CSA Provides Guidance on Unacceptable IPO Share Structures


On September 24, 2010, the Canadian Securities Administrators (“CSA”) published CSA Staff Notice 41-305 Share Structure Issues – Initial Public Offerings (“41-305”).

The CSA have encountered a number of initial public offerings (“IPOs”) by issuers with share structures that lead them to question whether those share structures are contrary to the public interest. In those cases, the CSA generally recommend that the securities commission in the jurisdiction of the IPO refuse to issue a receipt for the prospectus.

41-305 explains the factors the CSA consider when assessing a proposed share structure in an IPO. These factors are in addition to those rules established by both the TSX Venture Exchange and the CNSX Exchange to deal with the same issues.

As structuring issues are complex, the CSA consider many qualitative and quantitative factors when evaluating the acceptability of IPO share structures.

The CSA considers how the IPO price compares to the average share price paid by the Issuer’s Founders. The CSA may object when the IPO price significantly exceeds the average price paid by the Founders. The CSA are concerned with structures in which the Founders have paid a nominal amount for a large block of shares compared to the IPO price.

The CSA assess the proportion of capital proposed to be contributed by the IPO purchasers in comparison to the percentage of ownership the IPO purchasers will receive in return. The CSA may object when the IPO purchasers are being invited to contribute an amount of capital that will be significantly disproportionate to their equity interest on completion of the offering.

The CSA considers the average capital contributed per share for all issued and outstanding shares on completion of the offering and compare it to the purchase price per share of the IPO. The CSA may be concerned if a large block of Founders’ shares issued for nominal amounts reduces the average capital contributed per share significantly in comparison to the IPO price.

Other factors considered in evaluating acceptable share structures include:

  • Prior development of business or concept: If the Founders have spent time, effort or resources developing a business, then a structure containing significant Founders’ shares may be appropriate. The CSA would not normally object to these structures when they represent a realization of business development efforts or otherwise demonstrate value. The CSA may request that the issuer explain and justify the size of the Founder’s position and the discount it represents relative to the IPO price. The CSA will consider relevant facts and circumstances, traditional valuation techniques that support the position, and other forms of third party corroboration of the value of the position such as significant pre-IPO arm’s length financing activities.
  • Distribution of Founders’ shares: In some cases, some of the Founders may have received their shares at a significantly lower average price than other Founders. In these cases, the CSA may be concerned with some of the Founders’ shares but not others.
  • Cash invested by Founders and length of time invested: Generally the greater the amount of cash the Founders have invested 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.
  • Warrants and options: If there are significant convertible securities outstanding at exercise prices lower than the IPO price, the CSA may include these securities in our analysis. If the number is large enough or the exercise price is low enough, the presence of these convertible securities may lead them to object to an otherwise acceptable share structure.

41-305 is not meant to provide certainty for every possible scenario and allow the reader to definitively determine if a given structure is acceptable or not. Rather it is intended to provide some insight regarding factors the CSA consider when evaluating proposed share structures.

If you have any questions about your capital structure or about conducting an IPO, contact any member of Clark Wilson LLP’s Corporate Finance & Securities Group.