On 28 April 2014, the Australian Stock Exchange (ASX) published Guidance Note 19 to assist listed entities in structuring the terms of performance shares to comply with the ASX Listing Rules (Listing Rules or LR).
Performance shares are securities in listed entities with limited rights, unless and until a nominated performance milestone is achieved. Upon achievement of the performance milestone, the performance share will convert into an ordinary share of the entity.
In this Alert, Partner Michele Muscillo and Trainee Solicitor Nastassia Tognini explore the key factors detailed in Guidance Note 19 which listed entities should consider when issuing performance shares, so as to ensure they do not fall outside the Listing Rules.
- There are a number of Listing Rules that should be complied with for the issue of performance shares to be considered appropriate and equitable.
- ASX will not regard the issue of performance shares to result in an acceptable capital structure if the issue results in the performance shares becoming the main class of securities in the entity.
- Performance milestones attached to performance shares must be appropriate and equitable to ensure investors can readily understand and have reasonable certainty to the circumstances in which the performance milestone will be taken to be achieved.
- Performance shares will generally require security holder approval under the ASX Listing Rules and may also require approval under the Corporations Act 2001 (Cth).
- There are a number of base requirements that ASX expects all performance shares to comply with.
- A listed entity may apply for in-principle advice from ASX to determine whether the issue of performance shares complies with the Listing Rules.
Reason for issuing performance shares
A listed entity may consider issuing performance shares:
- to a vendor selling an asset to a listed entity as a form of contingent deferred consideration. This may be used where the value of the asset being sold is unclear or may vary materially, depending on whether the relevant performance milestone is achieved;
- to directors, senior managers or contractors as a means on incentivising them to achieve a particular performance milestone. This may be common for start-up ventures that may have no other practical means of remunerating key management personnel for the substantial efforts that may be required to get the venture up and running profitably; or
- under an employee incentive scheme with the intention of the incentive scheme being used to attract, retain, motivate and reward key employees. However, for tax and other reasons it is more common for employee incentive schemes to utilise performance rights rather than performance shares.
Acceptable capital structure
ASX will generally not permit a listed entity to issue performance shares if the issue results in the performance shares, or performance shares in conjunction with other convertible securities, becoming the main class of security of the entity. ASX does not regard this to be an acceptable capital structure for the purposes of LR 12.5.
Appropriate and equitable performance milestones
In order to meet the requirements of the Listing Rules, the performance milestones must be appropriate and equitable. This is to ensure that investors and analysts can readily understand, and have reasonable certainty as to, the circumstances in which the performance milestone will be taken to have been met. ASX considers the following requirements as to whether a performance milestone is appropriate:
- There is an appropriate link between the performance milestone and the transaction or purpose for which the performance share is to be issued;
- The performance milestone must be in reference to objective, measurable criteria;
- The number of ordinary shares which the performance share will convert must be fixed or calculated by reference to a formula; and
- The performance share must have an expiry date by which the relevant milestone is to be achieved.
Requirement for security holder approval
ASX will generally consider the milestones appropriate and equitable, and therefore will impose a condition that a listed entity obtain the approval of the holders of its ordinary shares to issue performance shares and that a voting exclusion statement apply in relation to any person who may participate in the issue.
Security holder approval under the Corporations Act 2001 (Cth) should also be considered when issuing performance shares. For example, under section 208 the performance shares will require security holder approval if they are being issued to a related party of the entity.
Base requirements for all performance shares
The essence of a performance share is that it has limited rights unless and until the applicable performance milestone is met. Therefore, ASX expects that unless and until that performance milestone is achieved, a performance share generally will not be transferrable, confer any right to vote, confer any entitlement to a dividend, confer any right to a return of capital, confer any right to participate in surplus profits, or confer any right to participate in new issues of securities.
If the performance share does not comply with these base requirements, ASX is unlikely to consider that a performance share meets the requirements of LR 6.1, LR 12.5 or LR 1.1 condition 1.
Applying for an in-principle advice
ASX strongly recommends that a listed entity proposing to issue performance shares apply to ASX for in-principle advice that the terms of the performance shares will satisfy will satisfy LR 6.1, LR 12.5 and LR 1.1 condition 1 before it issues the performance shares or enters into any legally binding agreements to do so.
The onus is on the applicant to satisfy ASX that the terms of the performance shares are appropriate and equitable and therefore should be acceptable to ASX. On this basis, the application for in-principle advice should set out a submission as to why ASX should not object to the terms of the performance shares.