Financial markets are still feeling the impact of the recent financial crisis. A public company's survival is often linked to its ability to obtain additional equity financing – an option which has been limited for many due to the financial crisis. More and more public biotech and mining companies in Canada have recently been turning to equity line of credit facilities as a means of securing their position through these difficult times.
What is an ELOC?
The equity line of credit facility, or ELOC, (also known as a standby equity distribution agreement, or SEDA or as an equity line facility agreement, or ELF) has been used in US financial markets in the past, but it is relatively new in Canada. The ELOC is a financing vehicle that is easy to implement, can be set up in advance, and provides the company with a degree of certainty regarding future cash flow.
The ELOC is entered into between the public company and an institutional purchaser (often, a US investor via an offshore entity in order to avoid being subject to certain US securities laws), whereby the purchaser commits to purchase up to a pre-established dollar amount of the company's shares in a series of "draw downs", at the option of the issuer. The purchaser is committed for a fixed period (usually 2-3 years) to buy the securities, whereas the company has the ability, but not the obligation, to sell the shares during this period.
If and when the company elects to draw down under the facility, it sends a notice to the purchaser. The purchaser then has a fixed period of time (usually 5-10 days) to sell the shares in the market. The price of the shares to be purchased pursuant to the ELOC is determined by taking the market price of the shares during the draw down period, less the applicable discount agreed upon between the purchaser and the company, and it is usually subject to a minimum price below which price no shares may be sold. At the end of the pricing period, the company issues the shares to the purchaser and the purchaser pays the issue price to the company. This process may be repeated during the term of the ELOC as often as the company deems appropriate until the amount under the facility is exhausted.
Principal Steps in an ELOC Financing
The process involves the following principal steps:
- Obtaining certain essential regulatory exemptions (see Certain Material Regulatory Considerations below);
- Execution of ELOC;
- Filing of prospectus (usually a base shelf prospectus which qualifies securities to be issued in accordance with ELOC but can also serve to qualify other distributions over a 25-month period);
- Issuance by the issuer, at its sole discretion, of a draw down notice indicating the aggregate price of the draw down and the minimum (or floor) price per security, if any, and filing of a press release announcing its issuance;
- Pricing period (usually 5 to 10 days) whereby the purchaser seeks to sell the securities on the open market;
- Filing of a prospectus supplement qualifying such securities and outlining the terms of the draw down in question, in addition to a press release announcing the details of the settlement; and
- Issuance of the securities and payment.
Certain Material Regulatory Considerations
- Exemption from prospectus delivery requirement: in the context of the ELOC, prospectus delivery requirements are not workable as purchasers who purchase from the purchaser through dealers engaged by the purchaser through the relevant exchange are not readily identifiable, and orders for securities made under the prospectus may be combined with other orders. As such, a formal request for exemption from this requirement must be made to the applicable securities regulatory authorities. As a result of such exemption, the issuer must also request exemption from the required disclosure relating to delivery requirements, withdrawal and rescission rights. Consequently, specific language may be imposed in the prospectus and any prospectus supplements.
- Exemption from registration: in Canada, most purchasers who have been willing to execute an ELOC (to date) have not been registered dealers for Canadian securities law purposes. As such, a formal request for exemption from this requirement must be made to the applicable securities regulatory authorities.
- Restrictions on short sales: Canadian securities regulatory authorities are particularly sensitive to activities that could be perceived as "short selling" in the context of an ELOC. The standard pricing period acceptable to the TSX is T+3 days. Where pricing periods are longer, as is the case for any draw down pricing period, certain additional requirements will likely be imposed on the purchaser by the authorities.
- Pre-clearance of prospectus supplements: although prospectus supplements under base shelf prospectuses are not subject to review by regulatory authorities, such authorities usually require that a draft of any prospectus supplement to be filed in connection with an ELOC be provided for comments and pre-cleared at least three business days prior to filing.
- Regulatory ownership limitations: in past transactions involving an ELOC, the Canadian securities regulatory authorities and the TSX have imposed certain limitations on the number of securities that may be distributed pursuant to the ELOC, namely:
- No distribution under an ELOC may at any time cause the issuer to issue securities in amount that exceeds 19.9% of the number of securities issued and outstanding without first obtaining securityholder approval;
- No distribution under the ELOC may at any time cause the purchaser to own in excess of 9.9% of the aggregate issued and outstanding share capital; and
- No distribution under the ELOC may, in any 12-month period, exceed 10% of the aggregate issued and outstanding share capital of the issuer.
- Underwriter certificate: the purchaser will be an underwriter for those prospectus supplements filed pursuant to the ELOC and will be required to sign an underwriter certificate.
Is the ELOC Right for Your Company?
A company considering an ELOC should be aware of certain inconveniences associated with the facility, and carefully consider these points prior to committing to its implementation.
- Establishing an ELOC can be a lengthy and expensive process. Given the regulatory exemptions required and the special attention given to such facilities by the Canadian regulators and the TSX, obtaining the necessary clearance can take time. Considerable communications with the Canadian regulators should be anticipated; and the constantly evolving treatment on how to regulate such facilities makes it such that relying on a recent precedent does not necessarily expedite the process.
- Drawing down under the facility may have a negative impact on share price. A substantial number of shares of the company are sold at a discount pursuant to an ELOC. Existing shareholders therefore experience dilution in the context of a draw down, and the sale of the shares may have an adverse effect on share price. Any downward pressure on share price could encourage short sales by third parties, which could further contribute to any decline in share price.
The ELOC can nevertheless be an attractive option to those public companies (particularly in the biotech and mining spheres) looking for alternative financing solutions. The main advantage of an ELOC is that the company maintains control of timing, given that the company has the right, but not the obligation, to draw down and sell its shares at any time, whereas the purchaser has the obligation to buy the shares whatever the circumstances. Once established, the ELOC can provide the extra level of comfort a company is looking for in order to flourish in today's harsh economic reality.