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Locked-in VenGrowth holders given a redemption path out

Almost two years after retail investors were locked into some of VenGrowth Asset Management's private equity funds, the handcuffs tying them to their investments have loosened, providing an opportunity for them to get at least some of their money back.

Covington Capital Corp., another private equity player, has announced plans to purchase five of VenGrowth's troubled funds and merge them into its own portfolio, which will provide enough liquidity for redemptions.

The five funds - VenGrowth Investment Fund, VenGrowth II Investment Fund, VenGrowth III Investment Fund, VenGrowth Advanced Life Sciences Fund and VenGrowth Traditional Industries Fund - saw their asset values plummet when the financial crisis hit, causing potential investors to back away. Around the same time, the Ontario government decided to phase out the province's generous venture capital tax credits for retail investors.

With almost no new money coming in, VenGrowth had to halt redemptions to preserve its liquid assets and pay the funds' expenses.

Once the sale is final, the five funds will merge with Covington Fund II's current holdings as well as a newly acquired biotech fund. Combined net assets of the merged funds is expected to come in around $425-million and will include 55 investments.

VenGrowth said the sale was the best option for investors because companies are hoarding cash until the economy recovers. "If they're not willing to write a cheque, it makes it awfully difficult" to sell off assets to raise money for the fund, a company spokesperson said.

Despite locking investors in, VenGrowth insists it took the best course of action for its shareholders, given the rocky investment environment. "The last thing we wanted to do was cap the funds," VenGrowth's spokesperson said. But by doing so, the firm did "not have to 'fire sale' companies in the middle of the recession," which could have seen them sold off at extremely low valuations.

As for Covington and its investors, the firm now gets to add some of VenGrowth's private equity investments to its portfolio.

Through the acquisition, current shareholders of the VenGrowth funds get class A shares of Covington II. Their options differ depending on what VenGrowth fund they are in, but the investors who were frozen first have three options: redeem immediately at a 40 per cent loss; follow a schedule that allows them to redeem up to 10 per cent of their investment annually over four years, after which the full market value can be redeemed; or remain a Covington II shareholder for the next eight years.

Dan Hallett, an investment fund analyst at HighView Financial Group, said investors have a tough choice. "[Investors] had already been in it for seven or eight years and now they have to stick in it a couple years longer" if they want full redemption value, he said.

But Mr. Hallett believes that VenGrowth tried everything it could. "Ontario basically said we're pulling the tax credit support," he said, and that caught most people by surprise.

"Who's going to put money into this thing knowing that fundraising has already completely dried up?" Mr. Hallett said.

© 2007 The Globe and Mail. All rights reserved.

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