Going Public In Canada - Corporate and Company Law

AN INTRODUCTION

Global financial assets have grown in 2012 to over $225 trillion, but growth has slowed since 2007 as issuers around the world scramble to adjust as governments change regulations and markets brace for further uncertainty in the global economic landscape.

For many companies, the decision to go public is an important one. A company must weigh the potential benefits and opportunities to be gained as a public company against the associated risks of corporate life in the public market. The matters to be considered by a particular company in reaching a determination whether to go public are numerous and diverse. Even once a decision to proceed has been made, the process of going public can often be challenging.

This booklet has been prepared in order to offer preliminary assistance to companies – as well as their directors, officers and shareholders – who may be considering going public in Canada and obtaining a Canadian stock exchange listing. Our effort is not a substitute for tailored legal advice.

We at Fasken Martineau DuMoulin LLP are accustomed to giving legal advice to business leaders and financial advisors in connection with going public transactions, both in the Canadian and cross-border contexts. Our experience extends to a number of industries, including financial services, mining, manufacturing, oil and gas, real estate, healthcare, technology and renewable energy. In addition to the historically more traditional initial public offering by way of prospectus, we have advised in connection with other types of going public transactions such as reverse take-overs, capital pool companies and special purpose acquisition companies.

1. THE DECISION TO GO PUBLIC – BENEFITS, BURDENS AND RISKS

The decision whether to "go public" may be one of the most important decisions made in a company's development.

1.1 Benefits Of Going Public

Going public has many potential benefits and opportunities that management must consider in both the context of the business objectives of the company as well as its existing shareholders, including:

1.1.1 Access To Immediate Capital

The principal benefit of a company raising financing from the public is that the net proceeds of the offering may be used by the company to pursue a number of possible business objectives, including acquisitions, research and development, modernization of facilities and assets, repayment of debt or working capital requirements. In addition, a greater value can frequently be generated through a public equity financing than through alternate forms of financing, such as venture capital, thereby reducing dilution to existing shareholders.

1.1.2 Enhanced Future Financing Opportunities

Once a public market for a company's securities has been created, that company will generally have access to a broader range of financing alternatives, including additional common equity, preferred share issuances or convertible debt. An expanded equity base also results in an improved debt to equity ratio thereby permitting the company to issue additional debt, possibly on terms more favourable than if the company was private.

1.1.3 Liquidity For Existing Shareholders

Creating a public market for a company's securities will provide existing shareholders with liquidity for their investment, permitting diversification of personal portfolios and estate planning. Securities regulators may, however, impose certain resale restrictions on existing shareholders. See Chapter 6 - "Going Public in Canada".

1.1.4 Improved Flexibility In Completing Mergers And Acquisitions

A public company enjoys the ability to issue shares instead of, or in addition to, cash in connection with any merger or acquisition, thereby providing greater flexibility in completing a transaction.

1.1.5 Enhanced Corporate Image

A well-managed public offering can enhance a company's public image by becoming better known in the business and financial community through the press, listings in the stock market tables and continuous public disclosure. A public company can often experience broader corporate opportunities, including the ability to attract and retain qualified personnel as well as increasing market awareness of the company's name, products or services. An enhanced public profile may also attract and facilitate dealings with customers, suppliers and other stakeholders who prefer to do business with established entities. A company's customers and suppliers may acquire securities under the public offering, which may in turn lead to new loyalties and possibly even preferential treatment.

1.1.6 Additional Employee Incentive

A public market for a company's securities can facilitate the compensation of that company's senior executives and employees through securities compensation arrangements such as stock option, employee share purchase and share appreciation rights plans. By making reference to the trading price of the securities of the company and that of its competitors, these arrangements can provide plan participants with a transparent measure of corporate performance, to which compensation can be tied. If a compensation arrangement provides for the issuance to participants of a company's securities, participants are afforded the liquidity of the public markets in order to realize efficiently on any appreciation of the value of their equity compensation. In light of these factors, securities compensation plans are often cited as improving a public company's ability to attract talented managers and employees.

1.2 Burdens Associated With Going Public

Although their impact can be controlled through proper advance planning, a going public candidate must consider factors often characterized as burdens.

1.2.1 Loss Of Control

Depending on the amount of equity sold to the public, existing shareholders may be at risk of losing control of the company. Provided the offering results in a broad distribution of shares, existing shareholders need not retain a majority of the issued and outstanding shares in order to retain effective control of the company. However, in circumstances where there is no controlling shareholder, the new public company will be more susceptible to a hostile take-over bid. Existing shareholders may minimize the risk of a loss of control by exchanging their current shareholdings into a new class of multiple-voting shares and offering to the public a separate class of "restricted" shares, which carry less than 50% of the votes. In addition, prior to, or in connection with any initial public offering, certain structural defences to a hostile take-over bid can be implemented such as the adoption of a shareholder rights plan or the creation of a class of "blank cheque" preferred shares in order to ensure that any "loss of control" results in the maximization of shareholder value.

