Despite lingering concerns about the global economy and another quiet first quarter in 2014, the Canadian IPO market appears to be showing signs of life. While IPO activity in Canada has not reached the levels seen during the peak of the Canadian income trust boom in 2005, activity was relatively strong during 2013, and the pipeline for the remainder of 2014 appears to be building. Since the beginning of 2013, there have been 22 Canadian IPOs raising aggregate proceeds of over C$3 billion1 in a variety of sectors, including real estate, technology, financial services, energy and consumer products.
The U.S. IPO market has been even stronger, with over 200 IPOs in 2013 yielding aggregate proceeds of over US$50 billion, a significant increase over the previous two years and one of the strongest U.S. IPO markets in recent memory. Companies from the energy, financial and health care sectors were dominant, representing over 50% of the aggregate IPO proceeds in 2013. U.S. IPOs by companies backed by private equity and venture capital firms were also on the rise compared to previous years. These trends have continued into 2014, with approximately 100 U.S. IPOs so far this year, led by the pharmaceutical, biotechnology, financial services, health care and technology services sectors.
Any company considering a Canadian IPO will inevitably face determining how best to tap the U.S. capital markets, whether through a concurrent U.S. public offering or private placement.
There are benefits for companies going public in Canada to simultaneously go public in the United States and become listed on a U.S. stock exchange. In addition to being a significant source of additional capital, the U.S. capital markets may provide better valuations for certain issuers, especially those whose peer group includes U.S. companies—and a dual listing generally results in greater liquidity for shareholders. Cross-border companies also have improved opportunities to use their securities as acquisition currency, since a U.S. listing will be viewed favourably by U.S. target stockholders.
Securities regulatory developments in both Canada and the United States continue to affect the cross-border IPO market. While the heightened corporate governance and auditing requirements imposed by the Sarbanes-Oxley Act (S-Ox) in the United States in the early 2000s were blamed for chilling the U.S. IPO market, more recent U.S. rule-making initiatives are having a positive impact, including the relaxation of regulatory requirements under the 2012 Jumpstart Our Business Startups Act (JOBS Act). Over 80% of U.S. IPOs since the beginning of 2013 involved emerging growth companies (EGCs), which, generally, are companies with less than US$1 billion in annual revenues. Most companies considering a Canadian IPO will qualify as EGCs, making them prime candidates for cross-border IPOs. The JOBS Act has significantly lowered the cost of going and staying public in the United States for these companies—at least for as long as they remain EGCs, which may be for a period of up to five years post-IPO.
One of the benefits afforded to EGCs under the JOBS Act is the ability to test the waters to gauge market interest in an IPO by communicating with certain sophisticated investors before filing a prospectus with the Securities and Exchange Commission (SEC). Testing the waters is also permitted in connection with Canadian IPOs. This regulatory change was implemented in Canada in mid-2013 as part of a larger suite of changes that liberalized the rules governing how public offerings may be marketed to Canadian investors. The changes resulted in the Canadian rules conforming more to the SEC’s public offering rules, although there are still some cross-border differences. For example, in Canada there is a 15-day quiet period after testing the waters for an IPO before a preliminary prospectus may be filed. And in the United States, materials other than the IPO prospectus, known as “free-writing prospectuses” (equivalent to “marketing materials” in Canada), cannot be given to investors until a price range is disclosed. These rule differences must be navigated during transaction planning and marketing, but the bigger picture for IPO markets is that securities regulators on both sides of the border now permit issuers and underwriters to gauge investor interest before publicly launching a deal and, during the marketing phase, investors now have access to term sheets and other helpful summary information.
In addition to permitting testing the waters, the JOBS Act provides several other accommodations to EGCs. These companies may defer compliance with auditor attestations of internal controls (a requirement originally imposed by S-Ox that is often of particular concern given the costs and time associated with compliance). EGCs may make confidential submissions of IPO registration statements with the SEC, which both mitigates the market risk of having a prospectus on the public record during what could be a very lengthy SEC regulatory review process and results in better alignment with the generally shorter process. EGCs may also provide reduced disclosure in their prospectuses, including fewer years of audited financial statements and selected financial information and less detailed executive compensation information. Canadian EGCs conducting cross-border IPOs are also permitted to present their financial statements under International Financial Reporting Standards without having to provide a U.S. GAAP reconciliation.
