Chapter
11
Financing and Listing
Securities
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11
Financing and Listing
Securities
CHAPTER OUTLINE
What are the Different Types of Business Structures?
What are Incorporated Businesses?
• Public and Private Corporations
• The Structure of the Organization
How do Governments and Corporations Finance Themselves?
• Investment Dealer Finance Department
• Canadian Government Issues
• Provincial and Municipal Issues
• Corporate Issues
How does the Corporate Financing Process Work?
• The Dealer’s Advisory Relationship with Corporations
• The Method of Offering
• The Prospectus
• After-Market Stabilization
What are the Other Methods of Distributing Securities to the Public?
• Junior Company Distributions
• Options of Treasury Shares and Escrowed Shares
• Capital Pool Company Program
• NEX
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How does the Listing Process Work?
• Advantages and Disadvantages of Listing
• Withdrawing Trading Privileges
Summary
LEARNING OBJECTIVES
By the end of this chapter, you should be able to:
1. Compare and contrast the three types of business structures and explain the process, outcomes,
advantages and disadvantages of incorporation.
2. Describe the processes by which governments raise debt capital to finance their funding
requirements.
3. Describe the processes by which corporations raise debt or equity capital to finance their funding
requirements.
4. Summarize the steps in the corporate financing process, explain the different methods of offering
securities to the public, summarize the prospectus system and evaluate after-market stabilization.
5. Identify other methods of distributing securities to the public through stock exchanges.
6. Discuss the advantages and disadvantages of listing shares for trading on an exchange and explain the
circumstances and ways in which exchanges can withdraw trading privileges.
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11•3
BRINGING SECURITIES TO MARKET
So far in this course we have learned a great deal about the different types of financial securities and the
roles played by financial intermediaries and the various financial markets. What we have yet to talk about is
the way in which a company has its securities listed on a stock exchange so that investors can trade them.
Stocks and bonds go through a very detailed process before they can be listed on a stock exchange.
Not only are there regulatory requirements, but there is also significant financial expense. The process
is established and rigorous and has been refined over the years so that investors are protected and the
integrity of the capital markets is maintained.
The media often discusses new and exciting initial public offerings (IPOs); however, before the new
issue can get to that stage, the issuing company faces many challenges. Financial institutions have specific
departments to handle securities offerings because the last thing a company wants to do is issue securities
that investors are not interested in buying.
This chapter begins with a look at the different ways that companies are structured and then reviews the
financing process.
KEY TERMS
11•4
After-market stabilization
NEX
Authorized shares
No par value
Banking Group
Non-competitive tender
Blue sky
Outstanding shares
Bought deal
Over-allotment option
Broker of record
Override
Capital Pool Company (CPC)
Partnership
Capital stock
Preliminary prospectus
Competitive tender
Primary dealers
Continuous disclosure
Primary offering
Corporation
Private offering
Covenants
Prospectus
Delayed opening
Protective Provisions
Delisting
Proxy
Direct bond
Public float
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Due diligence report
Red herring prospectus
Equity capital
Reporting issuer
Escrowed shares
Selling Group
Exchange offering prospectus
Shareholder
Final prospectus
Short form prospectus
Financing
Short position
Fiscal agency
Sole proprietorship
General partnership
Statement of material facts
Government securities distributor
Suspension of trading
Green shoe option
Syndicate
Greensheet
Transparency
Halt in trading
Tombstone advertisements
Information circular
Treasury shares
Initial Public Offering (IPO)
Trust Deed
Issued shares
Trust Deed Restrictions
Limited partnership
Trustee
Listing agreement
Underwriting
Material fact
Voting trust
Negotiated offering
Waiting period
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CANADIAN SECURITIES COURSE • VOLUME 1
WHAT ARE THE DIFFERENT TYPES OF BUSINESS
STRUCTURES?
There are three forms of business organization: sole proprietorships, partnerships and
corporations.
•
Sole proprietorship involves one person running his or her own business, and the
individual is taxed on earnings at their personal income tax rate. While the individual
profits if the venture is successful, he or she is also personally liable for all debts, losses and
obligations arising from the business activity beyond the assets held in the business.
•
Partnership involves two or more persons contributing to the business, whether it be
capital or expertise required to run the enterprise. This form of business organization is
legislated under the Partnership Act. There are two forms of partnership agreements: general
partnership and limited partnership.
•
–
General partnership: the general partners are involved in the day-to-day operations
and are personally liable for all debts and obligations incurred in the course of business,
–
Limited partnership: a limited partner cannot participate in the daily business activity
and liability is limited to the partner’s investment.
A corporation is an incorporated business that is a distinct legal entity separate from the
people who own its shares. Corporations pay taxes and can sue or be sued in a court of law.
Property acquired by the corporation does not belong to the shareholders of the corporation,
but to the corporation itself. The shareholders have no liability for the debts of the
corporation and there can be no additional levy on shareholders if the debts of a bankrupt
corporation exceed the value of its realizable assets. In addition, corporations are able to raise
funds by issuing equity or debt, and are thus more suitable for large business ventures than
proprietorships or partnerships.
WHAT ARE INCORPORATED BUSINESSES?
Although corporations form a small percentage of the total number of businesses, they attract
a large proportion of the total capital invested. The basic procedure for incorporation is for
one or more persons to file documents with the appropriate department of either the federal
or a provincial government and pay the required fees. The government will issue a charter, the
document under which the corporation comes into existence, in the form of letters patent,
memorandum of association or articles of incorporation.
A corporation’s name must include the words limited, corporation, or incorporated (or
abbreviations thereof or French equivalents). Certain enterprises must be incorporated under a
specific statute dealing only with that type of business. For example, chartered banks can only be
incorporated under the federal Bank Act.
There are a number of advantages and disadvantages to consider before incorporating a business.
Table 11.1 summarizes some of the advantages and disadvantages of incorporation.
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ELEVEN • FINANCING AND LISTING SECURITIES
TABLE 11.1
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ADVANTAGES AND DISADVANTAGES OF INCORPORATION
Advantages of Incorporation
Limited Liability The principle that shareholders of a corporation risk only the amount of money
of Shareholders they have invested in the corporation’s common shares is an outstanding
advantage of the corporate form of organization. For example, a shareholder who
has invested $1,000 in a corporation’s common shares is not liable for additional
contributions even if the corporation were to go bankrupt and its obligations to
creditors far exceeded the value of its realizable assets.
Continuity of
Existence
A sole proprietorship ends when the proprietor dies, and, subject to an
agreement to the contrary, a partnership terminates upon the death or
withdrawal of one partner. A corporation’s continued existence is not affected by
the death of any or all of its shareholders.
The existence of a corporation is terminated only by imposed acts such as
bankruptcy of the corporation itself.
Transfer of
Ownership
Shareholders of a public corporation can usually transfer their shares to other
investors with relative ease. This liquidity is an attractive feature of share
ownership. And, although the ownership of shares may change, the assets of the
corporation continue to be owned by the corporate entity itself.
Ability to
Finance
The raising of capital by a corporation, through the issue of different classes
of shares and debt instruments is much easier than for sole proprietorships or
partnerships. The limited liability feature permits investors to contribute capital
with a chance of return and without further liability.
Growth
The corporate form is well suited to handle easily the large amounts of capital
needed to operate large and growing businesses.
Legal Entity
A corporation is an entity separate from its owners and can sue or be sued.
Professional
Management
Although the shareholders are the ultimate owners of the corporation, they play
a very small part in the management of the corporation. They elect, through their
voting rights, a board of directors who manage the affairs of the corporation.
If the directors do not manage the corporation to their satisfaction, the
shareholders may elect different directors.
Disadvantages of Incorporation
Loss of
Flexibility
A corporation is subject to many rules imposed by various statutes, and the trend
is towards an increase in the degree of regulation. Changes in the charter and
by-laws of the corporation can be complicated and sometimes require formal
approval of the government of the incorporating jurisdiction as well as of the
directors and shareholders.
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CANADIAN SECURITIES COURSE • VOLUME 1
TABLE 11.1
ADVANTAGES AND DISADVANTAGES OF INCORPORATION – Cont’d
Disadvantages of Incorporation
Taxation
The possibility of double taxation arises when the after-tax profits of a
corporation are distributed in the form of dividends to shareholders, who
themselves pay tax on their dividend income.
