The Canadian Securities Administrators (CSA) released Staff Notice 41-307 (Notice) in March 2012, which discusses the CSA’s approach to the review of a prospectus related to any offering, including an IPO, new issue or secondary offering, when there are concerns with the financial condition of an issuer or the sufficiency of the proceeds of such offering. According to the Notice, this guidance is not intended to inhibit capital raising through prospectus offerings, other than in instances of significant investor protection concerns.
Pursuant to securities legislation, the regulator must issue a receipt for a prospectus unless it is determined that it is not in the public interest to do so or for certain other reasons enumerated in securities legislation. The Notice states that, pursuant to securities legislation, a receipt for a prospectus will not be issued in certain circumstances related to an issuer’s financial condition, including if it appears that the proceeds from the offering relating to the prospectus, together with the issuer’s other resources, will be insufficient to complete the stated purpose for the proceeds as set out in the prospectus or when an issuer lacks the required funds to continue operations.
Areas of Focus
The Notice sets out focal points in prospectus disclosure where comments from the regulator may arise, noting that this list is not exhaustive and each prospectus will be reviewed on its own merits:
- Missing information regarding offering amount and pricing
- Offering structure
- Use of proceeds disclosure
- Risk factor disclosure
- Representations to support ability to continue operations
If a preliminary prospectus is filed with bulleted offering amounts, pricing information and use of proceeds, the Notice states that a comment will be issued requiring the issuer to provide the regulator with a reasonable opportunity to review the draft blackline final prospectus that includes the bulleted information. Such draft blackline final prospectus should be filed no less than two business days prior to filing the final materials. If providing complete information is not practicable, estimates or ranges may be accepted. Copies of green sheets or similar marketing materials may also be requested. This information is required to assess the sufficiency of the proceeds for the stated purpose and whether it is in the public interest to issue a receipt.
The Notice indicates that the overall structure of the proposed offering will be reviewed with respect to the issuer’s ongoing financial condition. In particular, where there is no minimum subscription for an offering, even if a minimum subscription is not required for an offering, and there are concerns over the issuer’s financial condition or where a minimum amount of proceeds appears necessary to meet the stated purpose, the following comments may be issued and the issuer may need to change the structure of the offering.
Best Efforts Agency Offering
As stated earlier, if there is no minimum subscription, questions may arise regarding how the stated purposes of the offering will be met and the proceeds used absent a minimum subscription. Quantitative and qualitative discussion may be required regarding the use of proceeds, with reference to thresholds of proceeds raised and the impact on the issuer’s liquidity, operations, capital resources and solvency.
Base Shelf Prospectus Offering
A base shelf prospectus may be considered inappropriate where there are concerns about an issuer’s financial condition or uncertainty related to financing. Further submissions may be required on the following:
- rationale for filing a base shelf prospectus, whether a prospectus supplement is intended to be filed in the near future and, if so, the details of the offering, including how the proceeds are to be used;
- availability of other sources of financing if sufficient financing cannot be raised;
- proposed nature, timing and details of offerings under the base shelf prospectus, including use of a minimum subscription amount and specific use of proceeds for offerings contemplated over the next 12 months; and
- details of anticipated development milestones, including expected timing and financing requirements.
Additionally, due to concerns that incremental draw-downs under the base shelf prospectus will not be enough with respect to short term liquidity requirements, it may be required that the issuer file a short form prospectus with a minimum subscription, a fully underwritten commitment and/or arrange for additional sources of financing.
Where there is a concern that the proceeds will not be sufficient to meet stated objectives or about the issuer’s financial condition, the CSA may comment with respect to alternatives to a minimum subscription, such as obtaining a standby commitment.
Use of Proceeds Disclosure
The Notice provides guidance on what is considered adequate use of proceeds disclosure under Form 41-101F1 Information Required in a Prospectus (NI 41-101) and Form 44-101F1 Short Form Prospectus (NI 44-101).
Principal Purposes of the Proceeds
If the use of proceeds disclosure is too general, additional disclosure will be requested from the issuer, such as a breakdown of the proceeds towards phases of an exploration or development stage project, capital expenditures and general and administrative expenditures and disclosure of how proceeds from recent financings have been allocated. Issuers are reminded that a statement attributing a portion of proceeds to “general corporate purposes” is insufficient disclosure, as is frequently noted in comment letters issued by the regulators.
Business Objectives and Milestones
Additional disclosure will be required regarding each significant event that must occur for the business objectives to be accomplished, including timing and costs. Proceeds of an offering must be sufficient to meet working capital and operational needs until the next significant milestone can be met. For mining issuers, the use of proceeds disclosure should be consistent with the technical report and disclosure in the prospectus must break down the exploration and/development activities and the anticipated timing for each phase.
Negative Cash Flow from Operating Activities
Where the issuer has negative cash flow from operating activities in its most recently completed financial year for which financial statements are included in the prospectus, the issuer should disclose such negative cash flow, including as a risk factor, and whether and to what extent proceeds from the offering will be used to fund anticipated negative cash flow in the future. Additional information may be required to be included in the prospectus regarding current working capital amount, cash burn rate, the period the proceeds of the offering are expected to fund operations and any significant debt obligations maturing in the short term.