An alternative to conducting a cross-border IPO is to go public in Canada first and later conduct a public offering in the United States. A company that is already public in Canada can qualify as an EGC for purposes of a U.S. IPO, and if the company has been public in Canada for at least one year and has a public float of more than US$75 million, it may simultaneously take advantage of the JOBS Act and the multijurisdictional disclosure system (MJDS). The MJDS permits companies with a one-year Canadian reporting history to plan and execute a U.S. IPO with minimal U.S. securities regulatory involvement. This approach accommodates a U.S. IPO but without the usual U.S. regulatory and consequential timing risks.
Barriers to entry for Canadian issuers are diminishing, including because U.S. investment banks are becoming more comfortable using a Canadian company’s existing public disclosure for U.S. marketing purposes.
Private Placement Alternatives
There are many companies, however, whose capital needs and business objectives simply do not warrant a cross-border IPO, or for which the benefits are outweighed by the added regulatory burdens and greater litigation and shareholder activism risks associated with becoming a U.S. registrant. For these companies, conducting a Canadian IPO combined with a U.S. private placement is the most common alternative. One of the more popular methods of accessing the U.S. capital markets in connection with a Canadian IPO is through a Rule 144A private placement of securities to sophisticated U.S. institutional investors, known as qualified institutional buyers or QIBs. Given the high threshold that investors must meet to be eligible to participate in Rule 144A offerings, Canadian issuers also often rely on Rule 506 of Regulation D. Rule 506 has historically been one of the most widely used private placement exemptions, in part because it permits offerings not just to QIBs but to a broader group of accredited investors. However, Rule 506 offerings were singled out for stricter treatment under the JOBS Act through the so-called bad actor rules, which prohibit certain individuals from participating in these offerings. In some cases, the effect of the bad actor rules has been to prevent or discourage issuers from relying on Regulation D.
The popularity of Rule 144A is demonstrated by recent cross-border offering statistics. Virtually every large Canadian IPO in 2013 and 2014 to date has included a U.S. private placement tranche under Rule 144A. A much smaller number of these transactions included a Rule 506 offering. To facilitate concurrent Canadian public/U.S. Rule 144A offerings, there has been a trend to reduce the complexities associated with these transactions. For example, Canadian companies that have little or no trading in the U.S. (which is likely the case for an issuer going public in Canada) can structure the offering so that securities issued in the United States do not have a legend, provided the purchaser is a QIB and covenants to resell the securities to the company or in accordance with the offshore resale exemption provided by Rule 904 of Regulation S. Although not universally accepted, this approach may alleviate some of the concerns that U.S. investors have with purchasing restricted securities, including the potential delays and expenses associated with removing legends on securities.
Another financing option available is the U.S. high-yield debt market. “Rule 144A for life” offerings, which involve privately placing bonds without back-end registration rights, are becoming more common and are losing the stigma historically associated with bonds that are not registered with the SEC. In our experience, barriers to entry for Canadian issuers are diminishing, including because U.S. investment banks are becoming more comfortable using a Canadian company’s existing public disclosure for U.S. marketing purposes.
Canadian Exempt Market Opportunities
Regulatory initiatives in Canada can also be expected to increase capital-raising opportunities, especially for pre-IPO companies. Canadian securities regulators have explicitly adopted the objective of facilitating financings in the exempt market with a focus on small- and medium-sized businesses. Various initiatives are underway in Ontario and other provinces that are expected to permit crowd-funding as well as improve opportunities to market securities using an offering memorandum instead of a prospectus and to sell securities to close friends and family. Predictably, these changes to the exempt market are accompanied by regulatory counter-measures to protect retail investors, including tightening access to the accredited investor and minimum amount exemptions, imposing new filing requirements and requiring investors to sign risk acknowledgment forms. However, we do not expect these measures to significantly undermine the overall objective of liberalizing the exempt market. Most importantly, if the planned regulatory changes are implemented successfully, they should facilitate small- and medium-sized companies becoming IPO candidates in the future.
1 Representing completed IPOs in Canada raising over C$25 million in proceeds.
To discuss these issues, please contact the author(s).
This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.
For permission to republish this or any other publication, contact Janelle Weed.
© 2019 by Torys LLP.
All rights reserved.