1.2.2 Sharing Success

Investors who contribute capital to a company will share in the risks and the profits of the business. While public investors will share proportionately to their overall investment, in the event that the company expects unusually high earnings in the short or medium-term, existing shareholders may want to defer a public offering until such earnings have been largely realized and command a higher price for the company's securities when it does go public.

1.2.3 Loss Of Confidentiality

Both the process of "going public" and the ongoing continuous disclosure requirements applicable to public companies and their insiders results in a loss of confidentiality. The company's prospectus and continuous disclosure documents will disclose previously confidential information about the company, including its financial position and competitive position, and about its directors and officers, including their remuneration and indebtedness, if any, to the company. While such disclosures rarely have a significant detrimental effect on a company's business following the public offering, some of this information will undoubtedly be of interest to the company's employees, customers, suppliers and competitors.

1.2.4 Initial And Ongoing Expenses

The expenses and time required in connection with a public offering are not insignificant. The greatest cost that will be incurred will be the underwriters' cash commission, which typically ranges in Canada from 5% to 10% of the total proceeds of any initial public offering. Legal, accounting, printing, translation (if applicable), filing and registrar and transfer agent fees, together with the underwriters' out-of-pocket expenses (most often not included in the underwriters' commission), can add between $200,000 to $500,000 to the cost of an offering for the issuer. In addition, there are also the fees of the underwriters' legal counsel that are most often paid for by the company out of the proceeds of the offering. These costs are generally one-half to two-thirds of the company's legal fees. Such expenses are generally deductible for income tax purposes and will not affect a company's reported net income as they are considered to be a capital item under generally accepted accounting principles. An additional and significant cost of the public offering process is the substantial amount of managerial time that must be devoted to the process. The ongoing costs of annual, quarterly and continuous disclosure reporting will also lead to higher administrative costs on a going forward basis for a company that becomes public.

1.2.5 Shareholder Expectations

Management will be subject to increased scrutiny by its shareholders once a company has gone public. Many investors are very interested in a company's short-term earnings because of the direct impact of current earnings on the company's share price. This emphasis on the short-term may require management to shift its strategy to one more focused on short-term rather than longer-term objectives. Certain investors may also desire dividends and management will have to weigh carefully the effect of paying dividends in circumstances where earnings would be more appropriately reinvested. By implementing an effective communications policy, management will be better able to balance shareholders' short-term desires with the company's longer-term goals.

1.2.6 Escrow Requirements And Resale Restrictions

Securities regulators will often require significant shareholders to place some or all of their shareholdings in escrow in connection with a company's initial public offering. Equity securities will generally be "released" in instalments, depending on the size and listing status of the issuer, over a period of 18 to 36 months. Securities legislation also imposes certain restrictions on the ability of controlling shareholders to resell their shares. However, it may be possible for significant and controlling shareholders to dispose of their shares in conjunction with the initial public offering through a contemporaneous "secondary offering", the proceeds of which go to the selling shareholders and not the company. See Chapter 6 - "Going Public in Canada".

1.3 Other Risks

1.3.1 Risk Of Failed Public Offering

A failed or aborted public offering can have a detrimental effect on the public image of a company. Also, depending on the stage of the process at which a determination is made not to proceed, a company may have incurred significant expenses without the benefit of satisfying them with the proceeds of the offering. The underwriters of the offering will play a crucial role in evaluating the market and timing of the public offering so as to reduce this risk.

1.3.2 Liability Under Securities Laws

Securities legislation imposes significant penalties, including fines, on directors and officers who are in breach of provisions of securities legislation. Directors and officers of a public company are accountable to numerous public shareholders and are therefore exposed to a greater risk of personal liability than directors or officers of non-public entities. The adoption of corporate policies on conflicts of interest and insider trading, together with corporate indemnities and directors and officers liability insurance can mitigate the personal financial risks associated with serving as a director or officer of a public company. Also, certain provinces, notably Ontario, the country's largest securities market, have in recent years adopted legislation that gives investors a statutory right to sue a public company and its directors, officers and expert advisers for making misrepresentations in certain written public disclosure documents or in oral statements. In addition, investors are permitted under this legislation to sue the public company and its directors and officers for failing to make required timely disclosure of material information.

