Australia: Pros and cons of conventional versus back door listing on ASX

Listing on the Australian Securities Exchange (ASX) can be achieved by either a front door or a back door listing. In 2011 there were 151 new listings on ASX, 19 of which were back door listings (13 per cent). Of the 19 companies that were back door listed in 2011, 14 (73.5 per cent) operated a business in the resources industry.¹

As explained in the recently revised ASX Listing Rules Guidance Note 12, a 'back door listing':

This article looks at some of the key issues that arise for the promoters of an entity looking to list on the ASX via the back door. Back door listings are often promoted as the 'cheaper, easier and faster way' to list. ³ However, there is very little published material on the advantages an entity listing by the back door would gain that would not have been available were the entity to list by the front door.

A conventional front door listing

A conventional front door listing requires the promoters of an entity seeking to be listed to comply with the requirements set out in Chapter 1 of the ASX Listing Rules (Listing Rules). ⁴ Listing Rule 1.1 sets out the 17 conditions that must be satisfied before a company is considered for listing on ASX. Those which are most relevant for present purposes are:

• Condition 2 — having the entity's quoted securities (except options) issued or sold for at least $0.20 in cash
• Condition 3 — issue a prospectus or product disclosure document lodged with the Australian Securities & Investments Commission (ASIC) or, if ASX agrees, an information memorandum
• Condition 7⁵ — the requirement to meet the minimum spread requirement, that is, either:
• • at least 500 holders each with a parcel of the main class of securities with a value of at least $2,000 (excluding restricted securities) or
  • 400 holders with a parcel of the main class of securities with a value of at least $2,000 (excluding restricted securities) and persons who are not related parties holding at least 25 per cent of the securities in the main class
• Condition 8 — meeting either the profit test or the asset test
• Condition 9 — complying with Chapter 9 of the Listing Rules in relation to any 'restricted securities' it has on issue or is proposing to issue
• Condition 11 — the requirement that any option the entity has issued are exercisable for at least $0.20 in cash and
• Condition 17 —satisfying ASX that each director or proposed director at the date of admission is of good fame and character and high business integrity.

The front door listing path is well-trodden and although it is usually a busy time in the life of a company, it is a fairly predictable path for those that have travelled it before. Nevertheless there are a small number of promoters that choose to list through the back door.

Circumstances where a back door listing might be favoured

A back door listing is often the only way to achieve a listing, for example:

• where a listed entity seeks to merge with a non-listed entity — a listed entity with a business in a particular industry may wish to take over a non-listed entity with a similar or complementary business. Usually the non-listed entity's business is larger than that of the listed entity, bringing into consideration the requirement that the new combination may need to be readmitted to the official list. This type of combination is usually achieved by a scheme of arrangement or a takeover and
• where a cashed up listed company acquires a new business — a listed entity may have sold its existing business and as a result has considerable cash resources and is seeking to buy a new business or company for the benefit of its existing shareholders. A recent US example of this type of back door listing is ASX listed Biota's proposal to ditch its ASX listing and move to the US. Biota proposes to merge with Nasdaq listed Nabi Biopharmaceuticals, a company with a pool of cash.⁶

The promoters of each of these two combinations would have to consider Listing Rule 11.1 which provides that if a listed entity proposes to make a significant change, either directly or indirectly, to the nature or scale of its activities, it must provide full details to ASX as soon as possible. ASX may then require the listed entity to obtain the approval of its shareholders to the combination and may require that the entity comply with the requirements of Chapters 1 and 2 of the Listing Rules as if the entity was applying for admission to the official list again.

ASX Guidance Note 12 sets out the circumstances in which ASX will require a listed entity to have a meeting of its shareholders and to reapply for admission. Whether the listed entities in the above two examples will have to have a meeting of their shareholders or reapply for admission will depend upon whether there has been a major change in the character of their business or a substantial change to the size of their business operations.

