Over the last year, we have encountered instances where, when
acting for IPO candidates or their underwriters, information on the
IPO candidates' capital structure was required by the
securities regulatory authorities. Reference was made to the
securities regulatory authorities, referring to their need to
assess the appropriateness of an IPO candidate capital structure in
the name of the public interest. Areas of interest included the
history and development of a corporation and investments made by
the founders as well as on any prior valuation. More specifically,
instances where the proposed IPO candidate never benefited from the
support of venture capital or from a third party investment were a
concern for the securities regulatory authorities as such
investments are of assistance in the determination of the valuation
of the proposed share capital IPO structure.
CSA Staff Notice 41-305 confirms that this concern has now
reached a stage where industry participants must be made aware of
the CSA position on this issue. It is intended to provide guidance
to IPO candidates and their advisors on how to best address the
acceptability of an IPO candidate share capital structure.
This notice mentions that issues regarding shares issued for a
nominal cost consideration were better addressed by the
underwriters, as indicated in National Policy 46-201 - Escrow for Initial
Public Offerings, and that these issues were also
examined by the TSX Venture Exchange and the CNSX as part of their
review of the listing conditions. However, notwithstanding those
policies and guidelines regarding the assessment of the
appropriateness of a share capital structure, the CSA indicated
that there are still IPO candidates with capital structure that
raise public interest concerns and that the regulatory authorities
may object to granting a receipt when the IPO price significantly
exceeds the average price paid by the founders. In particular,
before granting a receipt, the CSA will consider the average
capital contributed per share for all issued and outstanding shares
on completion of the IPO and compare it to the purchase price of
the IPO, thereby assessing the dilution suffered by the IPO
However, other factors considered by the CSA in evaluating
acceptable share capital structures in those circumstances include
the prior development and history of the business, including
whether there exists third-party corroboration of the value
proposed from significant pre-IPO arms-length financing activities,
as noted above, the involvement and sums invested by the founders,
and the length of time and development of the business since its
In addition, outstanding convertible securities with an exercise
price at a significant discount from the IPO price will also be
considered when assessing the capital structure of an IPO
candidate. As a result, if the number of convertible securities is
large enough, or the exercise price is low enough, and if such
convertible securities resulted in a substantial dilution for the
subscribers in the IPO, the securities regulatory authorities may
object to an otherwise acceptable share structure.
This notice brings back to the forefront certain issues
regarding the pre-IPO pricing of convertible securities and escrow
requirements, which had been erased from the minds of industry
participants by previous modifications to the prospectus regime. As
mentioned in this notice, it is not the intention of the CSA to
provide certainty for every possible scenario and to definitively
determine whether a given structure is acceptable, but to provide
some insights regarding factors considered by the securities
regulatory authorities in this respect. These factors should be
kept in mind by potential IPO candidates and their advisors at the
structuring stage of the transactions.
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.
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