Private EquityGoing Public in CanadaPublished: 12/12/2011 The decision to become a reporting issuer and offer securities to be traded on a public exchange is a milestone for a company of any size. There are many advantages to going public, however, doing so brings new responsibilities for which a business must be prepared. Management is encouraged to ask the following questions when faced with this decision and carefully consider whether they are prepared to become a public company. Is it in the company’s best interest to go public? Whether for a particular project or an acquisition, access to capital is important for any business and allows for a flexible capital structure. When a private company goes public, current shareholders benefit from the new market for their securities. The value of the shares increases as they can now be sold to anyone to realize gains, giving the shareholder the option to diversify their portfolio. The company may also diversify its capital structure; access to public markets gives the company more flexibility in its capital structure as equity can be sold for cash. Going public can increase bargaining power when dealing with parties outside the business as public companies are seen as more prestigious than private companies; contractors and suppliers will deal more readily with a public company. Public companies are also regarded more highly by capital and labour markets. Employees can be offered shares as part of their compensation package, creating an incentive to improve the business’ earnings and allowing the company to attract and retain better talent. Going public creates a new currency for companies as shares can be used as payment, which is especially useful when the company is considering acquiring another company. There are a number of consequences of becoming a public company that must be carefully considered when making this decision. To start, the company’s management will lose a degree of control over the business. Managers are accountable to shareholders and must justify their behaviour to them. This means that maximizing shareholder value is a priority, creating pressure for short-term performance. A company must also be prepared for the heightened level of scrutiny a public company receives. Business information that was formerly private, such as employee compensation and key contracts, may be required to be revealed to the public, including to competitors. The continuing disclosure obligations can be onerous and costly, as some judgment calls will require the assistance of outside professionals. The initial cost of going public must be justifiable. A public offering will require the retention of lawyers, auditors and investment bankers, as well as administrative costs for printing the prospectus and “road shows”. Going public also exposes the company and its directors to potential liability. Compared to private shareholders, public shareholders are often loosely tied to the business and may be more likely to sue. The increased visibility of management means directors must be even more aware of their fiduciary duties when making decisions for the company. This risk is somewhat mitigated by the availability of director insurance, however, it only covers limited situations. Going public also exposes the company to the risk of a take-over as a bid could be made directly to shareholders. Can I go public? Even if a company feels they are prepared to deal with the risks and obligations of being a public company, the stock exchange may not believe it meets the listing requirements. There are three stock exchanges in Canada, the Toronto Stock Exchange (“TSX”), TSX Venture Exchange (“TSXV”) and the Canadian National Stock Exchange (“CNSX”). The TSX is designed to provide senior issuers with a market for their securities, while the TSXV is designed to give early stage companies access to venture capital markets. The CNSX is a cost-effective disclosure-focused exchange for smaller issuers. Companies initially listed on the TSXV or CNSX may graduate to the TSX when they meet the appropriate thresholds. The listing requirements for the TSX are the most advanced of the three exchanges. A full list of requirements can be found here and here. Companies apply to be listed by submitting a letter request with all supporting documents to the desired exchange. Application documents include a listing agreement, personal information form, declaration and a prospectus if the company is issuing one, or a long form application if they are not. TSXV applications must be sponsored by a TSXV member. This sponsor considers the expertise of management and directors, the integrity of the company’s financial statements, the listing requirements and whether the company is suitable for a public listing. The sponsor also plays a role in determining how the company will go public. For all applications, additional documents may be required depending on the industry the in which the business operates. For example, mining companies will be required to submit geological reports in compliance with NI 43-101 – Standards for Disclosure for Mining Projects. How do I go public? In Canada, a company can go public by completing a prospectus offering, through a reverse take-over, a capital pool company or, if a company’s securities are listed on a foreign exchange, by applying directly to the TSX or TSXV. Each of these are briefly summarized below. Initial Public Offering A preliminary prospectus, which is a public document, is filed with the desired exchange and the respective securities commissions of the provinces where the securities will be offered. The prospectus is then reviewed by the regulatory authorities and comments are sent to advise of any deficiencies. Once all comments have been dealt with, a final prospectus is filed and a final receipt is given. The securities are then sold, the offer is closed and the securities are listed. Will my IPO be successful? For there to be a public offering of securities, the company must first find underwriters who are confident the securities will sell. Considerations should be made regarding the company’s potential for growth and whether the funds raised can be used to increase the value of the company. The company’s past earnings and future prospects, as well as management’s abilities and previous experience are considered. A public company needs a management team and board of directors with experience in public companies. Why do an IPO? An IPO allows for a wide distribution of securities. From a marketing perspective, the company is given more publicity as more people become aware of the offering. Unlike a reverse take-over, an IPO does not involve dealing with a pre-existing company, so there is no chance of inheriting another company’s issues or obligations. However