Expense
After the initial cost of incorporation, there are annual costs additional to those
incurred in proprietorships or partnerships. Annual returns, audits, preparation
of federal and provincial corporate tax returns, the holding of shareholders’
meetings and, for many corporations, the requirements of securities laws can
result in substantial additional administrative costs.
Capital
Withdrawal
The statutory procedures for the redemption of shares and purchase of shares by
the corporation, when permitted by the applicable statute, must be very carefully
followed. Practically, a small investor in a public corporation can withdraw his or
her capital only by selling the shares on the market.
Once a decision has been made to incorporate, the jurisdiction of incorporation must be selected.
In most cases the choice will be whether to incorporate under the laws of the province where the
corporation’s chief place of business will be located or to incorporate federally under the Canada
Business Corporations Act (CBCA).
A provincially incorporated corporation can carry on business in the province of incorporation,
but may need a further licence or registration to carry on business in other provinces.
A federally incorporated corporation is subject to the laws of general application in a province
and may have to register there, but no provincial law may discriminate against a federal
corporation so as to deprive it of the powers conferred on it by the federal government.
Complete the following Online Learning Activity
Advantages and Disadvantages of Incorporating
Use this study aid to review the first section of Chapter 11 and the related
learning objective that requires you to compare and contrast the three types
of business structures and explain the process, outcomes, and advantages and
disadvantages of incorporation.
Download the Advantages and Disadvantages of Partnership/
Corporate Business Structure study aid.
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11• 9
Public and Private Corporations
Historically, corporations have been divided into two types:
•
Private corporations, which have in their charters a restriction on the right of shareholders
to transfer shares, a limitation on the number of shareholders to not more than 50, and a
prohibition on inviting members of the public to subscribe for their securities
•
Public corporations, which are companies whose shares are listed on a stock exchange or
traded over the counter.
THE BY-LAWS
A corporation is regulated by:
•
The federal or provincial act under which its charter is issued
•
Its own charter
•
Its by-laws
A general by-law is prepared at the time of incorporation and contains rules that govern the
conduct of the corporation. By-laws are passed by the directors and approved by the shareholders.
Provisions in the by-laws usually deal with items such as:
•
Shareholders’ and Directors’ meetings
•
Qualification, election and removal of directors
•
Appointment, duties and remuneration of officers
•
Declaration and payment of dividends
•
Date of fiscal year end
•
Signing authority for documents
VOTING AND CONTROL
Through the right to vote at the annual meeting and at special or general meetings, shareholders
exercise their rights as owners to control the destiny of the corporation. They elect the directors
who guide and control the business operations of the corporation through its officers. Many
matters of an unusual, non-recurring nature, such as the sale, merger or liquidation of the
business and the amendment of the charter, must receive shareholder approval before action
is taken. To vote, an individual must have shares registered in his or her own name or be in
possession of a completed proxy form.
Usually each common shareholder has one vote for each share owned.
•
If there were nine directors being elected, each shareholder may cast a ballot for each of the
nine persons to be elected, with a vote equal to the number of shares the shareholder owns.
•
Under this system, one or more shareholders controlling more than half of the total number
of voting shares can determine every question and elect all the directors.
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CANADIAN SECURITIES COURSE • VOLUME 1
•
The result is control by those holding a majority of the voting shares and not necessarily by
the majority in number of shareholders.
•
If the voting shares are widely held (i.e., held by many shareholders), a corporation may be
controlled by a shareholder or a group of shareholders owning substantially less than 50% of
the voting shares.
SHAREHOLDERS’ MEETINGS
All shareholders must be given the opportunity to receive materials relating to meetings of
shareholders, including proxies and audited (or unaudited) annual financial statements, and
to attend and to vote at the meetings. Shares may not be voted by intermediaries (including
investment dealers) unless instructions have been given by the shareholder to do so.
In the case of a regular meeting, the list of eligible shareholders is prepared as of a certain date
prior to the meeting and shareholders are notified of the meeting within a specified time period.
At the annual meeting, they elect the directors, appoint independent auditors (or accountants),
receive the financial statements and the auditor’s (or accountant’s) report for the preceding year
and consider other matters regarding the company’s affairs. Special meetings may be called for
any matter that requires attention prior to the next annual meeting.
VOTING BY PROXY
A proxy is a power of attorney given by a shareholder that gives a designated person the authority
to vote the shareholder’s stock at a shareholders’ meeting. Under the federal act and many
provincial acts, the proxy holder need not be a shareholder of the company. Proxies are always
revocable.
Sending proxies to company shareholders is compulsory. A proxy form and an information
circular must accompany the notice of a shareholders’ meeting which is sent to all shareholders.
The information circular sent with the notice of the annual meeting must contain details about
proposed directors, directors’ and officers’ remuneration, interest of directors and officers in
material transactions, the appointment of auditors and particulars of other matters to be acted
upon at the meeting.
At the annual shareholders’ meeting of a public corporation, enough shareholders have usually signed
proxy forms appointing the management nominees as their proxy that the management is able to carry
any resolution it wishes. Most resolutions are passed as a matter of course with or without significant
prior discussion. Even in these circumstances, where individual shareholders have no real chance to
defeat a management proposal, the meeting can be a valuable opportunity for shareholders to question
management and to make their views known.
In many public corporations, the management group itself does not own a large percentage of
the issued shares and may be dependent upon the support of the shareholders at large. In such
circumstances, there is always the possibility of a contest for control of the corporation, with both the
management group and the challengers actively seeking proxy support from the shareholders at large
before the meeting. Although such “proxy fights” are rare, they can lead to the removal of the existing
management if enough shareholders lend support to the challengers.
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ELEVEN • FINANCING AND LISTING SECURITIES
VOTING TRUSTS
A corporation that is undergoing a restructuring due to financial difficulties may be placed under
the control of a few individuals through a voting trust. The voting trust is usually put into
effect for specific periods of time, or until certain results have been achieved. It is used because
financiers may be willing to inject new capital only if they can be assured of control to protect
their investment until there is a recovery in the fortunes of the corporation.
To transfer voting control, shareholders are asked to deposit their shares with a trustee, usually
a trust company, under the terms of a voting trust agreement. The trustee issues a voting trust
certificate, which returns to the shareholder the same rights possessed by the original shares, with
the exception of the voting privileges which remain with the trustee.
The Structure of the Organization
Organizational Chart 11.1 illustrates the way corporations are structured.
CHART 11.1
SIMPLIFIED ORGANIZATION CHART OF A HYPOTHETICAL CORPORATION
Shareholders
Board of Directors *
Chairman of the Board
President
Executive Vice-President
Vice-President
Finance
Vice-President
Manufacturing
Vice-President
Marketing
Vice-President
Secretary
and General
Counsel
Vice-President
Human
Resources
Vice-President
Research
* Many Boards of Directors elect Executive Committees, Finance Committees and Audit Committees.
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Vice-President
Public Affairs
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CANADIAN SECURITIES COURSE • VOLUME 1
Table 11.2 lists the main responsibilities of the highest members of a corporation’s structure.
TABLE 11.2
Directors
MAIN RESPONSIBILITIES OF THE HIGHEST MEMBERS OF A
CORPORATION’S STRUCTURE
Must be of the age of majority, of sound mind and not an undischarged bankrupt.
Responsibilities:
• Set company policies by passing resolutions;
• They are normally responsible for the appointment and supervision of
officers and signing authorities for banking, the approval of budgets, financing
and plans for expansion; the decision to issue shares; and the declaration of
dividends and other dispositions of profits;
• They are personally liable for illegal acts of the corporation done with their
knowledge and consent;
• They are personally responsible for employees wages, declared dividends and
government remittances;
• They must act honestly, in good faith and in the best interests of the
corporation.
Officers
Appointed by the company directors
Responsibilities:
• They are corporate employees responsible for the day-to-day operation of
the business
Chairman of
the Board
Elected by the board of directors
Responsibilities:
• May have all or any of the duties of the president or any other officer of the
corporation
• May be the chief executive officer
• Presides over meetings of the board and generally exerts great influence on
the management of the affairs of the corporation
• May be combined with the job of president
President
Appointed by and responsible to the board of directors
Responsibilities:
• Exercises authority through the other officers and through the heads of
departments or divisions
• If the job of president is not combined with that of the chairman, the
president may act as chairman in the latter’s absence
VicePresidents
Appointed by and responsible to the president
Responsibilities:
• Head specific areas of the corporation’s operations such as sales or finance
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HOW DO GOVERNMENTS AND CORPORATIONS FINANCE
THEMSELVES?