A back door listing as an alternative to a front door listing

The facts of the above two examples dictate that the transaction has to be undertaken as a back door listing. There are also transactions where the promoters and their advisers can choose to do a back door listing instead of a front door listing. ASX Guidance Note 12 notes:

These types of back door listings can be called 'classic back door listings' and typically involves the following features:

• the listed entity is essentially a shell. That is, it has minimum assets, usually some cash⁸
• the directors, owners or promoters (collectively called the promoters in this article) of the non-listed entity wish to list on ASX
• the majority of the directors of the listed entity propose to resign on completion of the combination. An existing director or two may seek to remain on the board to protect the future interests of the existing shareholders in the combination and
• the future interests of the shareholders in the listed entity in the combination will be limited as they will not have much value to trade into the combination.

An example of a recently created listed shell company is Dolomatrix International Limited (DMX). For various commercial reasons, the directors of DMX sought and obtained approval from its shareholders to sell DMX's main undertaking to another company. The transaction was completed in midFebruary 2012 and currently the directors are returning capital to shareholders. In the explanatory memorandum that went to shareholders for the purpose of getting shareholder approval to the transaction, it is stated that:

Thus DMX is presenting itself to the market as a potential classic back door listing vehicle after the distribution to shareholders of the cash from the sale of DMX's main undertaking.

How to go about a back door listing

The main reason why the promoters of a non-listed entity would seek to use an existing listed entity as the vehicle to list their business in a classic back door listing scenario is because the listed entity has the required spread of shareholders or close to the required spread.

As mentioned above, Condition 7 of Listing Rule 1.1 requires the new listed entity to have a minimum spread of shareholders. If a non-listed entity with a small number of shareholders wishes to list

by the front door, it would usually achieve this by offering shares to the public under a prospectus with a minimum subscription of $2,000 per subscriber.

If the prospectus offer is underwritten, or if a sponsoring broker undertakes to assist with the prospectus offer, it would usually be the case that there is an obligation on the underwriter, or a best endeavours commitment on the sponsoring broker, to achieve the minimum spread.

When investors are worried about the market, it may be difficult to get the required spread by a prospectus offer to the investing public. In such times, underwriters and brokers might encourage certain companies to list via the back door, using an existing listed entity that already has the minimum spread, or close to the minimum spread, of shareholders. The controllers of the listed shell will be 'selling' this spread of shareholders to the promoters of the non-listed entity.

Thus the first step for the promoters of a non-listed entity is to choose a non-trading listed entity to be the vehicle for the listing of its business on ASX. The promoters of the non-listed entity and the directors of the chosen listed entity will then negotiate a number of matters.

• What percentage will the existing shareholders of the listed entity have in the new vehicle once the non-listed entity is acquired? It is likely that the existing shareholders will only have a small shareholding in the combined entity as the value of the listed entity is likely to be low.
• Is any cash to be paid to the listed entity's shareholders? Normally, any cash that is paid would go towards paying for the expenses of the proposed re-listing or, if the company is in administration, to the administrator to make a part payment to the creditors of the listed entity. It may be, though it is not often the case, that cash will be paid to the listed entity so that a dividend can be paid to the existing shareholders. However, if there is cash to be traded, then it is usually left in the listed entity and the existing shareholders retain some equity interest in the on-going vehicle.
• Does the capital of listed entity (A) need to be consolidated? Condition 2 of Listing Rule 1.1 requires that the entity's quoted securities are sold for at least $0.20 in cash. It is likely that the existing shareholders' shares will not have a minimum value of at least $0.20 per share. It may be necessary to increase the per share price of the existing shareholders' shares to the value of the shares to be issued under the offer to the public. This would be done by a consolidation of the shares held by the existing shareholders.

An example

An example will clarify the issues. Table 1 sets out the share structure of listed entity (A).

The current market price of each share in A is $0.10 per share, which represents the value of the cash in the company (a total of $662,500). It is proposed to consolidate the existing capital of A so that for every two shares held, each shareholder will have one share after the consolidation. This will reduce the number of shares on issue in A from 6,625,000 to 3,312,500.

The shareholders of non-listed entity (B) think their company is worth about $10,000,000. This means that at an issue price of $0.20 per share on the acquisition of B, they will be issued 50,000,000 shares in A and the new combination will need about $2,000,000 for working capital purposes, which means that, at an issue price $0.20 per share, 10,000,000 shares will be issued to the investing public.

