With the continuing global spread of novel coronavirus COVID-19 ("COVID-19"), capital markets and stock exchanges in Canada, as well as abroad, have been experiencing significant turmoil. At the same time, as a result of COVID-19 many issuers have experienced a material lessening of the demand for their products or services, and may otherwise be experiencing decreasing cash flows and/or liquidity issues, making it necessary to raise capital.
Prior to COVID-19, the capital markets experienced a multi-year bull market where raising capital by way of equity offerings was relatively easy to accomplish. However, the unique confluence of adverse circumstances resulting from COVID-19 raises the question of what alternatives, outside of traditional equity offerings, may be available to raise capital during this time of global crisis. Despite the market turmoil, Fasken has been involved in assisting its clients to raise capital in Canada since the declaration of the COVID-19 pandemic. Outlined below are some considerations that may be worth pursuing should an issuer wish to raise capital during these challenging times.
Underwritten Versus "Best Efforts" Offering Structure
Most issuers like the certainty of "firm" underwritten commitments by investment banks to purchase securities. Such commitments substantially reduce the likelihood of a failed transaction, which generally tend to have adverse stock price implications and also result in significant expenses being incurred by an issuer without a corresponding return. However, Canadian investment banks have regulatory capital requirements and may be unwilling to assume the risk of having to purchase securities on a firm underwritten commitment basis if they cannot resell the securities to investors.
Accordingly, COVID-19 has created market uncertainty precipitating a general movement by investment banks away from "bought deal" financings in Canada whereby an investment bank agrees to purchase securities as principal without having the protection of a "market out" clause in an underwriting agreement. A "market out" clause essentially enables an underwriter to decide not to complete an offering of securities if the underwriter cannot profitably market the securities. The result is that investment banks have, in general, migrated to only be willing to sell an issuer's securities on a "best efforts" agency basis - i.e., they will sell as many securities as they are able, but will not be responsible for a "failed" offering or if the proceeds raised are not as much as an issuer expected.
A possible alternative to the linear thinking of capital raising transactions as either being underwritten or conducted on a "best efforts" agency basis is to undertake a hybrid offering that is combination of the two offering structures. As a result, to the extent the capital raising transaction is partially underwritten, the issuer will gain certainty that there will at least be some proceeds and that there will not be a failed transaction, while the participating investment bank will in general have a competitive advantage in obtaining an engagement from the issuer relative to other investment banks that are not willing to underwrite the transaction. Further, to the extent that the offering is partially conducted on a "best efforts" basis, the investment bank will have the ability to market the offering and raise additional proceeds. This will align with the interests of the issuer and the investment bank as both parties will in all likelihood want to increase the size of the offering if there is market demand.
To the extent that an issuer is either unable or unwilling to engage an investment bank to assist with a capital raising transaction, the issuer should consider the possibility of conducting a private placement of its securities on a non-brokered basis. Non-brokered private placements can typically be implemented by an issuer on an expedited basis. Different types of securities can be offered on a non-brokered basis, but given the current market volatility, in order to raise funds, an issuer should expect that its cost of capital will be more expensive. For example, the discounts to market price needed to raise funds are becoming higher. In addition, more dilutive securities are generally being required to entice investors to buy securities - such as convertible debentures which may need to be combined with warrants or other "sweeteners" that preserve the upside for the investor to acquire additional stock should market valuations improve over time.
In order to improve the likelihood of a successful non-brokered private placement, an issuer generally needs to have significant shareholders and/or insiders that believe in the long-term viability of the issuer and who are willing to provide sustaining capital, such that the issuer has visibility on some minimum amount of proceeds. However, an issuer should also be cognizant that when a capital raising transaction is conducted with insiders, applicable stock exchange rules and applicable Canadian securities laws may impose certain requirements triggered by the "related party" nature of the transaction, such as shareholder approval. Whether such related party transaction requirements are triggered will ultimately depend on the extent of insider participation in the capital raising transaction.
To the extent an issuer is experiencing serious financial difficulty as a result of COVID-19 or otherwise, in such circumstances the applicable Canadian stock exchange on which it is listed, as well as Canadian securities laws, may provide a path forward without having to obtain shareholder approval despite the related party nature of the transaction. For example, both the rules of the Toronto Stock Exchange and Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions generally provide relief from their respective related party transaction requirements where an issuer is in "financial hardship". To rely on this relief, the independent directors of an issuer must determine that: (i) the issuer is in serious financial difficulty; (ii) the offering is designed to improve the financial position of the issuer; and (iii) the terms of the transaction are reasonable in the current circumstances of the issuer. While historically there has been a general reluctance among issuers to disclose that they are in financial hardship, the reality is that COVID-19 and its adverse economic effect has placed many issuers in a position of financial hardship. Thus, it is generally expected that reliance on the financial hardship relief when raising capital will become more commonplace.
