By Dan Hallett on November 12, 2010
The recently announced deal reached by Covington Fund II Inc. and all of VenGrowth’s retail labour sponsored investment funds (LSIFs) has sparked a bit of controversy and attracted another party into the mix. The Covington-VenGrowth deal, announced recently, would see all VenGrowth LSIFs merged into the Covington Fund II Inc.
The controversy
Since VenGrowth Capital Management (VCM) would be terminated as investment managers upon the deal’s closing, VCM would be paid a termination fee (which is part of the investment management and administration agreements between the funds and VCM. Termination fees would total about $19.8 million (or $22.3M if HST-taxable). This represents about 5% of the total assets across all five VenGrowth LSIFs. These fees would be paid by the VenGrowth funds.
In part to ‘sell’ this deal to shareholders, a Covington Q&A document alludes to the potential to lower fees. In other words, VenGrowth has simply failed to raise new money. And since many of their funds have frozen redemptions, assets have been shrinking – which in turn has pushed up annual fees and expenses in percentage terms. This deal is implicitly stating that Covington will be more successful at raising new money. And merging all of the funds into a single LSIF will help with cost control. That’s no guarantee of course.
Another item of concern is the financing cost that will be involved in this deal. A couple of sources peg the cost at between 10% and 15% annually on the borrowed funds. Money may be borrowed, for instance, to fund the cash needed to pay out redemptions for those who choose one of the redemption options proposed as part of this deal.
Competing offer
While VenGrowth notes that a few bidders were at the table, it sounds like LSIF consolidator GrowthWorks Capital (a unit of publicly traded Matrix Asset Management) was not invited to make an offer. Indeed, GrowthWorks is gathering its troops to mount a grassroots campaign to buy some time.
It is soliciting NO votes to the proposed Covington purchase of VenGrowth LSIFs. They stated, in a proxy circular released yesterday, that they can offer a better deal for shareholders. They want all VenGrowth shareholders to vote down the Covington deal to allow more time for GrowthWorks (or anyone else for that matter) to formalize a competing offer.
Between a rock and a hard place
It is unfortunate that there are not any great options available to frozen LSIF investors. If no deal is made – a possibility if the Covington deal is rejected – VenGrowth would gladly continue managing the funds (and continue to collect fees). But assets would likely continue shrinking which would keep pushing up annual fees. And the spiral of asset shrinkage would accelerate toward an ugly wind-up.
The Covington deal is a better deal than no deal – but it’s too early to know if it’s better or worse than what may materialize from GrowthWorks. VenGrowth funds’ boards of directors vetted a few offers but it makes sense to put at least two competing offers in front of VenGrowth shareholders to give them a choice. And if invetors don’t exercise their rights, they could find themselves frustrated later with no recourse. Just ask VentureLink investors if they wished they’d taken their voting rights more seriously.
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