the IPO process can be long and costly and the company will have to work to attract new investors and sell enough securities to justify the cost. Reverse take-over Another way to become a public company is to be acquired by an existing public company listed on an exchange. This is referred to as a “back-door” listing as it allows private shareholders to become shareholders of a public company without the obligations and due diligence needed for prospectus level disclosure. A public company, usually a shell company that no longer has significant assets, acquires the private company as a subsidiary. Shareholders of the private subsidiary then become shareholders of the public company following the reverse take-over. Why do a reverse take-over? The benefit to this method is that the public parent has a pre-existing shareholder base that will satisfy the exchange’s public float requirement. Therefore, it may not be necessary to attract as many new investors or hire a team of underwriters to distribute stock. Choosing to use a “back-door” listing does not eliminate the work involved in taking a company public. The new company, on a post-transaction basis, must still meet listing requirements and the transaction is subject to regulatory approval. The company performing the reverse take-over will still need to prepare the disclosure documents associated with any merger, asset or share purchase. This means the fees associated with going public can still be high. Qualifying Transaction with a Capital Pool Company (“CPC”) A “qualifying transaction” is similar to a reverse take-over except it is done using a CPC instead of a public company. The CPC program is offered by the TSXV in an attempt to provide smaller businesses with alternative access to capital markets. The CPC is created and listed for the sole purpose of raising funds to take a private company public. The established CPC merges or enters into another business transaction with an operating business through a qualifying transaction so that the assets become owned by the CPC. Shareholders of the private company become shareholders of the CPC. Once the CPC completes the transaction its shares continue to be traded on the TSXV. This may allow the incoming company to retain a high percentage of ownership, unlike an IPO where equity is sold but somewhat similar to a reverse take-over where the shell company has pre-existing shareholders. Why choose a CPC? A private company may choose to do a qualifying transaction with a CPC to allow the private company to go public where it is not otherwise ready to have its securities very widely held, or if the market is not strong enough for a successful IPO. The CPC can be created for the transaction or is pre-existing but with no activity, so there is potentially less due diligence than for a regular reverse take-over. This can also speed up the process. As with the other methods for going public, a strong and experienced management team and professional advisors are needed on the transaction. For any trading activity to occur once the transaction is complete, a company still needs to create interest in its securities. Foreign Direct Listing If a company’s securities are listed on a foreign exchange they may list directly on the TSX or TSXV. If the TSX or TSXV recognizes the foreign exchange, the company may not be subject to all regulatory and reporting requirements. One benefit to a foreign direct listing is the additional marketplace for the company’s securities. There is still a risk that there will be little trading activity on the TSX or TSXV, especially if the application is done without a concurrent financing. What happens once the company goes public? It is important for businesses to realize the obligations associated with being a public company. The continuing disclosure requirements can be onerous and costly. Companies are required to provide both periodic and timely disclosure. Periodic disclosure means that there will be regular reporting of financial statements, auditor’s reports, management discussion and analysis, an annual information form and an information circular. These items require a significant amount of resources to prepare. The timely disclosure regulations may also be onerous, as companies are required to report material changes within 10 days of their occurrence. Deciding what constitutes a material change often requires the assistance of a lawyer for inexperienced companies and the consequences of failing to disclose a change can be severe. One benefit to the continuous disclosure regime is the ease with which subsequent financings can occur. If a company is up-to-date with their filings they may qualify for a short-form prospectus. This prospectus allows a company to incorporate documents by reference and is a much shorter prospectus process than for a regular prospectus. Is there a way to sell securities without going public? A company does not have to go public in order to raise capital through the capital markets by issuing securities. Private placements allow for the sale of securities to select investors as determined by securities regulators. These investors do not require prospectus level disclosure to make an informed decision due to either their relationship to the company or their level of sophistication. Private placements are attractive as they tend to require less disclosure and therefore require fewer resources than a prospectus offering. Securities sold through a private issuance can only be resold to other exempt investors unless or until the company becomes a reporting issuer, which can lower the value of the securities. Companies performing private placements often create an offering memorandum to market the securities. Offering memoranda must contain a statement informing investors of their right of action for damages or rescission if a misrepresentation is contained in the document. Securities law deems any document providing information about the securities to be an offering memorandum, creating liability for the company. Accordingly, while private companies may raise capital initially from family, friends and business associates, they will generally not access the broader markets with a prospectus-exempt distribution until they are getting prepared to go public. Conclusion Going public represents a big step for many companies, but it is often a necessary step to obtain adequate capital in Canada and satisfy the demand of early round investors for liquidity of their investment. Provided management takes the time to understand the process, costs and ramifications and applies adequate resources to the exercise, the experience should be positive regardless of the route chosen. The assistance of Keri Wallace, student-at-law, in preparing this article is gratefully acknowledged. |