Factors Considered by the CSA in Assessing IPO Share Structures

May 4, 2011 | Dwight D. Dee

Issuers considering an initial public offering should be aware of guidance issued by the Canadian Securities Administrators (“CSA”) with respect to appropriate pre-initial public offering (“pre-IPO”) share structures.  The CSA has released Staff Notice 41-305 Share Structure Issues – Initial Public Offerings (“Staff Notice”) to provide guidance on the factors that will be considered when reviewing an issuer’s pre-IPO share structure as part of a prospectus review.

The CSA indicated that they have encountered and recommended against the issuance of prospectus receipts in a number of initial public offerings (“IPOs”) by issuers with share structures that led the CSA to question whether those share structures were contrary to the public interest.  In the Staff Notice, the CSA noted that it is particularly concerned with an IPO by a company that has already issued an unusually larger number of shares for nominal cash consideration, especially if the business has a limited history of operations or development or if the IPO financing is relatively small.

The CSA outlined qualitative and quantitative factors that would be considered in the evaluation of the acceptability of an IPO share structure:

  1. How the IPO price compares to the average price paid by the founders.  The CSA is concerned with structures in which the founders paid a nominal amount for a large block of shares compared to the IPO price.
  2. The proportion of capital to be proposed to be contributed by the IPO purchasers in comparison to the percentage of ownership the IPO purchasers will receive in return.
  3. The average capital contributed per share for all issued and outstanding shares on completion of the offering compared to the purchase price per share of the IPO.
  4. The amount of time, effort or resources the founders have spent in developing a business.
  5. The relative price per share for each founder.  The CSA would be concerned with some of the founders’ shares but not others if some of the founders have received their shares at a significantly lower average price than other founders.
  6. The greater the amount of cash invested by a founder and the longer it has been actively used as part of the issuer’s capital structure and development of its business, the more likely a given structure will be acceptable.
  7. With respect to convertible securities such as options and warrants, the number of convertible securities relative to the amount of shares issued and outstanding or if the exercise price of such convertible securities are significantly lower than the IPO price.

The Staff Notice does not provide certainty for every possible scenario and is not specific as to the thresholds that would lead to the denial of a prospectus receipt.  Rather, the CSA notes that the Staff Notice is intended to provide some insight into the factors considered in the evaluation of proposed share structures.

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