Canada: Initial Public Offerings in Canada - A Business Law Guide

INTRODUCTION

Going Public

The decision to go public is a significant milestone for a company. "Going public" refers to the process by which a private company becomes a public company. The most common procedure for going public is completing an initial public offering (IPO) of securities to the public. Generally speaking, a company completing an IPO will also apply to list its securities on a stock exchange. This guide provides a general overview of the IPO process in Canada and ongoing reporting and governance requirements for Canadian public companies. The focus of this guide is on Canadian and foreign private companies rather than companies that have previously gone public in another country.

Completing an IPO will often involve significant changes to a company's corporate, capital and management structures. Once public, a company will be subject to a number of rules and reporting obligations. Accordingly, the decision to go public is not one to take lightly. First, a company should focus on why it wants to go public, what its plans are and how going public will help it accomplish these plans.

Benefits and Costs of Going Public

Going public has considerable benefits:

  • A value for securities can be established.
  • Liquidity for investors is enhanced since securities can be traded through a public market.
  • Publicly traded securities are attractive for certain other purposes (as transaction currency or executive and employee compensation, for example).
  • Other financings, both public and private, can be facilitated more cost-efficiently.
  • Credibility with the public is enhanced, as is the corporate image.
  • No interest is paid on common equity in a company, whereas funds borrowed from a financial institution or raised as a debt issuance do yield interest.

Although there are many benefits, the costs of going public are considerable – for example:

  • Upfront costs of an IPO can be significant. Underwriters' commissions are typically 5%–7% of the proceeds of an IPO; their expenses are additional. A company will also incur other expenses, including legal, accounting, printing and filing fees.
  • IPOs can lead to greater public scrutiny: financial results, share price, management and director performance, executive compensation, corporate governance practices and insider trading information will all be available to the public.
  • The controlling shareholders' percentage equity interest and voting interest in the company is typically lowered, a situation that, among other things, could make the company vulnerable to a control transaction.1
  • Extensive management resources are required.
  • Transaction freedom is more limited (related party transactions for a public company are regulated, and a public company will be subject to stock exchange requirements, including requirements for shareholder approval of certain matters).
  • The potential for lawsuits against the directors and management is increased.

Going Public in Canada

Several unique benefits are gained by going public in Canada:

  • A vibrant institutional and retail investor base exists in Canada.
  • Canada has a strong investment culture – 50% of Canadians own shares of public companies.
  • The Toronto Stock Exchange (TSX) is the world's leading exchange for mining companies.
  • The TSX includes many companies holding exclusively or primarily foreign assets.
  • There is significant analyst coverage for TSX-listed companies.
  • Going public in Canada can be a stepping stone to a U.S. IPO.
  • Canadian regulatory compliance requirements are less onerous than U.S. requirements in some respects. For example, auditor attestations of larger companies' internal controls are mandated by the U.S. Sarbanes-Oxley Act of 2002 but are not required in Canada.
  • The Canadian business environment is generally less litigious than its equivalent in the United States.

The TSX is becoming an increasingly appealing exchange for foreign companies. More than 300 foreign companies, including those from the United States, China, Israel and the United Kingdom, trade on the TSX and the TSX Venture Exchange (TSX-V). Of these, approximately 150 either were incorporated in the United States or have their principal headquarters there (see chapter 7 for information on adding a Canadian offering to a U.S. IPO).

As the TSX is home to approximately 58% of the world's public mining companies and approximately 35% of the world's public oil and gas companies, the TSX and the TSX-V are particularly attractive to companies of all sizes in the mining and energy sectors. These exchanges are also increasingly the market choice for small to mid-cap companies in the technology, clean-tech and industrial sectors.

A foreign company does not need to be incorporated in Canada or have Canadian operations or management to list on the TSX or the TSX-V. However, the exchanges will generally require that some members of the company's board of directors have North American public company experience.

OVERVIEW OF SECURITIES REGULATION AND STOCK EXCHANGES IN CANADA

Securities Regulation in Canada

In Canada, securities regulation is a provincial and territorial matter: each province and territory enacts its own securities legislation, whose requirements and structure are generally consistent across Canada. Although there is no national securities commission in Canada, the provincial and territorial securities commissions generally work together to coordinate and harmonize regulation of the Canadian capital markets through the Canadian Securities Administrators (CSA). The CSA has focused its efforts on developing uniform rules and guidelines, coordinating approval processes, developing national electronic filing systems and coordinating compliance and enforcement activities. In describing Canadian legal requirements, this guide focuses on the harmonized CSA regulations and the requirements under Ontario law, which are very similar to those of other provinces and territories.

