On March 2, 2012, the Canadian Securities Administrators (CSA) issued Staff Notice 41-307 (the Notice) to alert issuers about its approach when concerns regarding the financial condition of an issuer and/or the sufficiency of proceeds in the context of a prospectus offering are raised. The guidance is applicable to all issuers other than investment funds and it applies to all prospectus reviews.
Significant Concerns May Result in Receipt Refusal
Securities legislation prohibits the issuance of a receipt for a prospectus if it appears that the proceeds from the offering, in addition to the issuer's other resources, will be insufficient to accomplish the purpose of the fundraising stated in the prospectus. This is referred to as the "sufficiency of proceeds receipt refusal provision".
The CSA have concerns with the potential implications to investors who invest in issuers that do not provide sufficient disclosure of their ability to fund current operations, where the issuer is experiencing negative cash flow from operating activities, or where the issuer has working capital deficiencies, net losses or other significant going concern risks.
Potential Receipt Refusal
A receipt for a prospectus will not be issued where:
- it appears that the prospectus inadequately discloses an issuer's financial condition and going concern risk; or
- there is adequate disclosure about the issuer's financial condition, but either the sufficiency of proceeds receipt refusal provision is applicable or it is not in the public interest to issue the receipt.
Guidelines for Short-Term Liquidity Requirements
It is the view of the CSA that issuers should have funds to meet short-term liquidity requirements as follows:
Type of Issuer
Resources to Meet Short-Term Liquidity Requirements
Exploration stage issuer
Sufficient to reach completion of next phase of a project
Development stage issuer
Sufficient to achieve the issuer's next significant milestone
Research and development issuer
Sufficient to achieve progress on development of a key product
Issuer with active operations
Ability to continue operations for the short-term
Areas of Focus
Key areas in which comments may be raised during the prospectus review process are identified below. These areas are not exhaustive.
Missing Information Regarding Offering Amount and Pricing
If a preliminary prospectus is filed with the offering amount and pricing information bulleted, the CSA will require a reasonable opportunity to review a blackline of the draft final prospectus showing the changes made to the preliminary prospectus. While this is not new, the guidance clearly states that in order to avoid unanticipated delays, issuers should ensure that the blackline form of the final prospectus is filed not less than two business days prior to filing final materials. The blackline should include the information bulleted in the preliminary prospectus and if it is not practical to provide that information an estimate or range of these figures, as applicable, may be accepted.
The CSA may also request copies of any green sheets or other marketing materials in order to assess at an early stage the financial condition of the issuer in the context of the anticipated offering amount. The green sheets will also show whether the final offering amount is substantially less than originally anticipated.
The CSA will review the overall structure of the proposed offering in the context of the issuer's financial condition. The following structures were discussed in the Notice:
(a) Best Efforts Agency Offering – The question here is whether there should be a minimum subscription amount. Currently, minimum amounts are not required in long form or short form prospectus distributions. Nonetheless, the Notice outlines that if there is no minimum subscription, issuers will need to explain, in detail, how the stated purpose of the offering and the use of proceeds will be achieved without one. Qualitative and quantitative disclosure will be requested describing how the proceeds will be used by the issuer with reference to thresholds of proceeds raised if less than the maximum amount is raised, including the consequent impact on liquidity, operations, capital recourses and solvency of the issuer.
(b) Base Shelf Prospectus Offering – Due to the long time frame during which a base shelf prospectus offering can take place (an issuer may raise small amounts of capital in increments over a period of 25 months under current legislation), the CSA may take a view that such a structure is not appropriate given an issuer's financial condition. Submissions on the following may be requested as a result:
- the issuers rationale for filing a base shelf prospectus;
- whether the issuer intends to file a prospectus supplement in the near future, and if so, the type of security to be offered, the amount of proceeds and the use of proceeds;
- availability of other sources of financing to provide working capital if sufficient financing cannot be raised;
- the proposed nature and timing of the offerings (including involvement of an agent or underwriter, whether there will be a minimum subscription and the specific use of proceeds contemplated in the subsequent 12 months); and
- specifics regarding concrete development milestones that would advance the issuer's business and when they are expected to be completed in the next 12 months.
If there are concerns that incremental draw downs may be insufficient to satisfy an issuer's short term liquidity requirements, the CSA may request that an issuer file a short form prospectus with a minimum amount, require the offering be fully underwritten, or the issuer arrange for additional sources of financing.
(c) Rights Offering – The CSA may suggest alternatives to a minimum amount, such as a standby commitment.