Table 1: Existing capital structure of listed entity (A)

Table 2: Capital structure of listed entity (A) after restructure and share issues

Table 1 shows that, of the 475 shareholders, there are:

• 250 shareholders with 10,000 shares (after the consolidation of the capital — 5,000 shares) at an aggregate market value of $1,000 and
• 100 shareholders with 15,000 shares (after the consolidation of the capital — 7,500 shares) at an aggregate market value of $1,500.

These 350 shareholders cannot count towards the required 500 shareholders that A needs to list. This is because none of them have a shareholding with a minimum value of at least $2,000. Only 125 of the 475 existing shareholders can count towards the total of 500 shareholders required for a relisting of A. Thus, from the proposed prospectus issue, the promoters of the combination would need to procure at least 375 new shareholders each holding a marketable parcel of at least $2,000.¹⁰

The promoters of B may conclude that A is not a particularly desirable entity for the listing of their business. An alternative vehicle with closer to or above 500 shareholders, each with a minimum parcel, would be more valuable than a vehicle with just 125 shareholders with such a parcel.

Table 2 sets out the capital structure of A after the consolidation of the capital, the issue of 50,000,000 shares to the shareholders of B and the issue to the public of 10,000,000 shares. You can see from this capital structure that the old shareholders of A are only entitled to have 5.2 per cent of the capital of the new entity going forward by reason of the cash in the company.

However, the controllers of A (that is, the directors, major shareholder or administrator) will be seeking to extract some extra consideration for giving B the right to use A for its listing. This consideration would be in addition to the 5.2 per cent of equity they are already entitled to (in their view) by reason of the $662,500 cash already in the company.

The promoters of B may be prepared to give some more shares or, in some circumstances, pay some cash to A which could be distributed to the existing shareholders. However, the promoters will not want to pay too much as at some point, it will be cheaper and simpler to just list by the front door.

Indeed, it is questionable whether it is always worthwhile to pay a premium for the opportunity to use an existing listed entity that already satisfies, or in particular, those that nearly satisfy, the minimum spread requirements under the Listing Rules, because it is common in Australian back door listings for a prospectus offer to be made contemporaneously with the readmission process. ¹¹ Therefore, promoters of B are equipped with an alternative means of achieving the 'spread' requirement, and do not need to rely on the shareholder base of the existing listing vehicle.

The promoters of the non-listed entity will have to weigh the advantage of the spread of shareholding offered by the listed entity against the need to give additional consideration for the so-called 'sale' of the listed entity and other issues that arise in a classic back door listing, including:

• the cost and time in preparing a notice of meeting for existing shareholders of the listed entity to approve the transaction
• the cost and time in undertaking due diligence investigations on the listed entity and including details from the due diligence in the prospectus to raise funds for the new listed entity
• the additional cost and time in negotiating a share or business sale agreement with the directors of the listed entity and
• the need to issue additional shares or options to the existing directors of the listed entity.

Shareholder approval

In a classic back door listing, given the proposed change in the nature and scale of the listed entity's activities, Listing Rule 11.1 will require that approval be obtained from the listed entity's shareholders to the acquisition of the non-listed entity. In addition, consideration will need to be given to whether shareholder approval is required under item 7 of s 611 of the Corporations Act 2001 (Corporations Act) and Listing Rule 7.1.

The requirement for shareholder approval may add additional time and expense to the combination process which will need to be taken into account.¹²

Section 611 item 7 and Listing Rule 7.1

It is not unusual for the issued capital in a non-listed entity to be held between a small number of shareholders, some of whom may have substantial holdings in the non-listed entity. Sometimes, as a result of the proportion of these holdings, the listed entity will need to issue more than 20 per cent of its capital to a shareholder of the non-listed entity as consideration for the transfer of that shareholder's shares in the non-listed entity to the listed entity.

The takeover provisions of the Corporations Act however provide that a third party cannot acquire a voting power ¹³ greater than 20 per cent in a company except via one of the approved means. One approved means is where an acquisition has had the prior approval of shareholders of that company, in accordance with the specific requirements of s 611 (item 7) of the Corporations Act.