Governments and large corporations often need to raise funds to finance large projects.
Governments may need money to finance bridges, highways or deficits while corporations may
want to finance new plants or business acquisitions. The process by which an issuer (government
or company) raises debt or equity capital either publicly or privately is called financing, or
underwriting.
•
For governments, this financing is often accomplished through an auction process and
occasionally through a fiscal agency.
•
For companies, financing takes the form of a private offering, an initial public offering or
IPO, or a secondary offering.
Public financings are undertaken by public companies that trade on the exchanges and the overthe-counter markets. Private financings are discussed only briefly in this chapter.
Investment Dealer Finance Department
The finance department of an investment dealer helps corporations and governments achieve
their funding targets by acting as an intermediary between investors and the issuers of the debt
and equity securities. There are usually two distinct groups in the finance department of an
investment dealer: Government Finance and Corporate Finance.
GOVERNMENT FINANCE
The government finance department specializes in selling debt instruments to institutions and
other interested parties, and advises both clients and the issuing governments on debt issues.
The persons charged with the responsibility of government finance need to be in touch with the
market at all times to ensure awareness of market conditions and prices. Their advice to issuing
governments includes:
•
The size (or dollar value), coupon (interest rate offered) and currency of denomination of
the issue
•
The timing of the issue
•
Whether the issue should be domestic or foreign
•
What effect the issue may have on the market
•
Whether the issue should be a new maturity, or whether a previous issue should be reopened
CORPORATE FINANCE
Corporate financing is a careful balancing act in which the dealer must balance the needs of
the corporate client that requires funding with the requirements of the investing public who
provide the money necessary for corporate purposes. The dealer must also balance current market
conditions in both the debt and equity markets with the limitations of the company’s statement
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CANADIAN SECURITIES COURSE • VOLUME 1
of financial position (formerly the balance sheet) and future prospects. This requires skill in
market timing, technical knowledge with regard to legal and financial matters, and a thorough
understanding of financial analysis and promotion. Some of the decisions involved with a new
issue include:
•
What types of securities are to be issued
•
Whether the issue should be a private or public offering
•
What the issue price will be
•
What the coupon rate or valuation multiple (such as the price-earnings ratio) will be
•
What the underwriting fee charged to the corporation will be
•
When the issue will come to market
•
What proportion of the issue will be bought by institutional and by retail investors
Canadian Government Issues
The Canadian Government brings new issues of fixed-coupon marketable bonds and treasury
bills to market on a regularly scheduled basis by using the competitive tender system. The
securities are issued by way of an auction, whereby the amount won at the auction is based on
the bids submitted. Only those institutions recognized as government securities distributors are
permitted to submit bids to the Bank of Canada.
These institutions include the Schedule I and Schedule II banks, investment dealers, and foreign
dealers active in the distribution of government securities.
Government securities distributors that maintain a certain threshold of activity are known as
primary dealers.
Bids can also be submitted on a non-competitive tender basis, whereby the bid is accepted in
full by the Bank of Canada and bonds are awarded at the auction average.
The process generally works as described below.
•
Bids are submitted to the Bank of Canada, usually electronically, by 12:30 p.m. on the date
of the auction.
•
Competitive tenders may consist of up to seven bids stated in multiples of $1,000 and
subject to a minimum size per individual bid of $100,000. Bids do not state a price for the
bond, but instead, the yield on the bond that each bidder hopes to earn.
•
Primary dealers have bidding limits on the auctioned amount that cannot exceed 40% of
the total amount of the bonds being offered. Bidders may not act in collusion with another
bidder to acquire more bonds than the auction limit.
•
Each government securities distributor may also submit one non-competitive tender, in addition
to any competitive bids. The ceiling on non-competitive bids for each participant is $3 million.
Non-competitive tenders are allotted by the Bank of Canada at the average price of the accepted
competitive tenders. A non-competitive tender is in multiples of $1,000, subject to a minimum
of $1,000.
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ELEVEN • FINANCING AND LISTING SECURITIES
The submitted bids are accepted in rising order of yield until the full amount of the auction
has been allocated. The total amount of the bids, as well as the high, low and average bid, are
published. The day of the tender, the Bank of Canada sends out complete information on the
results of the tender. Based on this information, each participant can determine the number and
cost of the bonds and/or bills specifically awarded.
EXHIBIT 11.1
EXAMPLE OF A GOVERNMENT OF CANADA 10-YEAR BOND ISSUE
Consider an auction of $2.5 billion Government of Canada ten-year bonds, for which ten government
securities distributors submit bids in the following manner:
Bidder
Competitive Bid Yield*
Size
1
5.041%
$500 million
2
5.043%
$500 million
3
5.043%
$500 million
4
5.044%
$500 million
5
5.047%
$500 million
6
5.048%
$500 million
7
5.048%
$500 million
–
$25 million
Non-Competitive Tenders
*Bond yields are discussed in detail in Chapter 7.
In this situation, bonds would be allocated to the first five competitive bidders only.
• The first four bidders would each receive $500 million of bonds which represents their total bid
amounts.
• The fifth bidder would receive $475 million of bonds which is equal to its bid amount of
$500 million minus the $25 million amount of non-competitive bids. Each of the five successful
competitive bidders pays a price based on its competitive bid yield. The non-competitive bidders
would receive $25 million of bonds, paying a price based on the average yield of the bonds awarded
(i.e., based on the average yield of the five accepted bids, or 5.0436%). No bonds would be allocated
to bidders 6 and 7, their bids being too high.
To maintain regularity and openness, or clarity (called transparency), in its debt operations,
the Canadian Government now holds regularly scheduled quarterly auctions of benchmark
two-, five- and ten-year bonds, and semi-annual auctions for the benchmark 30-year bond.
Denominations available are $1,000, $5,000, $100,000 and $1 million.
Provincial and Municipal Issues
New issues of provincial direct bonds and guaranteed bonds offered in Canada are usually sold
at a negotiated price through a fiscal agent. Under this method, a provincial government appoints
a group of investment dealers and banks, called a syndicate, to underwrite issues as well as advise
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CANADIAN SECURITIES COURSE • VOLUME 1
and manage the process of issuing securities. The syndicate usually includes many major dealers,
whose combined financial responsibility and distribution powers are more than adequate to
underwrite and sell the large issues required by these parties.
The terms direct and guaranteed refer to the structure of the debt issued by the government.
•
A direct obligation is one that is issued in the government’s name, e.g., Province of
Manitoba bonds.
•
A guaranteed debt is an obligation that is issued in the name of a crown corporation, but
is guaranteed by the provincial government as to payment. An example of a guaranteed
obligation would be a bond issued by Ontario Electric Financial Corporation but
guaranteed by the Province of Ontario.
Municipal bond and debenture issues are more likely to be placed in institutional portfolios
and pension accounts. Municipal bonds and debentures require in-depth knowledge of the
tax-generating potential of the local municipal area as well as the industrial base and other
demographic information.
Corporate Issues
Corporations seek new financing for a variety of reasons, including the need to increase working
capital, repay debts, purchase fixed assets or other companies, or repurchase the firm’s own shares.
Very few companies generate enough cash internally to satisfy all their cash needs. Companies
often need to borrow to fund activities such as additional research, expansion and growth.
Even a profitable company must seek external funds to expand and compete in an increasingly
competitive global marketplace. This new funding is provided by the market, if the company can
prove that its plans are viable, and that such an investment sufficiently compensates the investor
for the risk borne from making the investment.
Some of the decisions involved with a new issue include:
•
What types of securities are to be issued and when the issue will come to market
•
What the issue price, coupon rate, underwriting fee will be
•
What proportion of the issue will be bought by institutional and by retail investors
Canadian financings usually occur through a negotiated offering. Under a negotiated offering,
a firm’s management negotiates with a dealer on the type of security, price, interest or valuation
multiple, special features and protective provisions needed to market a new issue successfully.
EQUITY FINANCING
The money to start a corporation is often raised by issuing common shares for cash to persons
who thus become the initial shareholders of the corporation. The common shares usually carry
the right to vote at shareholders’ meetings.
In many cases, charters also authorize another class of shares, sometimes called preferred or special
shares, which may be non-voting but have a special status compared to the common shares in
terms of dividends, distribution of assets in liquidation, etc. In larger corporations, there may be
several classes of preferred shares with different features.