2. WHEN TO GO PUBLIC

Timing is a critical factor in the success of any public offering. Improper timing may result in either a failed or delayed offering or a reduced price for the company's securities. Determining when to "go public" requires a company to consider a number of factors, including:

2.1 Management

The quality of a company's management is essential to any successful public offering. Not only must management possess the expertise and experience to lead the company, but management must also exhibit the skills necessary to deal effectively with the financial community and public base of shareholders. If key existing management lack these characteristics or the desire to assume the responsibilities that are required of management of a public company, the necessary talent should be recruited well in advance of commencing the public offering.

2.2 Size Of Candidate

In order to ensure sufficient liquidity to attract institutional investors and to provide for meaningful trading in the "aftermarket" to facilitate continued marketability of the company's shares, larger Canadian investment banks have historically required that the public company candidate have a minimum market value subsequent to the public offering of at least $50 million to $100 million. Public offerings can be structured for issues as small as $1 million especially if a capital pool company or reverse take-over is pursued rather than a traditional initial public offering. See Chapter 6 – Going Public in Canada, Section 6.2 - "Alternatives to the Prospectus Process". However, larger Canadian investment banks normally pursue initial public offering issues that are by way of prospectus and are at least $15 million to $20 million in size.

2.3 Financial Track Record And Future Prospects

While companies with a consistent record of growth over five or more years were once considered ideal candidates for initial public offerings, investors have become increasingly accustomed to support younger companies with innovative products or services, or proprietary or "early adopter" advantages, with high growth rates that appear to be sustainable in the near term.

2.4 Market Conditions

If market conditions are not good, a company could be faced with the possibility of selling its shares at a lower than desirable price or having a smaller than desirable offering, or aborting the offering all together. The underwriters will play a critical role in assisting the company in gauging market conditions and determining the timing of any public offering.

3. WHERE TO GO PUBLIC

Once the decision to "go public" has been made, a company must determine in what market it will do so. The choice of market will depend on a number of factors, including:

3.1 Nature Of Business

A company whose business is primarily conducted and known in a particular market may find that market to be more receptive to an initial public offering. In addition, certain industry sectors are followed more closely by the investment community in a particular market and may command a higher valuation. For example, mining and natural resource companies often find it easier to raise capital in the Canadian public markets.

3.2 Size Of Market

Given the size and diversity of the global investment community, companies may find it easier to complete offerings in markets outside of Canada. For example, some companies prefer to tap the United States capital markets through "private placement" sales to qualified sophisticated United States investors in order to establish their United States shareholder base without becoming subject to the initial or ongoing United States compliance requirements. These private placements are often paired with a broader initial public offering conducted in Canada. Once these companies meet specified size requirements and establish specific reporting histories, many then avail themselves of the "multi-jurisdictional disclosure system" that exists between Canada and United States and permits companies to complete public offerings in the United States through a more stream-lined and cost effective regime by relying, essentially, on Canadian rules.

3.3 Exposure To Litigation

Companies that go public in jurisdictions outside of Canada may be subject to more stringent regulations and an increased exposure to litigation. For example, the United States is a more litigious environment than Canada. Accordingly, companies that go public in the United States subject themselves (and their directors and officers) to the jurisdiction of United States courts and may therefore be more susceptible to litigation than their Canadian counterparts.

Further, companies should be aware that certain foreign regulatory regimes may impose obligations and duties on directors and management that are more onerous than those of Canada. For example, in the United States directors and officers of corporations must comply with the Sarbanes-Oxley Act, commonly known as "SOX". The Sarbanes-Oxley Act imposes additional duties and responsibilities on directors and officers of corporations with a particular emphasis on financial reporting and corporate audit procedures.

4. PREPARING TO GO PUBLIC

There are a number of matters that should be addressed as far in advance as possible by a company prior to undertaking the going public process in order to save considerable time, effort and, most importantly, money, including:

4.1 Business Plan

A business plan should be prepared by management well in advance of any "going public" process. Typically, a business plan will include a description of the company's business and strategies, an analysis of the company's markets, a description of the company's products and services and its primary customers and suppliers, an overview of the company's business units and management structure, a compilation of the company's financial statements and operating results, and a description of the company's financial requirements. (In fact, a good business plan will be a useful tool in dealing with a number of constituencies including early round investors, lenders and potential underwriters.)

4.2 Financial Statements

A prospectus is generally required to include statements of comprehensive income, statements of changes in equity and statements of cash flows for the three most recently completed financial years ended more than 90 days before the date of the prospectus (120 days for an issuer seeking a listing on the TSX Venture Exchange ("TSX-V"), and a statement of financial position as at the end of the two most recently completed financial years. A prospectus must also include a comparative interim financial report, statement of financial position and statement of comprehensive income for the most recently completed interim period that ended more than 45 days before the date of the prospectus (60 days for an issuer seeking a listing on the TSX-V).

