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Going Public In Canada - Reverse Takeovers (RTOs)

One of the enduring and popular mechanisms for going public in Canada is and has been the “reverse takeover”, sometimes referred to as a “back-door listing” or “reverse merger” transaction and collectively referred to here as an “RTO”.

One of the enduring and popular mechanisms for going public is and has been the “reverse takeover” – sometimes referred to as a “back-door listing” or “reverse merger” transaction (collectively referred to here as an “RTO”).

Generally, a reverse takeover or RTO is a form of a going public transaction that facilitates a non-public company (with a current business or assets which meet a particular stock exchanges listing criteria) becoming a public company listed on that stock exchange without the need to file a receipt a prospectus with applicable securities regulators. This is typically achieved by having an existing publicly listed "shell" company (ie. a public company with no current business undertaking or little to no assets) acquire the non-public company through an exchange of securities of the public company in consideration of all of the issued and outstanding securities of the non-public company. In most, but not all, cases this results in the former shareholders of the non-public company holding a large and/or controlling interest in the public company (which now owns or controls the business or assets of the previous non-public company), a change of all or most of the management of the public company to management of the previous non-public company and a public company listed and in good standing with a stock exchange with a new business to pursue or assets to exploit.

There are several advantages to using a RTO as a going public process - some real and some perceived - which make using a RTO a popular option in Canada. Many of the discussion points around consideration of a RTO include:

  • In many cases a RTO transaction can be completed quicker (usually three to six months), with somewhat less formalities and hopefully less cost. This is not always the case. A RTO is generally regulated only by a stock exchange rather than, for a typical initial public offering ("IPO") of securities and listing of those securities, a securities commission or commissions tasked with the review and receipt of a prospectus and a stock exchange tasked with a review and facilitation of listing. IPO's can take six to 12 months or longer. While stock exchange scrutiny is often believed to be less formal and more flexible, many stock exchanges have stepped up reviews of RTO filings and the disclosure related to RTO transactions and the resulting business or assets of the resulting public company.

  • There should be no doubt - going public via a RTO does not generally avoid costly and often time consuming prerequisites of any going public process such as prescribed technical (for mining issuers) or other reports, audited financial statements and prospectus level disclosure of material information related to the public and non-public companies involved. Often there it is perceived that these fundamental elements of a typical IPO are avoided or mitigated by a RTO process. This is simply not the case as the legal disclosure requirements for a public company resulting from an IPO are virtually the same, albeit sometimes accomplished in a different manner, as a public company resulting from a RTO.

  • A RTO requires an existing and generally suitable public shell company seeking a RTO (or at least willing to consider a RTO proposal) and an existing non-public operating company with a business or assets suitable to sustain a public company listing. Identifying potential candidates, approaching those candidates and coming to some agreement on even the basis elements of a proposed RTO can be a difficult, time consuming and at times expensive proposition. Deciding who and when to engage parties - including legal counsel - is a fundamental decision to make as many potential leads may go no where and any resulting negotiations may not necessarily lead to an agreement. Planning and budgeting for all potential outcomes becomes important prior to engagement.

  • With a RTO there is a pre-existing public company shareholder base which usually facilitates meeting any stock exchange listing criteria for shareholder distribution and assists with liquidity considerations. This existing shareholder base typically negates the need for an IPO to achieve the prescribed shareholder distribution upon the commencement of trading. However, the existing shareholder base may have held on to their shares for a prolonged period of time while the public company maintained its "shell" status and trading in such shares was muted if not non-existent; those existing shareholders may not be particularly interested in holding shares in the resulting public company upon completion of any RTO either because of the business of the resulting public company (for example, originally a mining company and now a tech company) or because of affinity for old management which has now moved on as a result of the RTO. Upon completion of the RTO there may be, hopefully, some revived trading volume and liquidity which may immediately be faced with selling pressure as soon as a RTO has closed and pre-existing public shareholders seek an exit.