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Both common shares and preferred shares form the company’s share capital.
SHARE CAPITAL
Authorized shares refer to the maximum number of common (or preferred) shares that the
corporation may issue under the terms of its charter. Usually more shares are authorized than
issued to shareholders so that the corporation may raise additional funds in the future by
issuing more shares. A corporation may amend its charter to increase or decrease the number
of authorized shares. In recent years, corporations’ acts have made it possible to provide for an
unlimited number of shares which may be issued for an unlimited amount of money.
Example: The charter of ABC Inc. indicates that it has 1,000,000 commons shares authorized. The
company’s statement of changes in equity would show the following:
Common Shares – Authorized 1,000,000 shares of no par value
Issued shares refer to that part of the authorized shares that have been issued by the corporation.
A corporation is not required to issue all of its authorized shares. In a related way, outstanding
shares refer to that part of the issued shares which remain outstanding and owned by the
shareholders of the company. Issued and outstanding shares are often used interchangeably.
The capital stock section of the statement of changes in equity (formerly the balance sheet) shows
the number of shares a company currently has issued and outstanding. From time to time, a
corporation may redeem or purchase some or all of various classes of its issued shares, which in
normal circumstances would then reduce the number of shares outstanding. If no redemptions or
repurchases of shares are made by the corporation, the total number of shares issued will be the
same as the total number outstanding.
Example: ABC Inc. has 850,000 common shares issued and outstanding. The company’s statement of
changes in equity would show the following:
Common Shares – Authorized 1,000,000 shares of no par value – Issued and outstanding 850,000
shares
The total of a company’s outstanding shares is used to determine its market capitalization,
which is the total dollar value of the company based on the current market price of its issued and
outstanding shares. For ABC Inc., if the shares are currently trading at a price of $10 a share, its
market capitalization is $8,500,000.
Public float refers to that part of the issued shares that are outstanding and available for trading
by the public and not held by company officers, directors or institutions that hold a controlling
interest in the company. Public float is different from outstanding shares as it excludes those
shares owned in large blocks by institutions (e.g., mutual funds or pension funds). Investors
should be interested in the size of a company’s public float. The smaller the float, the more
volatile the price of the stock will be because large buy or sell orders on the stock can influence its
price dramatically. A larger float means that the stock’s price would be less volatile.
Example: ABC Inc. has 200,000 common shares held by the company’s officers and directors and by
large institutions. Its public float is then 650,000 shares (850,000 issued and outstanding shares less the
200,000 non-public shares).
© CSI GLOBAL EDUCATION INC. (2013)
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CANADIAN SECURITIES COURSE • VOLUME 1
DEBT FINANCING AND OTHER ALTERNATIVES
A corporation with a large need for new capital may also undertake debt financing. Unlike equity
financing, funds raised by issuing debt securities really represent a loan from investors and must
be repaid. The two main types of securities used in long-term debt financing are mortgage bonds
and debentures. Other financing methods include bank loans, medium-term notes, callable
bonds and convertible bonds. Mortgage bonds are backed by a specific pledge of assets such as
land or properties, similar to the way that a mortgage loan on a house is secured by the house
itself to protect the lender. Debentures are backed only by the general credit of the corporation.
The corporation’s ability to repay its obligations is considered sufficient without a specific pledge
of its assets.
In practice, a corporation also has many other financing alternatives including bank loans, money
market borrowing, commercial paper, bankers’ acceptances, leasing, government grants and
export financing assistance.
Complete the following Online Learning Activity
Debt and Equity Financing
Assess your knowledge of the differences between debt and equity financing.
Complete the Features of Debt and Equity Financing activity.
HOW DOES THE CORPORATE FINANCING PROCESS WORK?
When deciding on who will be the corporation’s inaugural lead dealer or its new lead dealer, a
corporate issuer considers the dealer’s reputation for providing various services. These include
advisory services on timing, amount and pricing of an issue, issue distribution, after-issue market
support, and after-issue market informational support. Corporate issuers attempt to engage a lead
dealer with a better reputation, since this usually results in both better market acceptance of the
issue and a cheaper financing for the issuing corporation.
When negotiations for a new issue of securities begin between the dealer and corporate issuer,
the dealer normally prepares a thorough study of the corporation and the industry within which
the corporation operates. This includes the position of the corporation within that industry,
the financial record and financial structure of the corporation, its future prospects, and all risk
factors associated with the industry and company. This report is sometimes referred to as the due
diligence report.
Often the assistance of outside consultants or experts in the appropriate field, such as engineering,
geology, management or chartered accountancy, is required. After the study is conducted, the
dealer decides whether it wants to continue to negotiate to be the lead in the proposed offering.
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ELEVEN • FINANCING AND LISTING SECURITIES
The Dealer’s Advisory Relationship with Corporations
Whether the dealer subsequently acts as principal or agent, the issuing corporation relies on the
dealer’s advice and guidance in security design, including establishing the amount of the issue,
its attributes and the final issue price. Corporations that frequently raise capital develop a close
advisory relationship with the lead dealer, similar to the professional relationship between a
lawyer and client.
Once the relationship is solidified, the dealer may become the broker of record and may have
the right of first refusal on new financings planned by the corporation.
ADVICE ON THE SECURITY TO BE ISSUED
The lead dealer’s corporate finance team plays an important role in designing the new issue and
advising the corporation on the best approach in the market. The corporation wants to ensure
both that the new securities are consistent with its capitalization (i.e., the way the firm is financed
with debt and equity) and that the restrictive covenants or provisions included in these new
securities do not limit the corporation’s future decision-making flexibility. Based on the dealer’s
assessment of current market conditions, investor preferences, the impact of various financing
options on the corporation’s existing capitalization, future earnings stability and prospects, the
dealer recommends an appropriate financing vehicle.
When considering the merits of recommending a debt issue instead of an equity issue, the dealer
considers the advantages and disadvantages of each type of financing.
Table 11.3 summarizes some of the advantages and disadvantages in issuing different debt and
equity securities.
TABLE 11.3
ISSUING SECURITIES
Type of Security
Advantages
Disadvantages
Bonds
Lower interest rate than a
comparable debenture.
Less flexible because of pledge of
assets to trustee.
Marketable to institutions that
require debt issues secured by
assets.
Difficult in mergers and
amalgamations because of pledges
against specific assets.
Flexible: there are no specific
pledges or liens.
Possibly a higher coupon than a
comparable bond because of lack
of pledge on specific assets.
Debentures
Reduction in cost at issue because
there is no registration of assets.
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CANADIAN SECURITIES COURSE • VOLUME 1
TABLE 11.3
ISSUING SECURITIES – Cont’d
Type of Security
Advantages
Disadvantages
Preferred Shares
Because preferreds are technically
equity, the company can increase
debt outstanding and still maintain a
stable debt-equity ratio if the issue
of preferreds is successful.
Cost of issuing preferred shares
is expensive as the dividends are
paid with after-tax income. This
can increase risk and cost to the
corporation.
Omission of a dividend payment
does not trigger default as nonpayment of interest on the bond or
debenture would.
Occasionally, non-payment of
dividends on preferred issues
can trigger the implementation
of voting privileges for preferred
shareholders.
Greater flexibility in financing
because of lack of pledge of assets.
Limited lifespan through redemption
of shares through open market,
lottery or purchase fund.
Common Shares
No obligation to pay dividends.
No repayment of capital required.
Larger equity base can support
more debt.
Market value of the company can
be established for estate purposes,
mergers or takeovers.
A purchase fund could be drain
on company assets during
recessionary times.
Dilution of equity for existing
shareholders on issuance of
additional shares.
Dividends if paid are more
expensive than interest because
they are paid with after-tax
dollars.
The underwriting discount is
usually greater than that which
would have been charged on debt
issue.
ADVICE ON PROTECTIVE PROVISIONS
The dealer also offers advice about the security’s specific attributes, which may include for bonds
the rate of interest, redemption and refunding provisions, and protective clauses called Protective
Provisions, Trust Deed Restrictions or Covenants. These clauses appear in a legal document
called a Trust Deed. They are called a Deed of Trust and Mortgage in the case of a mortgage
bond secured by assets, or a Trust Indenture in the case of a corporate debenture. These clauses
are essentially safeguards placed in the issue’s contract with the purchaser to guard against any
further weakening in the position of the security holder if the issuer’s financial position weakens.