Companies organized under Canadian corporate laws may also be subject to additional requirements under those laws after they go public. However, those requirements are generally consistent with the securities law requirements described in this guide.

Where to File a Prospectus and Why

Because each province and territory has its own securities commission, a company must file a prospectus in each jurisdiction in which it wishes to raise capital. National Policy 11-202, Process for Prospectus Reviews in Multiple Jurisdictions, provides a coordinated process for filing and reviewing prospectuses and related materials in multiple jurisdictions. Under NP 11-202, a company can access capital markets in several jurisdictions by dealing with only one securities regulatory authority, which acts as the principal regulator. In general, the principal regulator for a company will be the securities commission of the province or territory in which the company's head office is located.

Despite the lack of a single national securities commission, most provincial securities commissions operate under a "passport system," so that compliance with the rules and decisions of the principal regulator constitutes deemed compliance with the requirements of all other participating jurisdictions. In essence, compliance with the home province's or territory's requirements provides a passport to undertake activity in capital markets across Canada. However, there remain concerns with this system. For example, Ontario, Canada's largest capital market, does not participate in the passport regime. If a securities commission outside Ontario is the principal regulator and the prospectus has also been filed in Ontario, the prospectus is known as a "dual prospectus." In this case, the principal regulator will coordinate its review with that of the Ontario Securities Commission (OSC), and the company may have to deal separately with two securities commissions.

The CSA has developed an online system whereby prospectuses and continuous disclosure documents can be filed with the various securities commissions and viewed by the public. The System for Electronic Document Analysis and Retrieval, or SEDAR, provides access to all Canadian public company filings under applicable securities laws on its website (www.sedar.com). The CSA's online system for insider reporting filings, SEDI, is described in chapter 8.

Filing a Prospectus in Quebec

As in the other provinces and territories, a company that wishes to raise capital in Quebec must file a prospectus with Quebec's securities commission. However, a prospectus filed in Quebec must be filed in French only, or with both English and French versions. The translation of documents makes filing in Quebec more expensive than filing elsewhere in Canada. Nonetheless, the general view is that costs associated with translation are outweighed by the benefits associated with access to prospective investors in Quebec.

Possible Switch to a National Securities Regulator

Critics argue that the current system of separate provincial and territorial securities regulation fosters inefficiencies and can compromise the effective development, administration and enforcement of securities laws in Canada. Despite the substantial harmonization of many securities law requirements, companies must comply with potentially differing rules and regulatory interpretations, a situation that can be exacerbated by regulatory competition among jurisdictions. Many observers believe that the current system has also been a disincentive to foreign issuers accessing the Canadian capital markets, and to foreign investment generally. In response, the Canadian government has begun to lay the groundwork for the establishment of a single national securities commission. In 2009, the government announced the launch of the Canadian Securities Transition Office (CSTO) to lead Canada's effort to establish a national securities commission. To date, the CSTO and the government have drafted a proposed Canadian Securities Act, which was released in May 2010 and is modelled on existing provincial securities regulation. Concurrently, the government referred the proposed Act to the Supreme Court of Canada to determine whether it is within the constitutional authority of the Parliament of Canada. The initiative might move forward if a favourable opinion is received and the political will to proceed is sustained.

In the interim, the current system continues to operate on a cooperative, generally harmonized basis, with the passport system as a key feature. The fact that Canada has a multilateral system, with many securities commissions, generally has minimal impact on a public company's day-to-day operations. As a practical matter, a company will usually have to deal with only one securities commission, in the jurisdiction where the principal office is located.

Stock Exchanges

The TMX Group owns and operates the TSX and the TSX-V. The TSX gives companies with an established business access to public equity, liquidity for existing and new investors and the market exposure associated with being listed on a world-class market.

The TSX-V is a public venture capital market for emerging companies, providing access to a marketplace in which these companies can raise capital to develop and market their properties, products and services. The TSX-V comprises a flexible, two-tiered system, with the potential to graduate to the senior exchange, the TSX.

