8 August 2011

Taking Your Company Public — Part V

McCarthy Tétrault LLP


McCarthy Tétrault LLP provides a broad range of legal services, advising on large and complex assignments for Canadian and international interests. The firm has substantial presence in Canada’s major commercial centres and in New York City, US and London, UK.
This final article in our "Taking your Company Public" series examines the issue of ongoing disclosure once your company is public.
Canada Corporate/Commercial Law
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This final article in our Taking your Company Public series examines the issue of ongoing disclosure once your company is public. In the four previous articles, we discussed the pros and cons of entrepreneurial companies "going public" (essentially, becoming companies that sell their shares into the public market, by having their shares trade on a stock exchange) and the exercise of becoming a public company (focussing largely on the importance of the prospectus as a means of informing the investing public about your company).

Continually Disclosing

Once your company is public, the disclosure does not end — indeed it is ongoing and quite rigorous. First of all, if your shares are listed on the Toronto Stock Exchange, like clockwork, you have to publish your unaudited quarterly financial statements within 45 days after the end of each of your fiscal quarters, and your audited annual financial statements within 90 days after the end of your fiscal year. If your shares are listed on the TSX Venture Exchange, you are known as a "venture issuer" and the timeframes are a little longer: 60 days and 120 days, respectively. Woe betide you if you are late in getting out these financial statements. Investors will lose confidence in your organization very quickly if your regular financial "report card" is not promptly forthcoming when it should be. In addition, you will be required to pay late filing fees to the securities regulators and may be subject to a cease trade order.

In your financial statements, one figure will be of particular interest: your earnings. With some entrepreneurial companies other metrics can be important, at least for a time, such as subscriber growth (or loss) for mobile communications operators. But ultimately, earnings rule, and many a public company stock has been punished because earnings were below the market's expectations.

To Forecast or Not to Forecast

How the market's expectations about your earnings are set comprises a fascinating exercise in collective soothsaying. Different analysts at the various brokerage houses opine periodically on your company's immediate past performance, current situation and most importantly, short- and medium-term prospects. Then a financial information firm aggregates all these analysts' predictions into one composite expectation for your next quarterly results.

Some companies (especially smaller US companies listed on the NASDAQ exchange south of the border) add fuel to this interesting fire by periodically giving guidance about their own future earnings. This is a dangerous activity, and one fraught with risk. It requires being ever-vigilant about market conditions, and at the earliest signs of softening (or even increasing) sales, announcing further earnings guidance to recalibrate the previous forecast downward (or upward). If the result is a sell-off of your shares, it is not uncommon for a class action lawsuit to follow, alleging on behalf of those who bought your shares just before your latest announcement that, had you given the guidance earlier, these investors could have avoided losses.

Of course this is an invidious situation for your company, because there will always be a group of investors who purchased your shares before your revised earnings guidance. So, why give earnings guidance at all? Why not just stick to publishing your quarterly and annual financials after the fact, and let the market make its own decisions based on actual results, rather than on predictions about the future?

This is indeed sound advice, and many Canadian companies follow it. Those, however, that have their shares listed on the NASDAQ in the US (in addition to the TSX in Canada) often feel compelled to give earnings guidance because their American counterparts do so. And these smaller American companies seemingly have to give earnings guidance because in the large US investment market they often have difficulty getting analyst coverage if they do not.

Here's the bottom line: Canadian public companies would do well to avoid giving earnings estimates, especially if they are in a particularly volatile space like semiconductor products, where quarterly swings in revenues, and therefore earnings, can be quite pronounced. On the other hand, a software company with a substantial installed base of customers from which it draws a steady and fairly predictable recurring maintenance revenue stream can more easily predict earnings from quarter to quarter. Nevertheless, even they should avoid the exercise, particularly in Ontario where we have a stricter legal regime for dealing with material misstatements (or material omissions) by companies and their officers.

Disclosing Material Changes

That is not to say Canadian public companies need only disclose quarterly financial results. Far from it. Every material fact relating to your company and every material change experienced by your company needs to be reported promptly. This explains the practice, for example, of issuing a press release whenever you sign an agreement to acquire another company (M&A activity being very common in the entrepreneurial space).

In fact, the Ontario Securities Commission has indicated that a press release and a related material change report may be required even before the signing of the definitive purchase agreement. For example, in certain circumstances, the disclosure may be required at the stage a non-binding letter of intent is executed between the parties if the parties are committed to proceed with a transaction (as evidenced by their actions) and there is a substantial likelihood that the transaction being discussed will be completed.

As a result of this OSC decision, it is important to record, on an ongoing basis, what material issues remain outstanding among the parties in the period leading up to the execution of the definitive agreement, and in particular, whether final senior management and/or board approval has been given by either side. In all likelihood, the widespread practice of only announcing publicly a deal when the definitive merger agreement is signed will continue, but parties will have to remain vigilant for exceptions to this rule.

Moreover, if you are acquiring a company that is large relative to your own size, then you also have to file a "business acquisition report" within 75 days of closing the deal. This report will generally require you to attach audited financial statements for the target for its last two years, as well as pro forma financial statements of your company which give effect to the acquisition. While often this is not a problem (where the target was a stand-alone business and has audited financials), it can be more of a challenge where the target is actually a division of a larger company, and therefore doesn't have stand-alone audited financial statements. In such a case, you need to address this issue in your purchase agreement for the target.

Disclosing Material Contracts

In addition to disclosing material changes, public companies must disclose certain material contracts even when they are entered into in the ordinary course of business. Most material contracts entered into in the ordinary course of business do not have to be disclosed, but the following types of contracts (in addition to a couple of others) do have to be disclosed:

  • a continuing contract to sell the majority of the company's products or services;
  • a licence agreement to use a patent, formula, trade secret, process or trade name;
  • certain financing agreements; and
  • a contract on which the company's business is substantially dependent.

It is possible to redact certain provisions of such publicly filed agreements to comply with confidentiality undertakings or if failure to do so would be seriously prejudicial to the interests of the company. However, you cannot black out certain provisions, including those relating to: debt covenants and ratios in financing or credit agreements; events of default or other terms relating to the termination of material contracts; and other terms necessary for understanding the impact of the material contract on the business of your company.

You cannot avoid the application of the material contract disclosure regime merely by putting some provisions in a "side letter." The rules are quite clear on this, and stipulate that a material contract generally includes a "schedule, side letter or exhibit referred to in the material contract."

Keep in mind that the above discussion does not cover all the areas of ongoing disclosure for your public company. For example, you will have to prepare proxy circulars for your annual meeting of shareholders, an annual information form (not a requirement, if you are a venture issuer, although many companies do one) and a "management discussion and analysis" which provides more colour and context to your financial statements, to name a few. Also, while strictly speaking not an obligation of your company, certain of your directors, officers and others considered "insiders" will have to report their trades in your company's shares.

Taken together, these rules stipulating extensive disclosure are important and require not insignificant resources within your company to ensure compliance. And that brings us full circle, to the discussion about the pros and cons of going public canvassed at the beginning of this series of articles. Some entrepreneurs will sell their private company to an already public company in order to avoid the various responsibilities of being a public company; others will find these burdens are outweighed by the advantages of being a public company. Whichever way you decide, it's important you make the decision in an informed manner.

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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