Protective provisions may make an issue more appealing to an investor. A company in weak
financial condition may need to include more, or more stringent, restrictive protective provisions
in order to float a new issue than a company with greater financial strength.
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ELEVEN • FINANCING AND LISTING SECURITIES
11•21
The Method of Offering
The dealer helps decide how the issue is to be distributed or sold, either as a private placement or
as a public offering.
THE PRIVATE PLACEMENT
In a private placement, one or a few large institutional investors, such as banks, mutual fund
companies, insurance companies and pension funds, are solicited and the entire issue is sold
to one or more of them. Given that private placements are generally offered to sophisticated
investors and institutional clients, the requirements for detailed disclosure and public notice are
typically waived, thus no formal prospectus need be prepared. This dramatically reduces the cost
of distribution for the issuing company. In many cases, private placements are announced after
they have occurred, usually via advertisements in the financial press.
PUBLIC OFFERINGS
Where the decision is to offer securities to the public in Canada, the corporation and the dealer
come to a preliminary agreement only on whether the dealer is to act as agent or is to underwrite
the securities as a principal. Agreement on the dealer’s commission (when acting as agent) or
on the spread between the possible offering price and the dealer’s cost price (when acting as
principal) is arranged at an early stage in the negotiations. The final offering price and certain
other details are usually finalized just before the public offering date. The pricing of the issue and
the actual volume of securities issued are dependent upon the market environment at the issue
date.
Prior to issue, steps are taken to comply with the provisions of the provincial securities acts
that regulate the manner in which securities may be sold. Whenever a new issue of securities
is offered to the public in the province, a prospectus must be prepared in accordance with the
requirements of the particular provincial act, and must be accepted for filing by the provincial
securities commission. The prospectus must be approved separately in each Canadian province
and territory where the offering will be sold.
A primary offering of securities refers to a new issue of securities by an issuer and generally takes
place in the IPO market. The IPO requires a great deal of finesse by the underwriter, especially in
terms of the pricing and marketing of the issue. The company seeking financing is relying on the
expertise and advice of the investment dealer in providing funding. How the issue is handled can
affect the financial well-being of the company for years to come.
A secondary offering refers to the public sale of a company’s previously issued securities made
after its IPO. As with an IPO, a secondary offering (or distribution) is usually handled by
an investment dealer or syndicate. The dealer purchases the shares from the company at an
agreed-upon price and then resells them at a higher price to institutions and the public, making a
profit on the spread.
In a related tactic, a company may find it advantageous to repurchase some of its outstanding
shares currently trading in the market. These repurchased shares are called treasury shares.
Treasury shares do not have voting rights or dividend entitlements; however, the company does
have the option of reselling them back to the market at a later date through a secondary offering
(or treasury offering). Accordingly, a secondary common share offering increases the number of
shares outstanding.
© CSI GLOBAL EDUCATION INC. (2013)
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CANADIAN SECURITIES COURSE • VOLUME 1
The Prospectus
A prospectus provides a detailed description of the securities offered and of the issuing
corporation, including its history, operations, management, risk and audited financial statements.
The basic principle governing prospectus requirements is
“full, true and plain disclosure of all material facts relating to the securities offered”
A material fact is any information that significantly affects, or would reasonably be expected
to have a significant effect on, the market price of the securities being offered. In no way does
the prospectus imply that any government body has approved the issue as being a suitable
or attractive investment. The prospectus is designed to enable prospective investors to make
intelligent investment decisions.
The acts of most provinces require that a prospectus be mailed or delivered to all purchasers of
the securities being offered through public offerings. This mailing or delivery must be made to
the purchaser or the purchaser’s agent by not later than midnight on the second business day after
the trade.
Examples of some of the more important items required for a prospectus company include:
•
Details of the offering (e.g., offering price to the public, plan of distribution, characteristics
of the security)
•
What the company plans to do with the proceeds from the issue
•
Information on the business and affairs of the issuer (e.g., history, operation details, directors
and their history, legal proceedings)
•
Factors affecting an investment decision (e.g., risk factors, income tax considerations)
•
Information on promoters, principal security holders, and interest of management in
material transactions
•
Financial information, including the company’s share and loan capital structure, operating
results, debt, etc.
The issuing company may decide to list its shares in the unlisted market. In this case, a
prospectus or a similar disclosure document would still be required for filing with the provincial
administrators.
THE PRELIMINARY AND FINAL PROSPECTUS
Most provinces require that issuers file both a preliminary prospectus and a final prospectus.
When the issuer and the underwriters have agreed to the basic terms and methods of issuing
the new securities, they submit the preliminary prospectus to the respective provincial securities
commissions for review. The applicable securities commission will then issue a receipt and
the issuing company will have 90 days to prepare, submit and receive approval for the final
prospectus. This period of 90 days is referred to as the waiting period.
Since the preliminary prospectus is not in its final form, it is required to display in red ink
on its front cover a statement, in approved form, stating that it is preliminary. It should say
something to the effect that the preliminary prospectus has been filed but is not final, is subject
to completion or amendment, and that commitments for the purchase or sale of the securities
cannot be made until a receipt for the final prospectus has been issued. This prominent warning
led to the term red herring prospectus.
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A preliminary prospectus serves two key purposes. It is a disclosure document required under
provincial securities laws. Secondly, underwriters use the preliminary prospectus to solicit
expressions of interest from potential buyers of the security.
The dealers may also prepare an information circular, for in-house use only, called a greensheet.
For sales representatives, the greensheet highlights the salient features of the new issue, both pro
and con, in order to successfully solicit interest to the general public.
The preliminary prospectus often does not include information that is quite important to
potential investors. The price and size of an issue are usually not stated in the preliminary
prospectus because that information is not finalized until after the issue has been marketed to the
investment community.
The interval between issuing the preliminary and final prospectuses is a mandatory period during
which only limited communication with potential investors is permitted. The sales staff is allowed
to identify the security, its features and price (if determined), and is obligated to record names
and addresses of individuals and corporations who have requested and received a preliminary
prospectus.
If any amendments to the preliminary prospectus are to be made, a copy of the amended
prospectus must be forwarded to all prospective purchasers that had received the original copy.
Most other activities in furtherance of an issue (e.g., entering into agreements of purchase and
sale of the new securities) are strictly prohibited. Additionally, information not contained in the
preliminary prospectus, such as market commentary, research and investment reports, projections
and other matters relating to the issuer in question, may not be distributed to interested investors
during this time.
Once all of the issues in the preliminary prospectus have been resolved, a receipt is issued by
the securities commission and a copy of the final prospectus must be delivered to all security
purchasers on record.
A final prospectus must contain sufficient details on the securities being offered for sale, so as
to provide full, true and plain disclosure of all material facts about the securities proposed to be
distributed. The final prospectus must contain all the information that may have been omitted
in the preliminary prospectus, such as the offering price to the public, the proceeds to the issuer
(and/or selling security holders), the underwriting discount, and any other required information
that may have been omitted in the preliminary prospectus. The final prospectus must include
the consent of experts such as appraisers, engineers, auditors and lawyers whose reports or
opinions are referred to in the prospectus, the certificates and undertakings relating to financing
and distribution arrangements, and other documents evidencing compliance with regulatory
requirements.
The regulators review the documents carefully and may require changes before final approval.
Once approval of the final prospectus is granted, the issue is then said to be blue skyed and may
be distributed to the investing public.
THE SHORT FORM PROSPECTUS SYSTEM
Certain issuers may have quicker access to capital markets without the necessity of preparing a
full preliminary and final prospectus prior to a distribution. The short form prospectus system
may be used only by certain senior reporting issuers who have made public distributions and
who are subject to continuous disclosure requirements of annual financial and other required
information.
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CANADIAN SECURITIES COURSE • VOLUME 1
The short form prospectus works on the theory that much of the information that would be
included in a full prospectus is already available and widely known because of this continuous
disclosure. The system shortens the time period and streamlines the procedures by which
qualified issuers can access Canadian securities markets through prospectus offerings.
Under the system, an issuer is permitted to use a short form prospectus if it:
•
•
•
•
•
•
files electronically using SEDAR (System for Electronic Document Analysis and Retrieval)
is a reporting issuer in at least one Canadian jurisdiction
is up to date in its filings in every Canadian jurisdiction in which it is a reporting issuer
has filed current annual financial statements and a current annual information form (AIF) in
at least one Canadian jurisdiction in which it is a reporting issuer
is not an issuer whose operations have ceased or whose principal asset is cash, cash
equivalents or exchange listing (i.e., capital pool companies)
has equity securities listed and posted for trading or quoted on a “short form eligible
exchange” (i.e., TSX, TSX V, and CNSX)
Under certain circumstances, a long form prospectus will still be required.
