In the light of new guidelines published this month by the Pre-Emption Group, most quoted companies will now want to seek authority at their AGM to issue up to 10% (rather than 5%) of their existing share capital for cash without regard to statutory pre-emption rights. The higher limit will give companies more flexibility to finance acquisition opportunities as and when they arise without having to convene an EGM.
Institutional investors are also likely to scrutinise more carefully equity fundraisings that are carried out using a “cash box” structure. The new guidelines make clear that even if, for legal purposes, statutory pre-emption rights do not apply - for example because a cash box structure is used - investors will treat any transaction that raises cash by issuing new shares as being subject to the limits in the guidelines.
Under the statutory pre-emption rules, when a company wishes to raise funds by issuing new shares to investors in return for cash, it must first offer each existing shareholder the chance to subscribe for its pro rata proportion of the new shares. An existing shareholder can therefore preserve its existing percentage holding by taking up its entitlement in full. The pre-emption rule does not apply, however, where shares are issued in return for consideration that is at least partly not in cash.
A quoted company can disapply the statutory pre-emption rules by means of a special resolution of shareholders passed at a general meeting. There is no statutory limit on the extent to which pre-emption rights can be disapplied – i.e. as a matter of law shareholders can allow any number of new shares (or any percentage of the company’s existing share capital) to be issued non-pre-emptively. But many investors in quoted companies consider pre-emption rights to be very important. In light of this the Pre-Emption Group, which consists of representatives of quoted companies, investors and intermediaries, has published guidance on the circumstances and extent to which investors will normally allow pre-emption rights to be disapplied (the Principles). The previous version of the Principles was published in 2008. Paragraph 1 of both the old and new versions says: “Pre-emption rights are a cornerstone of UK company law and provide shareholders with protection against inappropriate dilution of their investments.”
Extent of disapplication
Under the 2008 Principles, companies were permitted each year to disapply pre-emption rights in respect of up to 5% of their issued share capital, provided that no more than 7.5% was issued non-pre-emptively in any rolling three-year period. Most Main Market companies therefore routinely seek approval from their shareholders at their AGM to issue up to 5% of their share capital non-pre-emptively during the next year, and state in the AGM circular that they will observe the 7.5% rolling limit. A company can of course also seek shareholder approval for a specific issue of shares – e.g. in connection with a particular acquisition or fundraising that has been, or is being, negotiated – at either the AGM or, more likely, an EGM.
Where shares are issued non-pre-emptively, investors will also be concerned that the shares are not sold too cheaply: “Any discount at which equity is issued for cash will be of concern, but companies should, other than in exceptional circumstances, seek to restrict the discount to a maximum of 5%, including expenses” (paragraph 5 of the 2015 Principles). The “discount” broadly means the difference between (i) the total sum actually raised by the company, net of the expenses of the issue and (ii) the sum that would have been raised had the shares been issued, free of expenses, at the market price prevailing at the time the issue price is agreed, expressed as a percentage of the latter figure.
Cash box structures
In a cash box structure, the quoted company issues new ordinary shares to investors in return for the transfer to it of shares in a company (often a newly-formed Jersey company) whose only asset is cash (the cash box company). The cash comes from investors who wish to acquire shares in the quoted company. As the quoted company issues shares in return for shares in the cash box company, which are non-cash consideration, it is generally accepted in the market that statutory pre-emption rights do not apply. The company therefore need not worry whether statutory pre-emption rights have been disapplied to a sufficient extent to cover the number of shares to be issued. It is fairly common to use a cash box structure where shares are placed with investors to raise funds for a specific acquisition, especially if the placing involves the company issuing more than 5% of its existing issued share capital. But a cash box structure can also be used to create distributable profits, rather than to avoid having to issue shares pre-emptively; and companies will often invite their key existing shareholders to participate in the placing, thus following a limited form of pre-emption process.
Because of their other advantages, cash box structures are also sometimes used on rights issues and open offers (which respect pre-emption rights).
The Principles have no legal force but they are supported by the National Association of Pension Funds (NAPF) and the Investment Association, as representatives of asset owners. Companies therefore risk disapproval from their institutional shareholders – particularly those who are members of the NAPF or IA – if they breach the Principles. Such disapproval may be expressed privately or publicly and, in more extreme cases, could lead to shareholders voting against the offending resolution(s) and/or other unrelated resolutions (e.g. resolutions to re-elect directors). As a result, most Main Market companies, and many AIM companies, comply with the Principles when seeking shareholder approval at their AGM to issue shares for cash without regard to statutory pre-emption rights.
The main changes to the 2008 Principles are highlighted below.
Authority to issue shares non-pre-emptively
As well as seeking authority to issue non-pre-emptively for cash in any one year up to 5% of the existing issued ordinary share capital for any purpose, companies can now seek authority to issue non-pre-emptively for cash up to an additional 5% in connection with an acquisition or specified capital investment. A company seeking this additional 5% authority will need to confirm, in the circular at which such additional authority is to be sought, that it intends to use it only in connection with an acquisition or specified capital investment which is announced contemporaneously with the issue, or which has taken place in the preceding six-month period and is disclosed in the announcement of the issue.
“Specified capital investment” means:
“one or more specific capital investment related uses for the proceeds of an issuance of equity securities in respect of which sufficient information regarding the effect of the transaction on the listed company, the assets the subject of the transaction and (where appropriate) the profits attributable to them is made available to shareholders to enable them to reach an assessment of the potential return.
Items that are regarded as operating expenditure rather than capital expenditure will not typically be regarded as falling within the term “specified capital investment”. In situations where there is doubt as to whether the use of proceeds of a particular issuance falls within the meaning of the term “specified capital investment”, companies should, where possible, consult with their main shareholders in advance of agreeing to undertake the issuance.”
