The Canadian Securities Administrators (CSA) today released a staff notice discussing the factors considered by regulators when assessing a proposed share structure in an IPO and, specifically, whether a proposed structure is contrary to the public interest. According to the notice, the CSA have encountered numerous IPOs recently where questions with respect to the proposed share structure led to a recommendation against the issuance of a prospectus receipt. The CSA is particularly concerned with companies that have already issued an "unusually large" number of shares for nominal cash consideration, especially where the company has a limited history of operations and the IPO financing is relatively small.
Ultimately, the CSA provided a list of qualitative and quantitative factors used in evaluating the acceptability of IPO share structures. These include:
- Whether the IPO price "significantly exceeds" the average price paid by the founders. The CSA is particularly concerned with structures where the founders of the company have paid a nominal amount for a large block of shares.
- Whether the amount of capital to be contributed by IPO purchasers will be significantly disproportionate to their equity interest on completion of the offering.
- Whether the average capital contributed per share for all issued and outstanding shares on completion of the offering is significantly lower than the IPO price due to the quantity and nominal price of the founders' shares.
- Whether founders have spent time, effort or resources developing a business, which may justify a structure containing significant founders' shares. The CSA may request an explanation of the size of a founders' position and the discount relative to the IPO price.
- The CSA may only have concern with some of the founders' shares, due to the fact that some founders may receive shares at a significantly lower average price than other founders.
- The more cash a founder has invested and the longer it has been invested, the more likely the share structure at issue will be acceptable.
- The presence of convertible securities at exercise prices lower than the IPO price may lead to the rejection of a share structure "[i]f the number is large enough or the exercise is low enough".
The notice stems from concerns that IPO investors may ultimately receive an "unconscionably low percentage of ownership" in cases where existing nominally priced shares cause a dilution of invested capital. Further, according to the CSA, such share structures could provide a platform for future market manipulation.
The notice, however, remains vague as to the thresholds that will lead to a regulator rejecting a particular share structure. For example, it is unclear how a regulator will assess whether an IPO price "significantly" exceeds the price paid by founders, whether the amount of capital contributed by IPO investors would be "significantly disproportionate" to the equity interest or whether dilution caused by founders' existing nominal shares will reduce the average capital contributed per share "significantly" in comparison to the IPO price. The CSA did, however, state that the notice is not meant to provide certainty for every possible scenario but, rather, is intended to provide insight into the factors considered when staff evaluate proposed structures. Further the CSA stated that they will continue to monitor the issue and consider further guidance or policy changes.
For more information, see Staff Notice 41-305 Share Structure Issues - Initial Public Offerings