Canada: Movin´ On Up: The Costs And Benefits Of Graduating To The TSX

Last Updated: December 1 2006

Article by Martin Aquilina and Jonathan Gilhen (student-at-law)

One of the biggest decisions a board of directors will face during the life of a corporation is the decision to go public. The board will weigh the benefits, such as improved access to capital and added liquidity for existing shareholders, against the costs, such as dilution of control, the expense of an IPO, stringent continuous disclosure and accounting requirements and increased potential liability. One aspect of the decision to go public is determining which, if any, exchange to list on. For emerging companies coveting a listing in Canada, the decision to list on an exchange usually means listing on the TSX Venture Exchange (TSX-V) while established companies will generally list on the Toronto Stock Exchange (TSX).

Upon becoming a reporting issuer, a TSX-V listed company will incur the costs of complying with provincial securities laws and the rules of the exchange as well as the fees relating to obtaining and maintaining a listing. Therefore, the decision to "graduate" to the TSX would be based on the marginal costs and benefits of this incremental step. This article highlights some of the issues a TSX-V listed issuer might consider when deciding whether to graduate to the TSX.

Benefits

A company approved for listing on the TSX joins a class of issuers that includes many large and reputable domestic and international companies. As the only Canadian exchange for senior issuers, listing on the TSX signifies that a company has met recognized minimum standards and imparts additional confidence for investors and other market participants. The TSX provides the best access to capital of all the Canadian exchanges and financial media and analysts give considerable attention to TSX listed companies, often resulting in an ongoing public interest in the issuer's financial performance.

Many companies who graduate to the TSX realize a step-up in their share price due, in part, to the increased credibility and public exposure of a TSX-listed company. An observation of 34 companies that graduated between October 14, 2005 and August 10, 2006, found that almost sixty per cent of the companies had an average share price over the thirty trading days post-graduation that was higher than the thirty trading days preceding graduation. On average, the share price of all 34 issuers went up over three per cent in that time frame, with four companies showing an increase of over 25 per cent. Although many companies attain an increase in share value, graduation is just one of many factors which may influence this outcome.

A company that realizes an increase in share value will find itself in a much more favourable position to engage in M&A transactions. If trading value is well above book value, shareholders of the listed company can sell at a premium. Shareholders will also experience less adverse dilutive effects where the company uses share consideration in their transactions. Even where share price is unaffected by graduation, the added liquidity and other benefits inherent in a TSX-listed stock makes the company's shares more attractive to asset owners and shareholders of a target corporation.

Some other benefits of graduating to the TSX include the asset value of the listing itself and the TSX requirement that a market maker be assigned to each listed company. Market makers take positions in a listed stock (by making firm bids or offers) in order to enhance liquidity and smooth out undue price distortions. For example, market makers must buy stock when trading volumes fall below certain thresholds.

Costs

Listing with the TSX has four basic administrative costs. The first is the application fee of $10,000. This cost is waived for graduating issuers. In addition, the TSX foregoes some other application requirements for graduating issuers, such as the sponsorship requirement where the issuer traded on the TSX-V for over 24 months and is in good standing with that exchange's requirements. The second cost to be considered is the listing fee. Every graduating company is required to pay this fee; however the company retains its trading symbol from the TSX-V. Thirdly, the graduating issuer needs to consider the annual sustaining fee. In general, the sustaining fees are higher for TSX listed companies than TSX-V companies, although the difference diminishes as market capitalization increases. Finally, the issuer should consider their future financing needs since future issues will entail additional listing fees. The TSX will give credit to a graduating company for any fees paid to the TSX-V within the 90 days prior to graduation up to a maximum of 25% of the TSX original listing fee.

The TSX and the TSX-V have substantially similar rules. However, in some instances, the graduating issuer will be subject to more restrictive regulatory requirements. For example, the issuer would have shorter time periods to file its interim and annual financial statements and related MD&A. The listed company will be subject to slightly more stringent requirements in respect of its audit committee and corporate governance disclosure. The company will also lose its status as a "venture issuer" upon graduation with the result that provincial securities laws may impose further requirements, particularly relating to continuous disclosure. The issuer will also be required to file an Annual Information Form (AIF), a document that describes the issuer and contains disclosure not unlike that found in a prospectus. Issuers with a current AIF have the ability to raise capital more rapidly through a short-form prospectus.

Although greater attention from the media and financial analysts is often welcomed by an issuer and its securityholders, this may actually do a disservice to the share price of the listed issuer. If the analysts find that the securities are over-valued in the market, the price may actually decline post-graduation. A TSX-V issuer contemplating graduation should consider engaging the services of a professional valuator or analyst before proceeding.

A TSX listed company cannot have stock option plans under which shares are at a discount to the market price or, in other words, are issued "in the money". Upon conditional approval for listing on the TSX, a company with a stock option plan that grants options with a strike price that is below the market price will generally be required to provide the TSX with an undertaking not to grant options that are in the money until the plan can be amended. The issuer may incur costs associated with the stock option plan. Options granted before conditional approval for listing will not need to be re-priced.

This discussion has been necessarily brief as one cannot canvas all the issues that may arise should an issuer decide to graduate to the TSX. Any TSX-V issuer which is contemplating listing on the TSX is advised to consult with legal counsel and accountants experienced with TSX graduation issues before proceeding.

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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