Similarly, Listing Rule 7.1 (also known as the 15 per cent rule) limits the capacity of a listed entity to issue securities equal to more than 15 per cent of the total number of ordinary securities on issue at the beginning of the immediately preceding 12-month period, unless the issue is approved by shareholders (or otherwise falls within one of the exceptions to Listing Rule 7.1).¹⁴

In other words, using our example by way of illustration, what the Listing Rules and the Corporations Act respectively require is that, if:

• a proposal to issue 50 million shares to the shareholders of B will breach the threshold prescribed under the 15 percent rule or
• as part of that issue, any shareholder in B is proposed to be issued with more than 20 per cent of the capital of A,

the directors of A must call a shareholders' meeting to approve that issue.

The above solution is of course on the proviso that A is not itself subject to the takeover provisions. Such circumstances would greatly complicate the back door listing process.¹⁵

Listing Rule 11.1

Approximately 79 per cent of back door listings from January 1992 to December 2007 were required to re-comply with ASX's listing conditions. ¹⁶ In accordance with Listing Rule 11.1, all of those entities would have been required to hold a general meeting for shareholders to approve the change in nature or scale of the business of the entity as a result of the combination.

On a comparison by Brown et al of those back door listed entities requiring readmission and those not requiring readmission in the above period, the duration of the back door listing in respect of the former entities took, on average, an additional 83.2 days to conclude than in respect of the latter entities.¹⁷

This extra time (and money) spent on the general meeting would not have been necessary had the non-listed entities involved in those back door listings, been listed by the conventional front door approach. The requirement for shareholder approval under the Corporations Act and the Listing Rules is therefore a real consideration for promoters of an entity in determining if it is worthwhile to list by the back door.

Notice requirements

Promoters should also note that the explanatory memorandum that must accompany the notice of meeting to shareholders of the listed entity must give shareholders all information material to making an informed assessment as to whether to approve or reject the combination. ASIC Regulatory Guide 74 sets out in more detail what ASIC considers should be included in the explanatory memorandum. One item that promoters should particularly observe is the need to include an expert's report where the expert is to express an opinion as to whether the transaction is fair and reasonable to the non-associated shareholders of the listed entity.¹⁸

The history of the listed entity

In assessing whether an existing listed entity is an appropriate listing vehicle for a back door listing, the promoters of the non-listed entity should also carefully consider the history of the entity.

Every company has a history. To return again to our previous example, listed entity A has a history and may have incurred liabilities (some actual, some contingent and some of which may be unknown to the current management) in the course of its previous trading.

To ascertain the true financial position of A, the promoters of non-listed entity B will need to undertake due diligence investigations on A. Again, this will add to the time and expense of the process. In addition, any findings from the due diligence investigations will have to be disclosed in the prospectus made available to the investing public.

If there is any possibility that A's past liabilities will affect the combination's future, A should not be used as the vehicle for the listing of B. This should be one of the first things that is considered before the promoters of B proceed too far with negotiations.

One way to deal with past liabilities of a listed entity is through the appointment of an administrator to the company pursuant to Pt 5.3A of the Corporations Act and then have that administrator enter into a deed of company arrangement (DOCA) with A's creditors. ¹⁹ Pursuant to s 444D, a DOCA binds all creditors of the company so far as concerns claims arising on or before the date specified in the deed.

With a valid DOCA, the promoters of B can be confident that A's past liabilities have been dealt with.

Share or business sale agreement

A listing will often involve the entry of a share or business sale and purchase agreement.

In a front door listing, if the non-listed entity is not itself to be listed, a 'clean skin' vehicle will often be used as the listing vehicle and will purchase all the shares in, or the business of, the non-listed entity. A share or business sale and purchase agreement will be entered into between the non-listed entity's listing vehicle and the shareholders of the non-listed entity.

With a back door listing, the listed entity will enter into a share or business sale and purchase agreement to purchase all the shares in, or the business of, the nonlisted entity

The difference to note is that, in the case of a back door listing, the controllers of the listed entity will be on the other side of the negotiations to the promoters of the listed entity. This would not be the case with a front door listing.