Taking the circumstances into consideration, negative cash flow from operating activities may constitute a material fact for issuers that are not technically junior issuers. In such a situation, the issuer must disclose this information in order to provide “full, true and plain disclosure of all material facts” as required.
Risk Factor Disclosure
Issuers are reminded that boilerplate statements for key risk factors are not sufficient disclosure and that risk factors must be disclosed in order of seriousness, from the most serious to the least.
Issuer’s Financial Condition
In order to allow readers to make an informed investment decision, a prospectus should clearly disclose the issuer’s going concern risk, addressing the uncertainties that contribute to going concern risk and how the issuer will address the risk. Adequate disclosure should include quantification of losses, working capital deficiencies, negative cash flow from operations and debt levels; consideration of liquidity or solvency issues; how such issues will be remedied; other sources of financing available; the impact of liquidity issues on operations; the issuer’s ability to remain a going concern; and the period of time that the proceeds are expected to fund operations.
Junior issuers with going concern risk should include the disclosure required by item 8.7 of NI 41-101F1, including disclosure of the period of time the proceeds are expected to fund operations; an estimate of total operating costs required to achieve stated business objectives during that period; and the estimated amount of other material capital expenditures during that period. Where this information constitutes a material fact for non-junior issuers, disclosure under item 8.7 of NI 41-101F1 may be required by the regulators.
The CSA notes that even where there is adequate disclosure of the risks, the regulator may refuse to issue a receipt if it would be against the public interest to do so.
Risk Associated with Negative Cash Flow from Operating Activities
Issuers are reminded that, pursuant to Companion Policies 41-101CP and 44-101CP, issuers should disclose negative cash flow from operating activities as a risk factor.
Risk Associated with No Minimum Subscription
If the offering is conducted on a best efforts agency basis, even where the regulator has accepted there is no requirement for a minimum subscription, the issuer must disclose on the face page of the prospectus that there is no minimum amount of funds that must be raised by the offering and that investors are not generally entitled to a return of their investment, even if only a small amount is raised.
Representations to Support Ability to Continue Operations
The CSA takes the view that an issuer contemplating an offering should be able to continue its operations for a reasonable period of time following the offering and must meet short term liquidity requirements. The period of time that is reasonable is determined in the context of the issuer’s industry group. Issuers should anticipate comments on these matters if there is a going concern risk.
Representation Regarding Ability to Continue Operations
The issuer may be asked to provide a written representation to the regulator with respect to the number of months it expects to be able to continue its operations given its financial condition, with such representation to be disclosed in the prospectus. The proceeds from the offering can only be considered in the representation where the offering is a bought deal, or if there is a minimum subscription or a stand-by commitment. The CSA may take the view that the absence of this information may be considered an omission of a material fact or may raise a public interest concern.
Support for Representations Regarding Ability to Continue Operations
It is the issuer’s responsibility to make the determination as to how many months it expects to be able to continue its operations. Where such representations are inconsistent with the issuer’s historical statement of cash flows, with the disclosure in the preliminary prospectus, or otherwise appear unreasonable, the issuer may be requested to provide a cash flow forecast to support determination.
The cash flow forecast should be prepared in accordance with International Financial Reporting Standards and should project the issuer’s cash flow from operating activities for the period of time the issuer has determined it can continue operations, supported by a list of assumptions used to make the forecast. The regulator will assess the forecast to determine whether the assumptions are consistent with disclosure in the prospectus and with the issuer’s historical financial performance.
The regulator may also request that the issuer disclose the entirety or significant portions of the forecast and all significant assumptions in the prospectus. This information may represent a material fact related to the issuer required to inform investors’ decisions. Any such disclosure required will be subject to the prospectus liability provisions.
Forward Looking Information and Future Oriented Financial Information
The issuer’s representation about its ability to continue operations will constitute forward-looking information (FLI), defined generally to mean disclosure regarding possible events, conditions or results of operations that is based on assumptions about future economic conditions and courses of action, and may also constitute future oriented financial information (FOFI), depending on its content. Such disclosure must comply with the FLI and FOFI requirements in NI 51-102 Continuous Disclosure Obligations (NI 51-102). Cash flow forecasts and related factors and assumptions may also be subject to these requirements. Issuers must also update previously disclosed Management’s Discussion & Analysis to comply with section 5.8 of NI 51-102.
Issuers must include sufficient disclosure in a preliminary prospectus with respect to their financial condition, particularly with respect to the use and sufficiency of proceeds from an offering. Where such disclosure is insufficient, the issuer should expect to receive comments in respect of their financial condition and sufficiency of proceeds from a prospectus offering. The regulator may require additional disclosure, depending on the issuer’s financial circumstances, especially where there is no minimum subscription or a going concern risk. While issuers will be required to make sufficient disclosure of financial risks and use of proceeds, they should be aware that, in certain cases, where such disclosure raises significant investor protection concerns, the regulator may recommend that a receipt for the prospectus not be issued.