A short form prospectus does not include a large portion of the information found in a full
prospectus. It focuses on matters relating primarily to the securities being distributed, such
as price, distribution spread, use of proceeds and the securities’ attributes. The short form
prospectus incorporates by reference certain information contained in the most recent AIF and
continuous disclosure documents of the issuer, and also describes how members of the public
may obtain copies of such documents.
CONVENTIONAL UNDERWRITING AND BOUGHT DEAL
In contrast to the conventional short form prospectus system or other offering in which an
underwriter agrees to make its best efforts to sell securities of an issuer to the public, a bought deal
underwriter commits to buy a specified number of securities at a set price. The underwriter will then
resell those securities to the public. In a conventional underwriting, if the securities do not sell, the
issuer will not receive the proceeds of the sale of the securities. In a bought deal, the underwriter
pays the full proceeds to the issuer regardless of whether the underwriter has been able to resell the
securities to the public.
In bought deals, an investment dealer negotiates with the issuer directly and bids for a specific new
issue of securities. Under a bought deal, the dealer assumes the risk of the position, that is, acts as
principal. The details of price and the type of issue are decided either simultaneously with filing the
short form prospectus or shortly thereafter. Under a bought deal arrangement, the spread between
the dealer’s cost and the final selling price may be as low as one per cent of the issue price, well below
traditional financing spreads. Once final regulatory approval is received, the bought issue is sold by
the investment dealer, either as a private placement to a select group of investors or as a public issue
under a short form prospectus. Distribution probably is not as wide, since only one, or possibly a few,
dealers are involved with the bought deal as opposed to the many dealers involved in other types of
public offerings.
The following is a step-by-step description of the financing process in a simplified form.
Chart 11.2 illustrates this process.
© CSI GLOBAL EDUCATION INC. (2013)
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ELEVEN • FINANCING AND LISTING SECURITIES
CHART 11.2
THE FINANCING PROCESS
Issuing Company
sells $100 million of bonds
at 98¼
Financing Group
(Dealers A and B) which sells
$100 million of fonds at 98½
Banking Group
(Dealers A, B and C to T)
which allocates
$60 million, i.e. 60% of
participation at 98½ to Banking
Group Members (Dealers A to T)
for distribution at 100 to clients
$30 million at
100 to
exempt list
$10 million at
various prices
Selling Group
at 99¼
Casual Dealers
at 99½
Special Group
variable
Step 1
The Issuing Company sells a $100 million bond issue at a discounted price of 98¼ to the
Financing Group (also known as managing underwriters and syndicate managers or lead
underwriters) consisting of Dealer A and Dealer B for public resale at the par value price of 100.
In this case, the bond issue is sold for a total cost of $98.25 million to the Financing Group,
while the sale to the public is made at $100 million.
Dealers A and B have been in continuous contact with the Issuing Company, providing
recommendations on type, size and timing of the issue, any covenants, protective clauses, as well
as currency of payment, pricing, etc. They also arranged for the preparation of the prospectus and
the trust deed, the clearing with securities commissions, and the provision of selling documents,
etc. The Financing Group accepts the liability of the issue on behalf of Banking Group members,
which include themselves.
In addition to Dealers A and B, the Banking Group consists of Dealers C to T, all of whom
have previously agreed to participate on set terms and to accept a liability up to their individual
participation. For example:
•
Dealers A and B might typically have participation (hence ultimate liability) ranging from
perhaps $7 million to $25 million for an issue size of $100 million.
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CANADIAN SECURITIES COURSE • VOLUME 1
•
Dealers C to T agree in advance to their individual participations (i.e., potential liabilities)
in the Banking Group. Dealers C to T undertake to comply with terms and conditions
concerning underwriting and distribution set out in the Banking Group agreement. Dealers
A and B offer various amounts to Banking Group Members C to T based on estimated
distribution ability, geographical locations, etc. However, the Issuing Company may request
or require that special consideration be given to certain dealers. For example, on its global
bond issues, the federal government may request that a certain minimum percentage be
reserved for Canadian dealers.
Step 2
The Financing Group sells the $100 million bond issue to the Banking Group (Dealers A to T)
at 98½. In practice, a “draw down” price somewhat higher than 98½ is established. The
differential provides a fund which is applied against expenses incurred by the Financing Group on
behalf of the Banking Group in connection with preparing and clearing the prospectus, legal fees,
accountant fees, IIROC levy, etc. Any residue in the fund is ultimately distributed to Banking
Group members proportionately.
The Financing Group (Dealers A and B) also obtains an override, which is an additional
payment over and above their original entitlement on the entire issue in payment for their
services as financial advisors and syndicate managers or leads. Each Banking Group member
(Dealers A to T) has a preset maximum liability.
Dealers A to T are the dealers whose names appear in so-called tombstone advertisements which
appear in the financial press as a matter of record once the deal has been completed.
Step 3
The initial designation of bonds set by the Financing Group may be altered as the sale of the issue
progresses.
•
$60 million of the issue may be allotted to the Banking Group (Dealers A to T) for
distribution to their clients at a price of 100 or par. This means that each dealer has 60% of
its participation to sell although the liability of each dealer is still 100% of the agreed-upon
participation.
•
$30 million may be designated for sale to the exempt list at 100. This list usually includes
only large professional buyers, mostly financial institutions, who are exempt from prospectus
requirements. They may receive a selling document instead of the prospectus, which
would include the salient features of the issue. Each of these buyers is offered bonds by the
Financing Group (Dealers A and B) on behalf of the entire Banking Group. Resultant sales
are applied to reduce each Banking Group member’s liability proportionately.
If exempt list sales are less than $30 million, the remainder may be returned proportionately
to the Banking Group (Dealers A to T) or, if considered desirable, allocated to other dealers.
© CSI GLOBAL EDUCATION INC. (2013)
ELEVEN • FINANCING AND LISTING SECURITIES
•
11•27
$10 million may be provided to (i) the Selling Group, (ii) Casual Dealers, or (iii) Special
Group. Bonds allotted to these three groups proportionately reduce each Banking Group
(Dealers A to T) member’s liability. However, any shortfall is returned to the Banking
Group.
i)
The Selling Group consists of other dealers, normally members of IIROC, who are not
members of the Banking Group (Dealers A to T). They are invited in writing by the
Financing Group to buy bonds at 991/4 to offer at 100 to their clients (excluding the
exempt list). The Selling Group orders are subject to allotment and each member of the
Selling Group has liability for the orders placed with the Financing Group.
ii) Casual Dealers are non-members of the Banking or Selling Groups. They may be
brokers, broker dealers, foreign dealers, banks, etc. They are not offered bonds directly
or indirectly, but may receive orders for bonds from clients and apply to the Financing
Group for an allocation. They may, at the discretion of the Financing Group, be
allotted bonds at, say, 991/2 for resale at 100. Since they have firm orders, they incur no
liability.
iii) Special Group orders occur under various circumstances. For example, the Issuing
Company may demand special consideration for a dealer or its banker, or its parent’s
banker if it is a subsidiary of a foreign parent. The terms and conditions of the
allotment are not standardized.
After-Market Stabilization
Once an issue is brought to market, one of the duties of the lead dealer may involve providing
after-market stabilization of that security’s offering. Under this arrangement, the dealer is
required to support the offer price of the stock once it begins trading in the secondary market
(also called the after-market). Typically, the issuing company and the dealer will negotiate the
terms of any after-market stabilization as part of the underwriting contract. The dealer’s role is
stated on the front page of the prospectus, and additional information must be provided inside
the prospectus.
Three types of after-market stabilization activities are possible.
The most common type of after-market stabilization activity is the over-allotment option. The
over-allotment option permits underwriters (or the dealer syndicate) to initially sell securities
in excess of the original amount offered by the issuer for sale to the public. In this way, the
underwriter may sell up to 15% more shares than those offered, setting up a short position in the
stock prior to the close of the offering. Once the offering begins to trade in the after-market, two
possible scenarios could develop: the share price falls below the IPO offer price, or the share price
rises above the offer price on strong demand for the issue.
