments of the BF Fund as of the Effective Date are described as the BF Fund Investments and the sum of the BF Fund Investments are described as the BF Fund Portfolio.
31The Manager will be entitled to a performance fee based on the realized gains and cumulative performance of the BF Fund Investments. The performance fee under the BF Fund Plan will consist of two parts as described below.
32The first part of the BF Fund performance fee pays the Manager a 5% bonus on proceeds in excess of the fair value of an eligible investment as at July 31, 2006 plus the threshold rate of return. Before the 5% performance fee is paid by the Innovation Fund on the realization of an eligible investment, the BF Fund Portfolio must have:
(a) earned sufficient income to generate a rate of return on eligible investments in excess of a cumulative annualized threshold return of 6% since July 31, 2006. The income on eligible investments includes realized and unrealized investment gains and losses earned and incurred since July 31, 2006;
(b) earned income from the eligible investment which provides a cumulative investment return at an average annual rate in excess of 6% since July 31, 2006; and
(c) fully recouped an amount equal to all principal invested in the eligible investment.
33Subject to all of the above, the performance fee under the first part of the BF Fund Plan will be an amount equal to the lesser of: (i) 5% of proceeds (realized gains and income) less the greater of the carrying value on July 31, 2006 plus 6% per annum and original cost; and (ii) the portion of the amount in section (i) immediately above that does not reduce returns on the BF Fund Portfolio since July 31, 2006 below a cumulative annualized threshold return of 6%.
34The second part of the BF Fund Plan pays the Manager a 10% performance fee on proceeds over the original cost of the investment. Before the 10% performance fee can be paid, the BF Fund Portfolio must have:
(a) earned sufficient income to generate a rate of return on eligible investments in excess of original cost of the portfolio plus a cumulative annualized threshold return of 6% since July 31, 2006. The income on eligible investments includes realized and unrealized investment gains and losses earned and incurred since July 31, 2006; and
(b) fully recouped an amount equal to all principal invested in the eligible investment.
35Subject to all of the above, the performance fee on the second part of the BF Fund Plan will be an amount equal to the lesser of: (i) 10% of all income earned from the eligible investment; and (ii) the portion of the amount in section (i) immediately above that does not reduce returns on the BF Fund Portfolio since July 31, 2006 below original cost plus a cumulative annualized threshold return of 6%.
36The Performance Bonus consists of the Continuing Plan, the DI Plan and both parts of the BF Plan and was designed to match expected proceeds to the Manager with or without the Amalgamation for all investments up to the Effective Date.
37The performance hurdles and conditions set out under the Performance Bonus are only applied at the time of realization of an eligible investment.
38The boards of directors of the Funds met, both with and without representatives of the Manager, to consider the Performance Bonus. The independent directors of each of the Funds concluded that a performance bonus should be offered by the Innovation Fund, analyzed various options for that performance bonus and concluded that it was in the best interests of the shareholders of the Funds to replicate, to the greatest extent practicable, the current entitlement of the Manager under the performance bonuses for the existing Funds.
39The independent review committee of the Funds reviewed and approved the Amalgamation and the Performance Bonus as they were described in the information circular delivered to shareholders in connection with their approval of the continuance and the Amalgamation, each of which was approved by special resolution of the shareholders of each Fund continuing under the CBCA and each Fund, respectively.
40The prospectus for the Innovation Fund will:
(a) fully disclose that the Manager considers the Performance Bonus to be appropriate given the disclosed investment objectives and strategies of the Innovation Fund;
(b) provide an explanation of why the Performance Bonus is appropriate for the Innovation Fund; and
(c) provide an explanation of the Performance Bonus calculation for partial dispositions of an eligible investment.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Amalgamation Approval and the Performance Bonus Exemption are granted.
Vera Nunes
Vera Nunes
Assistant Manager, Investment Funds Branch
Ontario Securities Commission
SEDAR Project No.: 1608781