Over the past year, an important focus of prospectus reviews by securities regulators has been issuers' short-term liquidity positions and the sufficiency of proceeds that issuers intend to raise. Now, staff of the Canadian Securities Administrators have published a notice (the "Notice") that articulates their concerns and sets out guidance for dealing with these issues.
CSA Staff Notice 41-307
The Notice was published on March 2, 2012, and is intended to alert issuers (in this case, not investment funds) and their advisors to the CSA staff approach regarding the financial condition of the issuer and the sufficiency of proceeds in the context of a prospectus offering.
Who Should Read the Notice
The Notice is intended for an issuer that has filed a prospectus and:
- the proceeds from the proposed offering, together with the issuer's other resources, may be insufficient to accomplish the purpose of the offering, as stated in the prospectus,
- the issuer has short-term liquidity issues, which call in to question the ability of the issue to continue its operations.
For these issuers, if the preliminary prospectus does not
contain satisfactory disclosure (as discussed below) CSA staff will
likely require significant disclosure to be included in the
prospectus before a receipt will be issued. Addressing disclosure
issues raised in the Notice will reduce the chances of a delay in
obtaining a receipt for a final prospectus.
Companies with real and significant short-term liquidity issues should be aware that the regulator may refuse to issue a receipt for the final prospectus, regardless of disclosure.
How Much Is Enough?
Where the concern is the application of the offering proceeds to the purposes identified in the prospectus, it will often be clear whether the net proceeds are "enough". However, for issuers with liquidity problems that threaten their ability to continue operations, the answer is more nuanced. The Notice does not set out hard and fast rules in this regard, but it does provide some general guidance, based upon the type of issuer in question:
Although not stated, a conservative view of
"short-term" would likely be a 12 month period,
consistent with the concept of "current assets" and
What Can I Do if Liquidity or Sufficiency of Funds is a Concern?
- Consider Your Offering Structure
If an issuer has liquidity or use of proceed issues, CSA staff
will typically seek to impose a minimum offering amount so that the
financing will only occur if the issuer raises enough money to be
able to meet its financial requirements.
Problems may arise where the offering structure does not permit the imposition of a minimum offering, such as with a base shelf prospectus. The Notice specifically identifies a base shelf prospectus as being possibly "inappropriate" for issuers with uncertain financing, and so should probably be avoided. Similarly, in the absence of a stand-by commitment, a rights offering structure may also be problematic.
If there are concerns about the inability to secure a receipt or to meet a regulator's imposed minimum offering size, issuers will need to consider alternative methods of raising funds, such as through a private placement.
- Disclose, Disclose, Disclose
The Notice makes clear that the issues surrounding the sufficiency of funds may be resolved simply by providing clear and complete disclosure about the issuer's financial condition. This will include disclosure on each of the topics below.
- Use of proceeds. Overly general and vague disclosure about the use of proceeds will be considered unacceptable. The regulators will expect disclosure that includes, among other things, a breakdown of proceeds between phases or milestones of a particular project (in the case of an exploration or development stage issuer), a breakdown of proceeds allocated to different capital expenditures and a breakdown of general and administrative expenses.
- Business objectives and milestones. The regulators will look for a description of significant events that must occur for each business objective to be reached, as well as specific time periods in which each event is expected to occur and the costs related to it. For mining issuers, this disclosure should be consistent with the issuer's technical report. However, general statements referring to a completion of a "phase" of an exploration program may be insufficient - a more detailed breakdown may be necessary.
- Negative cash flow from operating activities. An issuer with negative cash flow from operating activities in its most recently completed financial year for which financial statements are included in the prospectus will be expected to prominently disclose that fact in its "use of proceeds" section. This will include disclosure regarding whether, and if so, to what extent, the issuer will use the proceeds to fund any anticipated cash flow shortage in the future. Issuers may also be required to provide additional disclosure about "total funds available" to the issuer, in a manner routinely required only for junior issuers.
- Risk factors. When preparing risk factor disclosure about financial condition, issuers should consider discussing, among other things, the quantification of the financial condition, how the issuer expects to remedy its financial condition and other sources of financing that may be available to the issuer.
Examples of disclosure that CSA staff consider unacceptable are included in the Notice.
- Be Prepared to Provide Back-up
Prior to obtaining a receipt, CSA staff will likely expect the
issuer to represent that it has the ability to continue operations
for a specified period. Staff may also seek additional support for
this representation, typically in the form of a cash flow forecast
supported by a set of "robust" assumptions. In limited
circumstances, staff may also request that the forecast be included
in the prospectus.
The Notice indicates that a representation regarding an issuer's ability to continue operations will constitute "forward looking information" ("FLI") for the purpose of securities legislation, and may constitute "forward looking financial information" ("FOFI"). As a result, the disclosure must comply with the FLI and FOFI requirements in Part 4A and 4B of National Instrument 51-102 Continuous Disclosure Obligations. Issuers are reminded that they are required to update previously disclosed material FLI in their management discussion and analysis in accordance with section 5.8 of National Instrument 51-102.
A copy of CSA Staff Notice 41-307 Corporate Finance Prospectus Guidance _ Concerns regarding an issuer's financial condition and the sufficiency of proceeds from a prospectus offering is available here.
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.