Streamlined Rights Offering Regime
In the world of private companies (where shares are not listed for trading on public stock exchanges) there are often restrictions set out in the charter documents requiring that when the company needs fresh capital it will offer its existing shareholders rights to purchase additional shares before it offers them to new investors (a “rights offering”). The thinking is that if there is to be a new round of financing, it’s only fair that current shareholders have the first opportunity to buy those shares, particularly if they are to be offered for sale at a discount.
In some jurisdictions, this thinking extends to public companies. In the United Kingdom, companies that want to be listed on the premium segment of the London Stock Exchange, and therefore eligible to be included in the FTSE indices, must have pre-emptive rights built into their corporate charter giving existing shareholders first call on any new equity to be issued.
In Canada, public companies rarely raise capital though rights offerings. Larger rights offerings require a prospectus, and although smaller rights offerings are exempt from the prospectus requirements, the time required and restrictions applicable to exempt transactions until now have made them unattractive to most issuers. In the past three years, while there have been thousands of financings (by prospectus or private placement), there have only been eight rights offerings undertaken by Toronto Stock Exchange listed companies using a prospectus, and 30 on a prospectus exempt basis.
These numbers may be about to increase significantly with the introduction on December 8, 2015 by the Canadian Securities Administrators (the “CSA”) of new rules for rights offerings by Canadian public companies.
Under the old system, if companies wanted to raise more than 25% of their current capitalization by way of a rights offering, they had to file and clear a prospectus with the Canadian securities commissions and the relevant stock exchange. For smaller rights offerings, the company could prepare a shorter rights offering circular, but that document still had to be cleared by both the securities commissions and the stock exchange. It regularly took two to three months to complete a rights offering, with often a month required to achieve clearance by the regulatory authorities. By comparison, seasoned issuers in the Canadian capital markets can close a bought deal financing with a group of underwriters in little more than a week.
Streamlining Changes of Note
The changes that will make rights offerings a significantly more efficient and useful financing method are:
- Offering Size: The maximum permitted size of an offering (as a percentage of the outstanding number/amount of the subject class of securities which may be issued in any 12-month period) has been increased from 25% to 100%.
- Offering Materials: The mandated format for rights offering circulars is now a more reader-friendly question and answer structure. More significantly, while the company must give notice of the financing by issuing a press release and mailing a short written notice (not more than two pages) to securityholders (which provides only basic information about the offering), the rights offering circular need not be mailed to shareholders and only has to be filed on SEDAR.
- No CSA Clearance Required: Rights offering circulars are no longer subject to advance review and clearance by securities commissions. Although the stock exchange must still review the circular before it is filed, the review period is expected to be much shorter.
- Business Disclosure: Issuers are no longer required to include a description of their business in the rights offering circular. For mining companies, this is quite significant as the requirements to file technical reports (supporting reserve/resource and other technical disclosure) under National Instrument 43-101 Standards of Disclosure for Mineral Projects will no longer be triggered.
Use of Proceeds and Related Disclosure
Under the old rules, the “use of proceeds” disclosure in a rights offering circular was limited to a description of the proposed use of proceeds and any minimum amount of funds required. In a Policy Statement related to the old rules issued by the CSA they cautioned that they may object to a rights offering being made on a prospectus exempt basis if (i) the rights offering was for the purpose of financing the reactivation of a dormant or inactive issuer or (ii) the proceeds would be used to finance a material undertaking that would constitute a material departure from the business or operations of the issuer as at the date of its most recently filed financial statements.
The new rules do not restrict the purpose for which proceeds can be used. However, the form requirements for rights offering circulars now include significantly expanded requirements for use of proceeds disclosure (Part 3 of new Form 45-106F15). The required new disclosure focuses in particular on short-term liquidity requirements, impact on “going concern” assessments, reduction/retirement of debt and R&D initiatives and milestones. The required disclosure is similar in many respects to the CSA’s guidance on use of proceeds disclosure (Part 3) in CSA Staff Notice 41-307 Concerns Regarding an Issuer’s Financial Condition and the Sufficiency of Proceeds from a Prospectus Offering.