The need for separate negotiations of a sale and purchase agreement may also add to the timing and costs of the listing for the promoters of the non-listed entity

Capital raising — Condition 3

The classic back door listing involves the backing of a non-listed entity into a listed corporate shell with no or very limited business operations, and therefore minimal assets. Therefore, at least in Australia, most — if not all — back door listings will entail a contemporaneous capital raising.²⁰

As a result, and in satisfaction of Condition 3 of Listing Rule 1.1, the listing entity will generally need to issue and lodge with ASX and ASIC a full prospectus, containing 'all the information that investors and their professional advisers would reasonably require to make an informed assessment' of the offer being made under that prospectus.²¹

This is no different to the requirements that a front door listed entity would need to satisfy in an initial public offering.

Even in the (rare) event that a back door listed entity has sufficient working capital such that it does not need to make a prospectus offer to raise capital at the same time as the back door listing, Condition 3 of Listing Rule 1.1 nevertheless requires that the listing entity must issue an information memorandum.

While an information memorandum is not a prospectus, ²² the degree of disclosure made by the listing entity in its notice of meeting pursuant to item 7 of s 611 and Listing Rules 7.1 and 11.1 — that is, all information material to making an informed assessment as to whether to approve or disapprove the combination — is generally no less onerous than the prospectus standard.

Further, a listing entity that issues an information memorandum and notice of meeting, and the promoters involved in the back door listing process, would not have the benefit of the due diligence defence that would have been available had the listing entity issued a prospectus. These considerations must be balanced against any value that the promoters of the non-listed entity may attribute to having a right to list through an existing listing entity

Securities to be issued

In preparing for a listing, it is also important that promoters have regard to both:

• what types of securities can be issued under the Listing Rules and
• what types of securities the promoters wish to issue as part of the combination.

Restricted securities

Condition 10 of Listing Rule 1.1 requires that if, in the two years before the date of application, the entity proposed to be listed acquired a classified asset from a related party of the entity or a promoter, the consideration must be in restricted securities unless the consideration was the reimbursement of expenditure incurred in developing the classified asset or one of the other exceptions applies.

A restricted security is a security where there is an agreement that the security will not be sold by the holder for a given period of time. Typically, a vendor of a classified asset who is also a promoter or related party of the entity would normally have their shares restricted for sale for 24 months. A classified asset includes:

1. an interest in a mining exploration area or similar tenement or interest
2. an interest in intangible property that is substantially speculative or unproven, or have not been profitably exploited for at least three years, which entitles the entity to develop, manufacture, market or distribute the property and
3. an interest in an asset which, in ASX's opinion, cannot readily be valued.

So, in preparation for listing, it is important that the entity proposed to be listed does not agree to pay cash to a promoter in exchange for a classified asset. It can only agree to issue restricted securities.

Restricted securities do not count in determining whether the listed entity has 500 shareholders with a minimum value of $2,000. If there are already restricted securities issued in the listed entity, they will have to be excluded from the calculation for the purposes of Condition 7 of Listing Rule 1.1.

Performance shares

Sometimes the promoters of the non-listed entity may wish to issue performance shares to executives or major shareholders in the unlisted entity on the basis that they will convert to ordinary shares on the achievement of certain milestones.

As part of the negotiation with the controllers of the listed entity, performance shares may be issued to directors or executives of the listed entity as well.

Listing Rule 6.1 requires that the terms that apply to each class of equity security must, in ASX's opinion, be appropriate and equitable. In this regard, ASX will often apply conditions to their approval to the issue of performance shares including:

• obtaining shareholder approval to their issue and
• requiring that the performance shares:
  1. are not transferrable other than as may be required by law
  2. do not have any voting rights, other than any that are required to have by law
  3. provide that the performance shares do not have any right to receive dividends or confer on the holder the right to participate in any new issues of capital including bonus shares and entitlement issues prior to this conversion to ordinary shares and
  4. will each convert into one ordinary share on achievement of the relevant milestones and if, the milestones are not achieved by the relevant expiry date, each holder's performance shares will be consolidated into one performance share and then converted into one ordinary share.

Conclusion

This article has looked at some of the issues to consider in deciding whether to undertake a back door listing.