A variant of the non-brokered private placement occurs when an issuer places its securities directly with a specific investor, such as a private equity buyer or a strategic investor. This type of investment is generally known as a "private investment in public equity" or "PIPE" when a private equity or institutional investor purchases securities directly from a public company, or a strategic investment when the securities are sold to another participant in the issuer's industry. These types of financings are typically bespoke and highly negotiated and include an investor rights agreement that addresses subjects such as: governance, standstills, information rights, anti-dilution and approval rights.
Where a non-brokered private placement is not available to an issuer - for example, where it does not have any significant shareholders or insiders to whom it can sell its securities - the issuer could consider undertaking a rights offering. A rights offering is an offering where an issuer issues rights to each of its existing securityholders to purchase additional securities upon exercise of the rights. While a rights offering can be conducted by way of a prospectus or private placement, the private placement route is likely to be more expedient than a prospectus offering and also can be implemented on a non-brokered basis.
Several years ago, the Canadian securities regulators expanded the rights offering private placement exemption to allow for private placements of rights to be effected in circumstances where the offering will result in up to 100 percent dilution. In order to conduct a rights offering by way of private placement, the following, among other, conditions must be satisfied:
• the issuer must be a reporting issuer and be up to date in all of its continuous disclosure filings;
• the issuer must file a rights offering notice and circular, each in a prescribed form;
• the subscription price must be lower than the market price of the security for which the right is exercisable, determined as of the day the rights offering notice is filed;
• all securityholders must receive rights that provide the securityholder with a "basic subscription privilege" to exercise the rights and purchase underlying securities to maintain its pro rata ownership interest;
• an "additional subscription privilege" can be provided to all holders of rights, whereby each holder can offer to subscribe for underlying securities not purchased by others under the basic subscription privilege; and
• if an "additional subscription privilege" is made available, the issuer can enter into a stand-by commitment whereby a person agrees to acquire any securities underlying the rights that were not otherwise subscribed for under the basic subscription privilege and the additional subscription privilege.
The exercise period of rights distributed by way of private placement must be a minimum of 21 days and a maximum of 90 days, which means that a rights offering is likely to take longer to complete than other forms of non-brokered private placements. Accordingly, depending on the urgency to which an issuer requires capital, a rights offering may only be a preferred offering form for an issuer that can withstand not receiving capital for the minimum exercise period of 21 days.
Another capital raising alternative is known as the "At-The-Market", or ATM, offering. An ATM is a form of offering whereby an issuer engages a designated investment bank to sell the issuer's shares directly into the market through the stock exchange on which the issuer is listed. In most cases, the issuer does not know the identity of the actual purchaser. The overall process is somewhat analogous to an investor calling his or her broker with instructions to sell shares through a stock exchange.
In order to implement an ATM offering on an expedited basis, an issuer must have available a short form base shelf prospectus (a "base shelf prospectus") which provides the issuer with the ability to undertake an ATM offering. If a base shelf prospectus is available, the issuer can look to file a prospectus supplement establishing the parameters for its ATM offering. Once the prospectus supplement is filed, the issuer can then sell its shares under the ATM offering for up to 25 months (the actual time will depend on when the issuer's base shelf prospectus expires). The issuer will then have broad discretion as to when, how and if it will conduct an ATM offering, including deciding the timing of any sales of shares through the market, the number of shares to be sold at any given time and the minimum price at which the issuer is willing to sell shares. Ultimately, the use of an ATM offering optimizes an issuer's flexibility in capital raising by providing it with the ability to rapidly access the market and sell shares at times when market conditions are favourable.
Some of the disadvantages of using an ATM offering is that Canadian securities laws prescribe that the maximum number of shares that can be sold are limited to 10% limit of aggregate market value limit of the issuer's equity securities, thereby capping the amount of capital that can be raised. Also, if an issuer does not have a base shelf prospectus available, then this form of offering may not be preferred as it will take time to prepare and clear with the Canadian securities regulators a base shelf prospectus.
Even if an issuer has a base shelf prospectus available, under current Canadian securities laws, prior to launching an ATM offering, an issuer will first need to apply to the Canadian securities regulators for exemptive relief from certain Canadian securities law requirements: namely the prospectus delivery requirement, the rights of withdrawal/right of rescission, and the form of prospectus supplement certificate page. This relief has traditionally taken several weeks to obtain.
While traditional equity offerings may still be available to some issuers despite the market turbulence caused by COVID-19, for many issuers this type of capital raising transaction will not be available. An issuer that finds itself in these circumstances may wish to consider one or more of the above alternatives, or other possible capital raising transaction structures, that may be available under Canadian securities laws.
Should you have questions or wish to canvass ways to raise capital, Fasken is available to discuss creative solutions to assist your company in raising capital during the COVID-19 pandemic.