Other Requirements and Provisions of Note
Many of the requirements and conditions in the previous rules for reliance on the exempt rights offering regime continue to apply under the new rules, including:
- The issuer must be current in its continuous disclosure obligations;
- The rights exercise period must be at least 21 days and no more than 90 days;
- All Canadian security holders of the subject class must be provided with a pro rata basic subscription right;
- If there is a standby purchase commitment, the offering must include an additional subscription privilege (i.e. a privilege to subscribe for securities not subscribed for under the basic subscription right) for all holders of rights. In any event, if the issuer includes an additional subscription privilege it must be provided to all holders of rights;
- Provided that they are purchasing as principal (i.e. not as underwriter), standby guarantors (unless they are “control persons”, and therefore subject to special resale restrictions) have the same ability to resell the securities acquired on exercise of rights as any other rights holder (the CSA had proposed, but did not ultimately institute, a four month hold period on the underlying securities acquired by standby guarantors that were not existing shareholders). The CSA have noted their expectation that underwriters in respect of a rights offering would purchase under the “Acting as underwriter” prospectus exemption in Section 2.33 of NI 45-106;
- The issuer is not permitted to pay a soliciting dealer a higher fee for the exercise of rights by holders that were not previously security holders of the issuer; and
- Unless insiders are restricted from increasing their proportionate interest in the issuer, the subscription price for a class of listed securities must be less than their market price. Canadian stock exchanges are particularly concerned that a rights offering not result in an existing large shareholder consolidating control. If there is no standby commitment, a relatively modest discount in the range of 3 - 5% is possible. Where there is a standby commitment, the Toronto Stock Exchange will generally insist on a larger discount (15% for a stock trading above $2.00) in order to strongly incent existing shareholders to exercise the rights issued to them.
As was the case under the previous regime, there is a separate exemption for rights offerings by issuers with a minimal connection to Canada. The previously existing Canada-wide conditions (i.e. that (i) the number of Canadian resident beneficial holders of the class for which the rights are issued be less than 10% of all holders of the class and (ii) the number/amount of securities of the class for which the rights are issued beneficially held by Canadian residents be less than 10% of the outstanding securities of the class) have been maintained. The previously existing single province/territory conditions (i.e. the same test as the Canada-wide test, but based solely on the subject province/territory and with a 5% limit rather than the 10% limit applicable to the Canada-wide test) have been removed.
Finally, secondary market civil liability will now apply for rights offerings that are exempt from the prospectus requirement, providing for liability for a misrepresentation in an issuer’s rights offering circular or its continuous disclosure documents.
With this new and improved process for raising capital through a prospectus exempt rights offering, we expect to see more companies issuing shares this way. The advantages include:
- It should now be possible to complete a rights offering in less than a month. The fact that the rights offering circular has been simplified, and that it does not have to be reviewed by the securities commissions, will significantly streamline the process.
- Unlike a bought deal, or an underwriting on a best efforts basis, there are no underwriting fees to be paid.
- If there is no standby commitment from an existing large shareholder, the discount to market required by the stock exchange may be quite modest. For example, a rights offering could be priced at a 3% discount to the current market price (being about the same as, or possibly less than, would be required in a conventional private placement). This would be particularly important for dividend/distribution paying issuers.
- Existing shareholders like rights offerings because it allows them to participate in a financing that might not otherwise be available to them, and to avoid being diluted.
The disadvantages continue to be:
- A rights offering will still take longer than a bought deal prospectus financing, or a conventional private placement.
- With a rights offering, in the absence of someone providing a standby commitment to purchase any shares not initially subscribed for, the issuer will not know until the end of the process how much money has been raised.
- Where there is a standby guarantee, the Toronto Stock Exchange is likely to insist on a significant pricing discount. That may make the financing less attractive to the issuer than other available options.
 The new prospectus exempt rights offering regime has been implemented by amending Section 2.1 of National Instrument 45-106 Prospectus Exemptions (“NI 45-106”). This section was previously largely a cross-reference to the requirements in National Instrument 45-101 Rights Offerings, but now includes all of the requirements for a prospectus exempt rights offering.
National Instrument 45-101 National Instrument 45-106 rights offerings