Use of Proceeds Disclosure
Intensified scrutiny of the use of proceeds disclosure should be expected by issuers. The CSA have noted inadequate use of proceeds disclosure in the following areas:
(a) Principal Purposes of the Proceeds
Issuers can expect comments requiring:
- a breakdown of the proceeds towards a certain phase of a project;
- a breakdown of the proceeds towards capital expenditures;
- a breakdown of proceeds allocated to general and administrative expenditures; and
- clarification of how proceeds were used under prior financings.
The disclosure should clearly outline the use of proceeds for both a minimum and a maximum amount and adjustments if the proceeds raised are less than the maximum. These adjustments and disclosure would also be requested to address the impact on the issuer's liquidity, operations, capital resources and solvency. Statements such as "for general corporate purposes" are not considered by the CSA to be sufficient disclosure.
(b) Business Objectives and Milestones
Issuers must sufficiently detail the disclosure of each event that must occur for it to achieve its business objective, as well as the time period and the costs related to such event. The proceeds of the offering must also meet the issuer's working capital and operational needs until that next significant milestone.
(c) Negative Cash Flow From Operating Activities
If the financial statements in the prospectus include negative cash flow from operating activities, then the prospectus should:
- prominently disclose that fact;
- disclose to what extent the issuer will use the proceeds of the distribution to fund any anticipated negative cash flow; and
- disclose negative cash flow from operating activities as a risk factor.
Additional disclosure may be requested to include current working capital amounts, monthly or quarterly burn rates, the period of time that the proceeds of the offering are expected to fund operations and disclosure of any significant maturing debt obligation.
In certain circumstances, the CSA may apply the rules that apply normally only to junior issuers to all issuers on the basis that the disclosure required in these circumstances is a material fact. Therefore, issuers will be required to provide the same information as if they were a junior issuer in order to meet the requirement to provide "full, true and plain disclosure of all material facts".
Risk Factor Disclosure
Risks in terms of cash flow and liquidity should be disclosed in order of seriousness from the most serious to the least serious.
The prospectus must clearly disclose an issuer's going concern risk and to explain any uncertainties that may create going concern risks and how the issuer is addressing that risk. Even if the risk is adequately disclosed, the CSA will exercise judgement whether to refuse a receipt or if there is a public interest concern in issuing a receipt. Issuers should consider disclosing the following when preparing risk factors:
- quantification of losses, working capital deficit, negative cash flow from operating activities, debt levels;
- how the issuer expects to remedy solvency issues;
- other sources of financing available;
- the implications to the issuer's liquidity, capital resources and operations (such as scaling back exploration activities, capital expenditures, research and development expenditures, and general and administrative expenditures) and its ability to remain a going concern; and
- the period of time that the proceeds raised are expected to fund operations.
Issuers should also disclose negative cash flow from operating activities as a risk factor. As well, a risk factor associated with there being no minimum subscription should be disclosed and the fact that there is no minimum included on the face page of the prospectus. The disclosure should clearly state that the investor will not generally be entitled to a return of its investment if only a small portion of the amount is raised.
Representation to Support Ability to Continue Operations
Issuers should anticipate comments regarding their ability to continue operations as a going concern.
(a) Representation Regarding Ability to Continue Operations
Issuers may be asked to provide a written representation of the number of months that it will be able to continue its operations given its financial condition (the proceeds of the offering will not be included in the calculation if the offering is not a bought deal or there is not a minimum subscription or a standby commitment). Issuers may also be requested to include the representation in the prospectus on the rationale that this information is a material fact in the particular circumstances of the issuer due to concerns over its financial condition.
(b) Support for Representations Regarding Ability to Continue Operations
Where the representation to continue operations seems inconsistent with the issuer's historical statement of cash flows or disclosure in the preliminary prospectus or in some aspect simply seems unreasonable, the CSA may request that the issuer provide a cash flow forecast. This cash flow forecast will not include the proceeds of the offering unless it is a bought deal, there is a minimum subscription or a standby commitment. The cash flow forecast should project the issuer's cash flow from operating activities for the period of time the issuer has represented that it can continue operations. Like any forecast, it should be presented in accordance with International Financial Reporting Standards. In these circumstances, the CSA may request supporting schedules and further details in order to assess the reasonableness of the assumptions upon which those forecasts are made.
While the Notice suggests that the circumstances may be limited, when a cash flow forecast (FOFI) is requested, the CSA may also ask that the forecast in its entirety along with all the significant assumptions and the material risk factors that could cause actual results to differ materially from the forecast be included in the prospectus. Such disclosure is subject to liability provisions and ongoing compliance and updating in accordance with National Instrument 51-102 Continuous Disclosure Obligations.
The CSA will continue to raise comments in respect of the financial condition of an issuer and the sufficiency of proceeds from a prospectus if the concerns above are identified. Additional disclosure will likely be required, and in some circumstances where there are significant investor protection concerns, the CSA may refuse to issue a receipt.
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.