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, an RTO is a transaction that facilitates a private company (which typically has a current business or assets) being effectively acquired by an existing publicly listed company (which typically has no business or assets) through an exchange of securities of the public company for the existing securities of the private company from that private company’s shareholders. Typically, this results in the former shareholders of the private company holding a large and/or controlling interest in the public company (which now owns or controls the business or assets of the private company and remains listed on a stock exchange or quotation system) upon closing and most often results in concurrent changes to management of the public company. Notwithstanding the public company “acquired” the private company, the ongoing business of the public company is that of the private company and typically the controlling shareholders and management of the public company are now those originally associated with the private company.
There are several advantages to using an RTO as a going public process, some real and some perceived. Certainly in many cases an RTO transaction can be completed quicker (usually three to six months), with somewhat less formalities and cost. This is not always the case. An RTO is generally regulated by a stock exchange rather than securities commissions (which would review and receipt a prospectus in a traditional IPO). While often believed to be less formal, more flexible, stock exchanges have been increasing their scrutiny of RTO filings. If there is any doubt, going public via an RTO does not generally avoid costly and often time consuming prerequisites such as technical reports, audited financial statements and prospectus level disclosure of the public and private companies involved. With an RTO there is a pre-existing public company shareholder base which facilitates meeting stock exchange listing criteria and assists with liquidity considerations. However, this shareholder base may not be sold on holding shares in the resulting company which may mean selling pressure as soon as an RTO has closed, liquidity improves 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 again assists in facilitating stock exchange listing criteria and also may mean the resulting company has no need to raise additional equity and therefore can avoid further dilution to existing shareholders. However, existing public companies with cash can, and should, be more expensive in terms of exchange ratio negotiations which may mean compromises on control issues. A public company shell with no cash has its own potential problem – how to finance the public company’s costs associated with due diligence, agreement negotiation and shareholder and stock exchange approval. However, perhaps one of the most tangible issues is that, while an RTO avoids liabilities associated with filing a prospectus, the nature of most RTO transactions means the public and private companies involved may be responsible for the pre-existing liabilities of each other after closing resulting in the absolute need for a thorough due diligence review in order for management of both to have fulfilled their respective fiduciary duties to their existing shareholders and avoid a nasty surprise down the road.
RTO’s are often completed by way of share exchange with each private company shareholder or statutory arrangement/amalgamation and 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. RTO’s are not simple transactions – an 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). Definitive transaction agreements will need to be catered to the structure filing 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 – 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.