For financial years beginning on or after January 1, 2011, issuers are required to prepare their financial statements on the basis of International Financial Reporting Standards ("IFRS"), and to make a clear statement regarding complete compliance with IFRS in the notes to their annual financial statements or, in the case of interim financial statements, to discuss compliance with International Accounting Standard 34, Interim Financial Reporting. The auditor's report accompanying these statements must also address the fact that the financial statements were prepared under IFRS.

While the changeover date for the use of IFRS by issuers was January 1, 2011, financial statements are generally required to be prepared in accordance with the same accounting principles for all periods presented in the financial statements. If an issuer has not prepared financial information for all periods presented in the financial statements using IFRS, additional financial disclosure would be required.

There is an exception to the requirement to prepare financial statements on the basis of IFRS for issuers that already make public filings with the United States Securities and Exchange Commission. Such issuers may be permitted to use financial statements prepared in accordance with United States generally accepted accounting principles, provided that these financial statements contain a reconciliation statement to IFRS. (See Chapter 12 for a more detailed description of exemptions that may be available for certain foreign listed issuers that go public in Canada.)

By preparing financial statements that satisfy these requirements as early as possible, the burden of redoing and obtaining audits for these periods can be avoided, thereby allowing the company to come to market as quickly as possible after the decision to do so has been made. Where the proceeds of an offering are to be used in whole (or in material part) to acquire a business, certain audited historical financial information for the acquired business and pro forma financial information will also be required.

4.3 Internal Systems And Controls

As public companies must provide timely and reliable financial and other information to investors, these companies require more formal management reporting systems than are typically employed by private companies. Management should co-ordinate with its accountants to ensure that systems and procedures to support the financial reporting requirements appropriate for a public company are put in place well in advance of the going public process.

4.4 Corporate Structure

Many businesses are operated through numerous subsidiaries or business units. In order to facilitate the public offering of a single corporate entity, it may be necessary to reorganize the corporate group by either combining the various operating entities or creating a holding company, the shares of which will be offered to the public. Certain non-core assets or business units may be "spun off" and remain private. Consideration must also be given to the tax and accounting consequences of any proposed corporate reorganization. See "Chapter 9 - Canadian Tax Considerations".

4.5 Share Structure Issues

The Canadian Securities Administrators released Staff Notice 41-305 Share Structure Issues – Initial Public Offerings, which discusses the factors that will be considered by securities regulators when assessing the appropriateness of an issuer's share structure in the context of an initial public offering.

The notice states that securities regulators will consider many qualitative and quantitative factors when evaluating the acceptability of initial share structures, including:

the IPO price and how it compares to the average share price paid by founders;
the proportion of capital proposed to be contributed by the IPO purchasers in comparison to the percentage of ownership the IPO purchasers will receive in return;
the amount of time, effort or resources spent developing the business;
the amount of cash contributed and the time invested by founders; and
the number of convertible securities, including stock options, outstanding at exercise prices lower than the IPO price.

While Staff Notice 41-305 provides some insight into the factors that securities regulators will consider when evaluating proposed share structures in the context of an initial public offering, the notice does not provide certainty for every possible scenario or allow participants to determine with absolute certainty if a given structure will be acceptable or not to regulators. As such, early consultations with advisors and regulators are recommended.

4.6 Board Of Directors

The role of directors of a public company is often more significant than the role of directors of a private company. Directors of a public company will require specialized expertise as well as an independent perspective. In addition, certain committees of the board such as the audit committee may need to be comprised entirely of independent members under applicable Canadian provincial securities laws. Management should consider carefully the current composition of its board of directors in these contexts. Stock exchange guidelines also recommend a relatively high degree of independence in a company's board and board committees. Listed companies must annually disclose their compliance (or non-compliance) with these guidelines under applicable Canadian provincial securities law. If there are no (or few) independent or "outside" directors, management should search for experienced individuals who will bring valuable input as board members. A company's underwriters, legal counsel and auditors can often assist in providing names of suitable candidates if required.

For a foreign based business considering using a Canadian corporate vehicle to go public, attention must be given to the fact that federal as well as certain provincial corporate statutes mandate that the composition of a corporation's board of directors must satisfy minimum Canadian residency requirements. For example, corporations incorporated federally or in the provinces of Ontario or Alberta generally must have at least one quarter of their directors be resident Canadians, whereas corporations incorporated in the province of British Columbia or the Yukon territory have no residency requirements for their directors to satisfy.

