Going public is among the most critical decisions an issuer can make. It is an intensive and complex process that affects virtually every facet of the issuer's character and its operations. Before proceeding with an initial public offering, an issuer must reflect upon whether it is in a position to make a successful public issue of securities and it must consider very seriously the implications and reality of being a public issuer.
The success or failure of a public offering depends on the state of the financial markets, domestic and abroad. Market conditions can change in a matter of days, sometimes even hours. Adequate preparation allowing for quick decision-making can prove critical in this process. The purpose of this memorandum is to provide an overview of the factors that should be taken into account when deciding whether to go public.
While this memorandum discusses most of the material aspects of the topic at hand, it is only a brief outline of some of the issues involved. It does not contain a full analysis of the law nor does it constitute an opinion of Norton Rose Fulbright Canada LLP or any member of the firm on the points of law discussed.
In deciding whether to go public, an issuer must determine whether it is realistically in a position to support a successful public offering. The following are some of the factors that should be considered in the decision-making process and are elements that could prove critical to the success of the offering.
Size of the issuer
Consider whether the issuer will have a market value after the issue that is large enough to attract institutional investors. While public offerings may sometimes be structured for issues as small as $1m, institutional investors and major underwriters usually take interest only in issues of $15m and up.
Growth history and potential
While it is clear that ideal candidates for successful public offerings are issuers with a consistent record of growth over several years, many development stage issuers with innovative products and services (such as the software or biotechnology fields) have successfully raised funds based on the potential of their business and management. Thus, an issuer with a short financial history can attract investor interest by showing a strong momentum in sales and profits and by being able to identify anticipated growth opportunities and competitive advantages.
A potential issuer should have either a solid net worth supported by tangible assets or, if technology based, solid proprietary intellectual property with strong business prospects. The quality of an issuer's patent portfolio and other intellectual property protection are critical.
Management and board of directors
An issuer's management must possess sufficient depth and experience to carry out a successful public offering. Prospective underwriters and investors are particularly interested in the strength of the management team. An issuer must therefore ensure that management is willing and able to assume the responsibilities involved in going public. In addition, changes to the board of directors and the establishment of appropriate committees of the board are recommended such as fully independent compensation and nominating committees. Boards of directors play a significant role in both the management of public issuers and in their public image. An issuer will often need to add to its board individuals with experience, expertise or the necessary independence. Canadian securities laws require issuers to disclose whether they comply with such practices or if not, why not. Lesser disclosure standards apply where the issuer is a venture issuer.
Securities policies which provide governance practices for public issuers recommend that an issuer's board consists of a majority of "independent" directors. Certain relationships between the issuer and a nominee or existing director (for eg. employment with the issuer) will deem that director or nominee not to be independent. A director or nominee will also not be independent if the board of directors determines that he or she has a "material relationship" with the issuer which would affect the independent judgment of the director or nominee.
Certain Canadian securities regulators have recently issued gender diversity guidelines intended to increase transparency for investors and other stakeholders regarding the representation of women on boards and in senior management of certain public issuers. TSX-listed and other non-venture reporting issuers in the participating jurisdictions must make annual disclosure of any director term limits in place and other mechanisms of board renewal; whether or not the issuer has adopted a written policy for identifying and nominating women directors; how the board or the nominating committee considers the representation of women in the director appointment process; whether targets have been set for the representation of women; and the number and percentage of directors and executive officers of the issuer (including its subsidiaries) who are women.
Business plan and use of proceeds
An issuer must think about its longer term business goals and whether going public is the best way to finance its growth. Prospective underwriters and investors as well as securities regulators will require that an issuer have a clear plan for the use of the proceeds from the issue. On occasion, a two-step process whereby a smaller private placement precedes the initial public offering may be more appropriate and financially advantageous as it may reduce dilution to the founding shareholders.
Market and competition
The going public process is typically heavily influenced by precedent. Having a good grasp of an issuer's industry and market, as well as its competitive strengths and weaknesses, is critical to building a credible "case" with underwriters and potential investors.
Internal systems and procedures
An issuer must have internal systems and procedures that are capable of supporting the demands associated with both the process of going public and the requirements to report reliable financial information to investors following the public issue.