•
If the share price falls below the IPO offer price, the underwriter buys share from the market
to close out its short position. In this case, the price of the stock is somewhat supported by
the demand of the underwriter. Since the underwriter closes out its short position directly
from the market, the over-allotment option is not exercised.
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CANADIAN SECURITIES COURSE • VOLUME 1
•
If the share price rises above the offer price, the underwriter cannot close out its position by
buying the stock on the market without experiencing a loss. In this case, the underwriter
exercises its over-allotment option and buys additional shares directly from the company, at
the offering price to close out its short position.
EXHIBIT
OVER-ALLOTMENT EXAMPLE
ABC Co. goes public with an IPO of 10 million shares at $10 a share. The offering includes an
over-allotment option (also referred to as a green shoe option) whereby 10 million shares are issued
but 11 million shares are actually sold by the dealer to the public. This creates a short position of 1 million
shares for the dealer once the offering begins to trade. If the price of the ABC shares drops below the $10
IPO offer price, the dealer will cover the short position by buying shares offered for sale by public investors
in the after-market. The buying activity on the part of the dealer is intended to support the price of the
issue through open market purchases and the dealer does not exercise its over-allotment option. If the
price of the ABC shares rises above the $10 offer price, the dealer can exercise the over-allotment option
and close out the short position by buying shares from ABC at the original IPO price.
The second most common after-market stabilization activity is called a “penalty bid”. The lead
underwriter will penalize members of the selling group if their customers “flip” (sell) shares
in weak issues in the after-market during the distribution or shortly after the offer closes. The
penalty may include paying back commissions to the underwriter or the underwriter may reduce
the number of shares the IA receives in future initial public offerings.
The least common stabilization activity is one where the dealer posts a stabilizing bid to purchase
shares at a price not exceeding the offer price if the distribution of shares is not complete.
These activities help to stabilize the after-market price of the recently issued security by
maintaining demand while the dealer attempts to complete the distribution of securities.
Complete the following Online Learning Activity
Ask the Expert
Two of the learning objectives for this module require you to:
1. Compare and contrast the three types of business structures and explain
the process, outcomes, and advantages and disadvantages of incorporation.
2. Summarize the steps in the corporate financing process, explain the
different methods of offering securities to the public, summarize the
prospectus system, and evaluate after-market stabilization.
In this activity, you are an investment expert with a weekly column in the local
newspaper. Readers send in their investment questions, and you select several
letters to answer in your column. Read the letters and write your responses.
Compare your answers to those of our expert advisor to assess whether you
have successfully accomplished the learning objectives.
Complete the Ask the Expert activity.
© CSI GLOBAL EDUCATION INC. (2013)
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11•29
WHAT ARE THE OTHER METHODS OF DISTRIBUTING
SECURITIES TO THE PUBLIC?
A different form of prospectus may be used when shares are distributed through the facilities of
Canadian stock exchanges. The exchange, rather than the Administrator, reviews the prospectus
and approves or disapproves it. Companies already listed may use a less detailed exchange
offering prospectus or a statement of material facts with the applicable exchanges and
securities administrators. Currently, only the TSX Venture Exchange maintains an Exchange
Offering Prospectus (EOP) system.
Junior Company Distributions
When a listed junior company decides it must raise new capital through a distribution of treasury
shares to the public, it must find a dealer member to act either as an underwriter for the offering
or as the issuing company’s agent with respect to the offering.
Historically, listed junior mining and oil companies are frequent users of such distributions,
raising millions of dollars. Such companies usually have no record of earnings and few assets that
would qualify as collateral for conventional credit sources (i.e., bank loans, mortgage or funded
debt, government assistance). The funds these companies need is known as risk capital because it
is usually earmarked for exploration and development with a high risk of failure.
Options of Treasury Shares and Escrowed Shares
As an incentive to an underwriter to provide risk capital as a principal rather than merely acting
as agent for an offering, junior companies often grant the underwriter specified treasury share
options.
This technique involves the use of escrowed shares which serve as payment for properties, goods
or services. Escrowed shares are shares held by an independent trustee in trust for its owner
that cannot be sold or transferred unless special approval is given. Shares can be released from
escrow only with the permission of the appropriate authorities, such as a stock exchange(s) or the
securities administrators.
Escrowing shares ties the value of the shares held by these shareholders to what happens to the
property used to obtain these shares. In addition, it prevents their owners from selling their
shares before a proper market can develop. This ensures some stability in the secondary market
performance of the new issue after the completed offering. Escrowed shares maintain full voting
and dividend privileges for these (primarily, non-dividend-paying) companies.
Capital Pool Company Program
For small, emerging private companies, the costs associated with going public through a
traditional IPO is not always financially viable. Accordingly, the TSX Venture Exchange, home to
many emerging Canadian businesses, developed the Capital Pool Company (CPC) program as a
vehicle to provide businesses with an opportunity to obtain financing earlier in their development
than might be possible with a regular IPO.
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CANADIAN SECURITIES COURSE • VOLUME 1
The CPC program permits an IPO to be conducted and a TSX Venture Exchange listing to be
achieved by a newly created company which, other than cash, has no assets and has no business
or operations. The new company’s goal is to buy an existing business or assets called “Significant
Assets” through a “Qualifying Transaction” (QT).
The CPC program involves a two-stage process. The first stage involves the filing and clearing of
a CPC prospectus, the completion of the IPO and the listing of the CPC’s common shares on the
Venture Exchange. The second stage involves:
•
•
•
the identification of a business or asset that can be acquired as a Qualifying Transaction
(QT)
the preparation and filing with the Venture Exchange of a comprehensive CPC information
circular containing prospectus-level disclosure of the QT
the holding of a shareholders’ meeting to get approval to close the QT
Under the CPC program, the issuer must raise between $200,000 and $1,900,000 in an initial
public offering. The IPO offering price can range from $0.15 to $0.30 per share.
NEX
NEX is a separate board of the TSX Venture Exchange that provides a trading forum for
companies that have fallen below the Venture Exchange’s listing standards. Companies that have
low levels of business activity or who do not carry on active business will trade on the NEX
board.
NEX provides a trading forum for:
•
Issuers that have been listed on the TSX Venture Exchange but no longer meet the TSX V
Maintenance Requirements (these companies are currently known as Inactive Issuers)
•
CPCs that have failed to complete a QT in accordance with the requirements of the
exchange
•
TSX issuers that no longer meet continued listing requirements and would have been
eligible for listing on TSX Venture as Inactive Issuers under existing policies
HOW DOES THE LISTING PROCESS WORK?
Companies wishing to be listed on a recognized exchange must apply and be accepted for trading.
The application is a lengthy questionnaire designed to obtain detailed information about the
company and its operations.
When the listing application is completed and supporting documents are assembled, the
company signs a formal Listing Agreement. The agreement details the specific regulations and
reporting requirements that the company must follow to keep its listing in good standing.
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ELEVEN • FINANCING AND LISTING SECURITIES
By signing a Listing Agreement, a company agrees to comply with specific regulations, some of
which pertain to:
•
The submission of annual and interim financial reports and other corporate reports to the
exchange(s)
•
Prompt notification to the exchange(s) about dividends or other distributions; proposed
employee stock options; sale or issue of treasury shares
•
Notification to the exchange(s) of other proposed material changes in the business or affairs
of a listed company
After approval is given, a specific date is set for applicable securities to be called for trading on
an exchange. There are formal announcements to members and public announcements in the
financial press.
Advantages and Disadvantages of Listing
When applying for a listing, a public company considers the advantages and disadvantages
both to the company itself and to its shareholders of doing so. Some of the advantages and
disadvantages of listing are listed in table 11.4:
TABLE 11.4
Advantages of Listing
Disadvantages of Listing
Prestige and
goodwill
Company prestige is
enhanced due to increased
public visibility. Shareholder
goodwill is increased as
buying and selling become
easier and visibility of market
performance is enhanced.
Additional
controls on
management
After listing, restrictions with
respect to such matters as
stock options (those issued for
internal use only), reporting of
dividends, issue of shares for
assets, etc., are put in place.
Established
and visible
market value
The market value of a listed
company is readily visible.
Financial analyst following is
likely to be higher with listing.
In turn, this can attract new
shareholders, enhancing overall
marketability in the secondary
market and increase the
market for new issues by the
company.
Need to
keep market
participants
informed
A listed company’s
management must devote
considerable time to meeting
with security analysts and
institutional investors
and meeting with the
press to explain company
developments.