4.7 Formalization Of Relationships Important To The Business

Private companies often rely on informal agreements, both with third parties and with the management and key employees. Many private companies also have ongoing business relationships with "related" parties, such as shareholders or members of management. In order to create certainty and minimize future risks, public companies strive to formalize wherever possible such relationships. Management should review the company's current business relationships to identify which existing contracts need to be revisited and which informal business relationships, especially those involving related parties, need to be formalized in writing. Consideration should also be given to adopting employee compensation arrangements and entering into written employment agreements with particular employees regarding their compensation arrangements. A company's legal counsel can assist in identifying and adequately documenting such relationships and arrangements.

4.8 Technology Companies - Special Considerations

In addition to the considerations set out above, early-stage and emerging technology companies have a heightened need to attract, retain and protect capital, talent and intellectual property, the essential assets of the modern economy. Management of technology companies should pay particular attention to the following special considerations prior to going public:

Obtain Good Title to Intellectual Property: Intellectual property is the primary basis for the generation of wealth for most technology companies. Technology companies should ensure that patent rights and copyrights are properly and enforceably assigned by the company's employees and/or consultants.
Ensure the Intellectual Property is Adequately Protected: Different aspects of the company's intellectual property may be protected by copyright, patents or trade secrets. Be sure to select the appropriate regime of intellectual property protection that best suits the technology and advances the company's objectives.
Institute a Trade Secret Protection Program: A technology company should ensure that "reasonable precautions" are taken to turn its confidential business information into legally protectable trade secrets. For example, a company should, among other steps, adopt a formal written trade secrets protection policy in addition to entering into nondisclosure agreements with its employees, consultants and third parties.
Conduct Timely Trademark Searches Before Adopting a Trademark or Registering a Domain Name: Conducting a complete trademark search before selecting a trademark or a domain name is often an important step for a technology company.
Take Care in Hiring Former Employees of a Competitor: As the technology industry work force is highly mobile, hiring individuals who may have previously worked for a competitor is common. By taking a few precautions, such as determining whether a potential hire is subject to an enforceable restrictive covenant or has had access to trade secrets of the competitor, companies can substantially reduce the risk of being sued successfully by a competitor.
Ensure Proper Licensing of Technology Patented by Others: When a company recognizes that an existing patent covers an element of its business, proper licensing of those rights is essential. Licensing patent rights can be complex. For example, licensees must ensure that the purported licensor actually has the right to license the rights in question.

5. THE TEAM OF PROFESSIONAL ADVISORS

A company's underwriters and professional advisors play a significant role in the going public process, from assisting with the initial decision whether to go public, to selling the securities offered. Careful consideration should be given to selecting the appropriate working group, both on an institutional and individual level. The central participants in the going public process, in addition to the company, are the following:

5.1 Underwriters

The underwriters play the central role in selling the offered securities. A company will select a "lead underwriter" who will be responsible for advising the company with respect to the public offering generally and market conditions in particular, and co-ordinating the marketing efforts for the company's securities. The lead underwriter will typically assemble an underwriting syndicate comprised of a number of other underwriters who also sell the securities to individual and institutional investors. The lead underwriter will typically also provide "aftermarket" support for the company's securities by writing and disseminating research reports and sponsoring timely investor meetings to help publicize the company's achievements.

5.2 Legal Counsel

A company's legal counsel will often take the lead in co-ordinating the going public process, including providing advice with respect to the structure of the transaction and any preliminary corporate reorganization, assisting the company in formalizing certain of its business relationships, introducing management to other potential professional advisors, including underwriters and accountants, and generally providing advice to management with respect to all matters in connection with the public offering. The company's legal counsel will also play a critical role in advising management as to appropriate policies of corporate governance and ongoing obligations of the public company following the initial public offering. Experienced legal counsel with significant expertise in securities law and the going public process is therefore essential for the company.

Similarly, the underwriters' legal counsel plays an equally important role in making the going public exercise run smoothly for participants, especially the company. Often, the underwriters' legal counsel will have extensive experience, not only in working with the underwriters on other initial public offerings, but in the industry in which the going public candidate operates.

5.3 Auditors

A company's auditors play a significant role not only in the preparation of the company's financial statements for its prospectus, but also in assessing the relative advantages and disadvantages of the going public process itself. As with its legal counsel, a company should engage auditors with a high degree of experience in dealing with the reporting requirements of public companies and who can assist in developing the reporting systems necessary to provide accurate and timely financial information.

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Canada: Going Public In Canada