Suitable accounting practices
An issuer must determine early on whether there are any accounting issues that must be dealt with and whether it is in a position to meet the financial disclosure requirements of a prospectus. More particularly, historical audited financial statements (three years) must be prepared under Canadian rules.
Corporate structure and governance
An issuer must consider whether its existing internal, capital, management and governance structures are appropriate for a public issuer and whether all of its corporate records and contracts are in order.
The choice of underwriters is critical to the success of an initial public offering, for it is the underwriters who will take the issue to the public market. It is important therefore that the underwriters have a solid reputation in both the financial community and in the particular industry of the issuer. An issuer should generally look for underwriters who have a wide distribution network nationally and, if necessary, internationally, underwriters who have or have access to good research facilities and underwriters who have a track record of bringing past issues successfully to market. The quality of an underwriting firm's research teams and analysts should also be considered as a going-forward concern.
The involvement of experienced legal counsel and auditors early on in the process is also critical to the success of an initial public offering. When selecting these experts, an issuer must consider their familiarity with the complex securities law and stock exchange requirements both in Canada and abroad. The legal counsel, the auditors and the underwriter(s) each play equally important roles and the whole offering process can grind to a halt if any one of these links is too weak.
In addition issuers operating in certain sectors such as mining and oil and gas will generally be required to produce technical or geological reports prepared by independent qualified persons.
ADVANTAGES OF GOING PUBLIC
The principal motivation for going public is to raise cost efficient funds with which to finance operating and growth objectives without the restrictions associated with bank debt financing. Such financing objectives may include the financing of research projects, new product development, expansion into new markets, acquisition of other businesses, plant construction or modernization, restructuring of capital, repayment of debt and working capital requirements.
Access to future capital
Going public can help a company or other entity such as a limited partnership or trust obtain future capital. As a public issuer, a company's current financial results as well as its future prospects are disclosed to the public on an ongoing basis. If the issuer is well-run and makes good use of its skills and resources, the market may respond favourably to its business success through upward pricing and acceptance of future share issuances.
Liquidity to shares of company
Shares or other securities that are publicly traded generally command higher prices because they are more marketable, because public issuers are seen as more sophisticated and because a great deal of information about public companies is made available to investors. Being public provides a company's shareholders or other issuer's securityholders with access to an active market, thus enhancing the liquidity and value of their investment.
An initial public offering provides founding shareholders and venture capitalists with access to an organized market in which to eventually dispose of their investment. It is also possible in certain circumstances to combine an initial public offering of new treasury shares with a simultaneous sale of shares held by existing shareholders, however such sales are subject to certain restrictions. See section "Other considerations — Escrow requirements".
Being public also brings a certain degree of flexibility for the founders in the medium and long term by helping them to diversify their investment portfolio and to simplify their financial, fiscal and estate planning.
Access to financing alternatives
A public issuer has access to a wider range of financing alternatives, including the issue of additional common shares and the issue of convertible debt obligations, convertible preferred shares or subscription rights. Also, by acquiring an expanded equity base, going public may lead to an improved debt/equity ratio, which in turn may make it possible to obtain additional debt on more favourable terms.
Mergers and acquisitions
Going public facilitates subsequent mergers and acquisitions through the sale and exchange of shares or other securities. Subject to certain statutory restrictions, public issuers have the advantage of being able to issue securities with a publicly quoted value (instead of paying a negotiated cash or securities value) to acquire other businesses.
Employee share incentives
Being public makes it easier for an issuer to offer to its executives, directors and employees certain incentives, such as stock option and share purchase plans, stock bonuses or other profit-sharing schemes. In general, the security based incentives of public issuers are more attractive because the public market values securities independently and thus enhances their marketability. Such securities incentives can therefore help a public issuer attract and retain key management personnel and develop a stronger sense of loyalty among employees.
Prestige and visibility
Going public may help increase an issuer's prestige and visibility in the business and financial community. Through press releases and other types of continuous disclosure, the issuer's name and products or services become better known to investors, the press, the public and, invariably, to its customers and suppliers.
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