Excellent
market
visibility
The daily financial press carries
full details of listed trading on a
daily and weekly basis.
Market
indifference
Low trading volume and poor
market performance of a
listed company are a matter of
public record.
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CANADIAN SECURITIES COURSE • VOLUME 1
TABLE 11.4 – Cont’d
Advantages of Listing
Disadvantages of Listing
More
information
available
Because of strict exchange
disclosure regulations,
investors have access to more
information on a regular basis.
Additional
disclosure
Listing imposes additional
disclosure requirements on
the company that consume
management time. Specifically,
management is required to
make continuous and prompt
disclosure of material changes
related to the company.
Facilitate
valuation for
tax purposes
The valuation of securities for
estate tax purposes and estate
tax planning is easier.
Additional
costs to the
company
Various fees, including a listing
fee and subsequent annual
sustaining fee, must be paid to
the exchange(s) when a class
of shares is listed.
Complete the following Online Learning Activity
Listing Shares for Trading
Chapter 11 discusses other methods of distributing securities and how shares
are listed on an exchange. This activity provides a review of these sections of
the chapter.
Complete the Listing Shares for Trading multiple-choice questions.
Withdrawing Trading Privileges
As a protection to investors, the exchanges are empowered to withdraw a listed security’s trading
and/or listing privileges temporarily or permanently. Serious action such as delisting occurs
infrequently. Other actions occur more frequently and may be implemented by either the
exchanges or at the request of companies with regard to their own securities.
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ELEVEN • FINANCING AND LISTING SECURITIES
11•33
TEMPORARY INTERRUPTION OF TRADING
There are three types of temporary withdrawals of trading privileges which exchanges can invoke.
Delayed Opening
Shortly before the opening of trading, an exchange can order trading in a
security to be delayed. The need for this action might arise if a heavy influx of
buy and/or sell orders for a particular security materialized. The delay gives
exchange traders time to sort out the orders and match up buys with sells to
allow fair and orderly trading when the delay order is removed. A delayed
opening in one security does not affect trading in other listed securities.
Halt In Trading
A temporary halt in the trading of a security can be ordered or arranged at
any time to allow significant news to be reported and widely disseminated (e.g.,
a pending merger or a substantial change in dividends or earnings).
Suspension In
Trading
Trading privileges can be suspended for more than one trading session. Such
suspensions are imposed if the company’s financial condition does not meet
the exchange’s requirements for continued trading, if a company fails to comply
with the terms of its listing agreement or for some other good cause. If the
company rectifies the problem to the exchange’s satisfaction within the time
required by the exchange, trading in the suspended security will resume.
During the suspension, members are usually allowed to execute orders for the
suspended security in the unlisted market except for those securities suspended
from trading on TSX Venture Exchange.
CANCELLING A LISTING (DELISTING)
A listed security can be delisted by the exchanges (or at the request of the company itself ) which
would be a permanent cancellation of listing privileges. Reasons for delisting could include:
•
The delisted security no longer exists, having been called for redemption (e.g. a preferred
share) or substituted for another security as a result of a merger
•
The company is without assets or bankrupt
•
The public distribution of the security has dwindled to an unacceptably low level
•
The company has failed to comply with the terms of its listing agreement
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CANADIAN SECURITIES COURSE • VOLUME 1
SUMMARY
After reading this chapter, you should be able to:
1.
2.
Compare and contrast the three types of business structures and explain the process,
outcomes, advantages, and disadvantages of incorporation.
•
The earnings from a sole proprietorship are taxed at the owner’s personal income tax
rate, profits accrue to the owner, and losses or debts are the owner’s personal liabilities.
•
A partnership (two or more persons contributing to the business) is legislated under the
Partnership Act and is either a general or a limited partnership.
•
General partners are involved in day-to-day operations and are personally liable for
debts and obligations. Limited partners are not involved in the day-to-day business and
are liable only up to the amount of their investment.
•
A corporation is owned by shareholders, is considered to be a unique entity under
the law, pays taxes, and can sue or be sued. Property of the corporation belongs to the
corporation, not to the shareholders. Shareholders have no liability for debts or other
obligations of the corporation. The corporation can raise funds by issuing debt or
equity.
•
Corporations are created through incorporation, which requires filing of jurisdiction
dependent documents with the relevant provincial or federal authorities.
•
Corporations are generally either public or private, and are regulated by corporate bylaws, a corporate charter, and relevant federal or provincial legislative acts.
•
Shareholders generally have a right to vote or to assign a proxy at annual or general
meetings.
•
Advantages of incorporation include limited liability of shareholders, continuity of
interest, ability to transfer ownership of shares, certain tax benefits, feasibility of capital
growth, status as a separate legal entity and professional management.
•
Disadvantages of incorporation include loss of flexibility, double taxation, additional
expenses, and restrictions on withdrawal of capital.
Describe the processes by which governments raise debt capital to finance their funding
requirements.
•
Federal government financing is usually accomplished through an auction and
sometimes through a fiscal agency.
•
Auction bids can be submitted on a competitive or non-competitive tender (the bid is
accepted in full and bonds are awarded at the auction average).
•
Competitive bids are filled from highest price to lowest price, until all bonds not
allocated to the amount of the non-competitive tender are distributed.
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ELEVEN • FINANCING AND LISTING SECURITIES
•
3.
4.
11•35
New issues of provincial direct and guaranteed bonds offered in Canada are usually sold
at a negotiated price through a fiscal agent.
Describe the processes by which corporations raise debt or equity capital to finance their
funding requirements.
•
Corporations issue shares (common and/or preferred) to raise capital, which creates the
company’s capital stock.
•
The term issued shares refers to all shares issued; authorized shares are the maximum
number of shares the company can issue according to its corporate charter; outstanding
shares are the issued shares that have not been redeemed or repurchased by the
company.
•
Corporations may also raise capital by issuing debt securities (e.g., bonds, debentures,
medium-term notes, callable bonds, convertible bonds) or by borrowing from lending
institutions (e.g., bank loan).
Summarize the steps in the corporate financing process, explain the different methods of
offering securities to the public, summarize the prospectus system and evaluate after-market
stabilization.
•
A corporate issuer chooses a dealer to act as principal or agent in a new security issue.
•
The dealer prepares analyses of market conditions and other factors and suggests the
terms and type of the issue, including debt or equity. Securities are then issued as a
public offering or private placement (one or more large institutional investors buy the
entire issue).
•
The prospectus is the primary information document for a new securities issue and is
based on the premise of full, true and plain disclosure of all material facts relating to
securities being offered.
•
Most provinces require that issuers file both a preliminary prospectus and a final
prospectus.
•
The preliminary prospectus is a disclosure document required under provincial
securities laws; it is also used to determine the level of interest of potential buyers of the
security.
•
Companies that have previously made public distributions and that are subject to
continuous disclosure requirements can use a short form prospectus.
•
After the securities have been issued, the lead dealer may be required to provide aftermarket stabilization in any of three ways: overselling to establish a short position
that will be covered later in the open market if the price falls below the issue price,
penalizing members of the selling group that sell securities shortly after issue, or
creating an open bid to buy securities at the offer price.
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CANADIAN SECURITIES COURSE • VOLUME 1
5.
Identify other methods of distributing securities to the public through stock exchanges.
Discuss the advantages and disadvantages of listing shares for trading on an exchange and
explain the circumstances and ways in which exchanges can withdraw trading privileges.
•
Other methods of distributing securities to the public include distributions through the
exchanges, junior company distributions, treasury share options, release of escrowed
shares, the Capital Pool Company (CPC) program, and NEX (a separate trading board
of the TSX Venture Exchange).
•
Companies must apply and be approved by the exchange(s) prior to listing.
•
Advantages of listing shares for trading on an exchange include prestige and goodwill,
establishment of market value, increased market visibility, wider distribution of
company information, easier valuation for tax purposes and increased investor
following.
•
Disadvantages of listing shares for trading on an exchange include additional controls
on management, additional costs, visibility of any market indifference, requirement
for additional disclosure, and the requirement to provide information to a range of
individuals and organizations on a regular basis.
•
Exchanges have the power to withdraw a listed security’s trading and/or listing privileges
temporarily or permanently if necessary to protect investors.
Online Frequently Asked Questions
CSI has answered many frequently asked questions about this Chapter.
Read through online Module 11 FAQs.
Online Post-Module Assessment
Once you have completed the chapter, take the Module 11 Post-Test.
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