  • An existing public company may have cash (either from the sale of assets of its earlier business, or preserved working capital) which provides a budget for facilitating any RTO process and requirements on behalf of the existing public company and further assists in meeting stock exchange budget and working capital requirements which may mean the resulting company has no need to raise additional capital through a concurrent offering of securities (and therefore can avoid further dilution to existing shareholders). However, existing public companies with cash can, and should, be more expensive in terms of negotiations related to share exchange ratios which may mean compromises on control issues. It is important that each party to the negotiation (but in particular the non-public company) have some rational view of a valuation of its business or assets and take into account the rational value of the existing public company which will at least be valued at its cash value plus some value attributed to its publicly listed status.

  • A public company shell with no cash has its own potential problem – how to finance the public company’s costs associated with due diligence, negotiations, disclosure requirements and shareholder and stock exchange approval. The process will (fundamentally) have a cost associated with it and that process may not, in call circumstances, result if a successful RTO. A discussion upfront as to who will finance those costs in the absence of any substantial working capital in the hands of the existing public company; how that financing will be facilitated; and the when and what for of any financing must be determined as part of the initial considerations of any RTO process.

  • Finally, perhaps one of the most tangible discussion points (at least for legal counsel) surrounding a proposed RTO is that while a RTO avoids legal liabilities associated with filing a prospectus, the nature of most RTO transactions means consideration of actual pre-existing liabilities of both the public and non-public. While any one company may understand, and be mildly comfortable with, the liabilities amassed in that one company (either as part of the ongoing business or the historical liabilities accumulated by operation of a previous business - think, for example, environmental liabilities of a previous mining company). In a RTO transaction - like any more straightforward acquisition or business combination - the question becomes who, what, where, when and how much questions related to those potential liabilities. The answer (should be) - proper due diligence. This is the process, and cost, that many undertaking a RTO fail to consider. Any reasonable legal advice would include the absolute need for a thorough due diligence review in order for management of both parties to a RTO to have fulfilled their respective fiduciary duties to their existing shareholders and avoid a nasty surprise down the road.

Discussion points aside, RTO’s are not simple transactions – a RTO will involve considerations of corporate law (board and shareholder approvals, share structures, statutory arrangement/amalgamation provisions); commercial law (existing commercial contract issues, including lease, loan and employment provisions); securities law (disclosure and filing requirements including distribution exemptions, minority approval disclosure and approvals, news releases and material change reports, technical reports, audited financial statements, filing statements and/or information circulars and if there is any concurrent financing through a distribution of further securities all securities matters usually associated with such an offering); potential environmental law (particularly in terms of assessing compliance and liability matters in mining and oil & gas undertakings); potential Competition Act and Investment Canada Act reporting and review; and, in all cases, extensive consideration of stock exchange policy matters (including change of control and/or change of business filings and approvals, management review, listing criteria, valuation, share offering pricing policies and escrow requirements). RTO’s in every form should include entering into of a form of letter of intent that facilitates a robust due diligence process and strict confidentiality provisions while a deal structure is finally determined and a comprehensive transaction agreement is entered into. Any resulting definitive transaction agreements will need to be tailored to the deal structure adopted including timing, closing conditions, covenants, indemnities and representations and warranties and may include provisions such as interim financing, break fees and non-solicit provisions and deal protection measures such as shareholder lock-ups.

Whether purchaser or potential target, the best advice is to get legal advisors involved early – at least prior to entering into any kind of letter of intent or memorandum of agreement (or even any related non-disclosure agreement or confidentiality agreement despite any perception that such agreements are “standard”). Early advice can go a long way to ensure intentions and deal terms are properly reflected; unintended obligations or liabilities or shareholder/ court/ regulatory challenges are avoided; proposed transactions are structured in the most efficient and effective terms possible; and that such transactions move from conception to completion with the highest degree possible of success.

Endeavor Law can assist on all aspects of a proposed RTO transaction including the initial planning and structuring; negotiation and settlement of a letter of intent; diligence, documentation and completion of the RTO transaction (on behalf of either the private or the public company); as well as coordination of listing and approval requirements of the applicable stock exchange or quotation system. Endeavor Law will always seek to provide competitive pricing for any legal services requested and is pleased to discuss fee arrangements that suit any potential client.

Does not constitute legal or other advice and must not be used as a substitute for legal advice from a qualified legal professional in your jurisdiction who has been fully informed of your specific circumstances. Information may not be up-dated subsequent to its initial publication and may therefore be out of date at the time it is read or viewed. Always consult a qualified legal professional in your jurisdiction.


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