The new, higher limit is designed to allow companies the opportunity to finance expansion opportunities as and when they arise, without having to convene an EGM. But the additional 5% cannot be used to issue shares for the purpose of building a “war chest” to fund unspecified acquisition opportunities.
Shares that are issued for the purpose of an acquisition or specified capital investment will not count towards the limit of 7.5% over any rolling three-year period.
Cash box structures
The new Principles make clear that even if, for legal purposes, statutory pre-emption rights do not apply - for example because a cash box structure is used - investors will treat any transaction that raises cash by issuing new shares as being subject to the limits in the guidelines. This appears to mean:
- Investors will treat any shares that are issued under a cash box placing as using up to the relevant extent the company’s existing disapplication of pre-emption rights.
- Investors will regard it as a breach of the Principles if a company issues shares via a cash box placing that:
- are issued at a discount of more than 5% to the prevailing market price; or
- represent a greater percentage of the company’s existing share capital than the directors are authorised to issue under their existing disapplication of pre-emption rights (to the extent the authority is unused).
Investors are unlikely to have concerns about pre-emptive issues that use a cash box structure. But they are likely to scrutinise more carefully non-pre-emptive issues that are carried out using a cash box structure, particularly if funds are not being raised for a specific acquisition or capital investment. If a company were to disapply pre-emption rights in respect of only 5% of its existing share capital but then needed to issue, say, 9.9% non-pre-emptively for the purpose of an acquisition or a specified capital investment, and decided to use a cash box structure in order to avoid convening an EGM, it is not clear whether investors would regard this as a breach of the Principles.
However, assuming that no EGM is needed to grant the directors authority to issue the new shares (under section 551 of the Companies Act 2006), or for any other reason (e.g. to approve a Class 1 or related party transaction under the Listing Rules), shareholders will not have an opportunity to vote against a cash box placing at the time it is carried out. They will therefore need to express their disapproval by, for example, voting against one or more resolutions at the next AGM. In practice, companies are likely to forestall such dissent by consulting their major shareholders before doing any cash box placing and/or giving them the opportunity to participate in the placing (as many do at present).
Vendor placings (where a quoted company arranges for new shares in itself to be placed with investors and the proceeds paid to the vendors of an asset) will not be treated as being subject to the limits set out in the Principles. However, shareholders will expect a right of clawback (i.e. the right of existing shareholders to subscribe for their pro rata share of an issue at the offer price) in respect of any vendor placing that represents greater than 10% of ordinary share capital or that is undertaken at a discount of greater than 5% to the prevailing market price.
Scope of the Principles
It is now clear that the Principles apply to both UK and non-UK incorporated companies whose shares are admitted to the premium segment of the Main Market (Official List). Companies whose shares are admitted to the standard segment of the Official List, to trading on AIM, or to the High Growth Segment of the Main Market of the LSE are also “encouraged” to comply with the Principles.
When agreeing the pricing of a share issue, companies should take into account any rise in the share price that may result from the issue itself or any related transaction. Further guidance has been added to the Appendix on the expenses that should be taken into account in calculating the discount, and how the reference market price should be determined. And greater transparency on the discount is now required: companies should disclose any discount at which equity is issued in the announcement of the pricing of the relevant issue, and certain information must be included in the annual report: see “Impact on market practice”.
The Principles clarify that (i) the sale of treasury shares for cash should be regarded as equivalent to an issue of new shares; and (ii) shares held by a company in treasury should not be regarded as forming part of the issued share capital when calculating the percentage of the disapplication.
The Pre-Emption Group has confirmed that it will monitor, and issue a report on, the use of the revised Principles, though it will not express a view on (or otherwise intervene in) specific cases. Although it encourages companies and investors to use the revised Principles immediately, it acknowledges that, as the 2015 AGM season is imminent, some flexibility may be required.
Placings and AGM resolutions
Placings are sometimes carried out to raise funds to provide working capital, repay debt, fund additional capital investment or developments, strengthen the balance sheet or provide funds to enable company to take advantage of future acquisition opportunities (essentially provide a war chest). But the majority of placings by Main Market companies have historically related to a specific acquisition: in such cases, it is common for companies to issue up to 9.99% of their existing issued share capital and for a cash box structure to be used. Under the new Principles, companies will be able to use the “additional” 5% for such acquisitions.
Most companies are therefore likely to want to take advantage of the new, higher limit – i.e. to seek shareholder authority at their AGM to issue up to 10%. If they do so, they are less likely to exhaust the limit during any year. This will also remove one of the reasons for using a cash box structure although, as noted above, there may be other compelling reasons for doing so. A company proposing to use all or most of a 10% disapplication will, as before, need to check carefully that no prospectus is required: for a Main Market company, this will mean ensuring that less than 10% of its issued share capital will have been admitted to trading over the previous 12 months (excluding any shares that were covered by a different exemption).
We would expect most companies to want to put a single disapplication resolution to the AGM for the full 10%, but some companies may prefer to have two resolutions – one for the general purpose 5% (which is unlikely to be opposed) and another for the “additional” 5% for acquisitions and specified capital investments (which may be more controversial).
The next annual report published following a non-pre-emptive issue of equity securities pursuant to a general disapplication of pre-emption rights (i.e. that does not relate to an issue of shares for a specific purpose identified at the time the resolution is proposed) should include the following information:
- The actual level of discount achieved.
- The net proceeds raised.
- How the net proceeds were used.
- The percentage increase in issued share capital due to non-pre-emptive issues for cash over the three-year period preceding the issue.
Cash box structures
If a company proposes to use a cash box structure, there are now even stronger reasons to consult major shareholders, particularly if shares will be issued non-pre-emptively in excess of the company’s unused existing disapplication.