It will usually be the case that a front door listing is to be preferred over a classic back door listing. However, the decision-making process is not always that simple.

What is important is that the promoters of a non-listed entity seeking a listing are able to make an informed and timely decision about which is the best way to list. Hopefully this article has informed them that little bit more.

Footnotes

* The assistance of Belle Jing, Solicitor, Addisons in the preparation of this article is greatly appreciated.

¹ Based on information provided by ASX
² ASX, 2012, Listing Rules Guidance Note 12 — Significant changes to activities, 1 January, p 2
³ Brown PR, Ferguson A and Lam P, 2010, 'What's in a Shell? Analysing the Gain to Shareholders from Reverse Takeovers', 30 November, http://ssrn.com/ abstract=1896004 [1 May 2012], p 2
⁴ ASX, Listing Rules, www.asx.com.au
⁵ On 2 April 2012, ASX released a consultation paper, Strengthening Australia's equity capital markets: ASX proposals and consultation. One proposal in the paper is to update the current admission requirements by:
" adjusting the shareholder spread test to 400 shareholders with holdings of $2,000 or more, or 350 shareholders with holdings of $2,000 or more and a minimum of 25 per cent held by unrelated parties, or 300 shareholders with holdings of $2,000 or more and a minimum of 50 per cent held by unrelated parties and
" increasing the net tangible assets test from $2 million to $4 million.
⁶ Heffernan M, 2012, 'Biota joins forces with US firm before seeking Nasdaq listing', Sydney Morning Herald — Business Day, 24 April, p 3, 24 April
⁷ ASX Guidance Note 12, p 3 ⁸ ASX will give a listed company six to 12 months before it will move to delist the company. In that time, the company's directors must seek to find another business in order to allow the listed company to start active life again. Some companies have been suspended from trading for many years but are still listed on ASX and still looking for a new life such as China JXY and Quoin Limited which have been suspended for 14 years 11 years respectively Rochfort S, 2012, China's slow boat journey to relisting', Sydney Morning Herald — Business Day, 24 April, p 2
⁹ DMX, 2012, Notice of General Meeting and Explanatory Memorandum, 9 January, p 8
¹⁰ 500 shareholders will be required to relist A as, after the combination, related parties would hold more than 75 per cent of the capital of the combined entity: Condition 7 of Listing Rule 1.1
¹¹ Brown et al, op cit, p19
¹² In respect of listings in the period of January 1992 to December 2007, back door listings took a mean duration of 162.9 (median 130.5) days to be concluded (measuring from the first announcement date till the date of completion) whereas the mean duration of an IPO, as measured from the prospectus lodgment date till the first date of trading, was 54.5 (median 50) days: Brown et al, op cit, p 18
¹³ The relevant prohibition is on acquiring a relevant interest in issued voting shares if someone's voting power in the company increases from (i) 20 per cent or below to more then 20 per cent; or (ii) a starting point that is above 20 per cent and below 90 per cent: s 606 Corporations Act
¹⁴ In its consultation paper, ASX has also proposed an amendment to 'supplement' the 15 per cent rule by enabling mid to small capitalisation companies to seek shareholder approval to issue an additional ten per cent of the relevant company's issued capital — at a maximum of 25 per cent discount to market price — within 12 months of the approval being given. This amendment would not affect issues up to the 15 per cent threshold under the existing Listing Rule 7.1, for which shareholder approval is not required
¹⁵ See, for example, the merger of Probiomics Limited (now, Bioxyne Limited) and Hunter Immunology Limited in late 2011 and early 2012
¹⁶ Brown et al, op cit, p 34
¹⁷ ibid
¹⁸ Some commentators have suggested that the requirement for the expert to determine that the transaction is fair and reasonable is a reason why listed entity shareholders may get a better deal than would otherwise be the case: Brown et al, op cit
¹⁹ Another way to minimise ongoing liabilities for A is to consider buying a reps and warranty insurance policy. These policies are becoming more common in merger and acquisition transactions
²⁰ Brown et al, p 19
²¹ s 710 Corporations Act
²² See note to Condition 3 of Listing Rule 1.1

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.