Listing on the Toronto Stock Exchange

A company seeking to list on the TSX must meet specified minimum financial, distribution and other standards. A company must file a listing application together with supporting data to demonstrate that the company is capable of meeting these minimum listing requirements. Further, the company must enter into a listing agreement with the TSX, committing it to comply with TSX requirements on an ongoing basis.

The minimum financial requirements and public distribution requirements vary with each category of applicant company. Applicant companies are placed in one of three categories: Industrial (General), Mining or Oil and Gas. If the primary nature of a business is not distinct, the TSX will place the company into a listing category following a review of its financial statements and other documentation. In general, an applicant company, once listed, must have at least one million freely tradable shares with an aggregate market value of at least C$4 million held by at least 300 public shareholders, each holding at least one "board lot," which means

  • 100 securities if the securities trade for C$1 or more;
  • 500 securities if the securities trade between C$1 and 10 cents; or
  • 1,000 securities if the securities trade under 10 cents.

"Freely tradable" refers to all the issued and outstanding securities (excluding the securities owned by directors, officers and significant securityholders), as well as any securities subject to resale restrictions.

An applicant company must also demonstrate that it has satisfactory management expertise and experience. This should relate not only to the company's business and industry, but also to public company experience. For a management team, companies must have at least two independent directors, a chief executive officer, a chief financial officer and a corporate secretary. The stock exchange or securities commission may undertake background searches of a company's officers and directors, either at the time of the IPO or when new members of management join the company.

At the time a company is approved for listing by the TSX, the company will be designated as either an "exempt issuer" or a "non-exempt issuer." Exempt-issuer status can be attained when the applicant company is established, has net tangible assets of C$7.5 million or more and meets prescribed cash flow, pre-tax profitability and working capital requirements. For non-exempt issuers, sponsorship by a Canadian registered dealer or affiliation with an established issuer on the TSX can play a significant role in determining the suitability of a company for listing on the TSX. Exempt issuers do not require sponsors. In the case of a mining applicant company, the company must also prove reserves capable of providing a mine life of at least three years. If these requirements are not met at the time of original listing, the company may gain exempt status later, when the requirements are met, either (i) on application in writing, accompanied by the applicable fee from the non-exempt issuer, or (ii) upon review by the TSX.

Listing on the TSX Venture Exchange

As in the case of the TSX, a company seeking to list on the TSX-V is subject to financial, distribution and other standards. An applicant company must file a listing application together with supporting data demonstrating its ability to meet the minimum listing requirements of the TSX-V. Further, an applicant company must also enter into a listing agreement with the TSX-V to uphold the ongoing requirements to maintain the listing.

The TSX-V is generally made up of emerging companies, with a focus on the resource sector. As a result, its listing requirements are aimed more toward management experience than toward a company's products and services. Applicant companies are classified into two tiers on the basis of historical financial performance, stage of business development and financial resources. Tier 1 comprises companies with greater financial resources and therefore has more onerous minimum listing requirements and ongoing tier maintenance requirements than tier 2, which comprises early-stage companies in all industry sectors. The TSX-V contains more tier 2 issuers, any of which can reach tier 1 status upon meeting the tier 1 minimum listing requirements.

A tier 1 company must have at least one million freely tradable shares with an aggregate market value of at least C$1 million, held by at least 200 public shareholders, each holding one board lot or more. Tier 2 companies must have at least 500,000 freely tradable shares with an aggregate market value of at least C$500,000, held by at least 200 public shareholders, each holding one board lot or more. Minimum quantitative requirements such as net tangible assets, working capital and financial resources are based on tier and industry sector.

An applicant company in certain categories and industry sectors may be required to submit a management plan that outlines its reasonable expectation of earnings, working prototypes, test results or geographical reports to demonstrate the company's viability. As mentioned above, sponsorship and a sponsor's report may be required in some cases. Sponsorship may be pivotal in determining whether an applicant company meets the TSX-V listing requirements.

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Footnote

1. For a detailed discussion on takeover bids in Canada, refer to Torys' Business Law Guide Takeover Bids in Canada and Tender Offers in the United States: A Guide for Acquirors and Targets.

Torys has offices in Toronto, New York and Calgary*
*For general inquiries, contact Oriana Cheung at ocheung@torys.com

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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