Corporate Finance Final Notes Fall 2024 PDF

CORPORATE FINANCE FALL 2024 RADHAPRIYA CHAWLA  1 Table of Contents Lecture 1 – Introduction To Financial Theory and F...

CORPORATE FINANCE FALL 2024 RADHAPRIYA CHAWLA  1 Table of Contents Lecture 1 – Introduction To Financial Theory and Financial Statements................................................................2 Lecture 2 – The Closed System, Private Placements (Exempt Offerings) & Public Offerings................................. 6 Lecture 3 – Debt and Equity Financing...................................................................................................................29 Lecture 4 – Corp Finance Scandals & Resulting Evolution of Securities Regs.......................................................40 Wall Street Stock Market Crash of 1929............................................................................................................41 Securities Law 101 – Background.......................................................................................................................43 Scandals..............................................................................................................................................................43 Other Scandals...................................................................................................................................................53 Importance of Due Diligence and the Role of Gatekeepers..............................................................................54 Lecture 5 – Anatomy of a Financing.......................................................................................................................55 Types of Markets................................................................................................................................................55 Types of Financings............................................................................................................................................55 Key Participants..................................................................................................................................................56 Types of Offerings...............................................................................................................................................58 Preparing for the Offering..................................................................................................................................59 Initial Public Offerings – Prospectus..................................................................................................................61 At-The Market (ATM) Offerings - probs not on exam.......................................................................................64 Capital Pool Companies (CPCs) and Special Purpose Acquisition Companies (SPACs).....................................64 Share Buybacks and Normal Course Issuer Bids (NCIBs)................................................................................... 66 Private Placements – Overview......................................................................................................................... 66 Lecture 6 – Financial Derivatives............................................................................................................................67 Lecture 6 – Deal Structure Fundamentals for Brokered Securities Offerings.......................................................74 Lecture 7 – Mergers and Acquisitions (Part 1)....................................................................................................... 85 Rationale.............................................................................................................................................................85 Acquisition Financing.........................................................................................................................................87 M&A Techniques................................................................................................................................................88 Lecture 8 – Mergers and Acquisitions (Part 2)....................................................................................................... 94 Fairness Opinions and Valuations in M&A Transactions...................................................................................98 MI 61-101 and Valuations................................................................................................................................104 Defensive Tactics..............................................................................................................................................110 Lecture 9 – Corporate Governance (Part 1).........................................................................................................113 Lecture 10 – Corporate Governance (Part 2).......................................................................................................127 Lecture 11 – Demystifying Alternative Financing Techniques.............................................................................136 Lecture 12 – What’s Wrong with Dragon’s Den...................................................................................................143  2 Lecture 1 – Introduction To Financial Theory and Financial Statements FINANCIAL THEORY Time Value of Money - Present Value: Present value tells us how much a future sum of money is worth today, given a specified rate of return. This is an important financial concept based on the principle that money received in the future is not worth as much as an equal sum received today. An investment that earns 10% per year and can be redeemed for $1,000 in five years would have a present value of $621. o A dollar today is worth more now than a dollar a year from now  very little risk, can use it, consume it, invest it o There is certainty - Future Value: The value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today. $1,000 invested for 5 years at 10%, compounded annually, has a future value of $1,610.51. o Expected value in the future o When you are recognizing the time value of money and certain about the interest rate (a dollar is a dollar when) - Net Present Value: Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. o The NPV approach is considered the most intuitive and accurate valuation approach to capital budgeting problems and investment analysis. o Discounting the after-tax cash flows by the weighted average cost of capital (or required expected return) allows managers (or investors) to determine whether a project (or investment) will be profitable or not.  Choose an appropriate discount rate o Cashflows are not revenue and expenses o Is NPV > 0? – If yes, then do the project or make the investment o Is NPV < 0? – If yes, then don’t do the project or make the investment - Risk: Must assess and quantify the riskiness of the expected cash flows to be received. o The more risk, the higher the required expected rate of return. - NPV: Is utilized to assess business projects and opportunities; it is also used as a valuation methodology for stocks, bonds, real estate and companies. - Other financial assessment tool: internal rate of return (the rate of return on a project that results in NPV = 0) o The internal rate of return is the expected discount rate that brings NPV to 0 - Other valuation methodologies: comparable transactions (how one would intuitively valuate  what is it worth compared to what the other one is worth); comparable companies (if you have a company trading on a stock market, look at the peer group company that is trading similarly); net asset value (assets minus the debts is the net worth); liquidation value; etc. o All of these methodologies will be looked at later  3 Efficient Market Theory - Efficiency” signifies a level of performance that describes using the least amount of input to achieve the highest amount of output. However, “market efficiency” refers to the degree to which market prices reflect all available, relevant information - How accurately prices reflect and adjust to information - Three Forms of Market Efficiency: 1. Weak Form: Current market prices reflect all historical information 2. Semi-Strong Form: Current market prices reflect all historic and all current publicly available information  Market place reflects all current publicly available information (everyone knows about it) 3. Strong Form: Current market prices reflect all information, including information not publicly available  Reflecting more than what is publicly available - Securities law objective = semi-strong form efficiency. o It seems very fair and has a level playing field o The weak form is not practical. o The strong form is not fair and results in a loss of investor confidence since the playing field will appear to be unfair. - Important to know because it is a policy objective - The “fraud on the market theory” (a US legal concept) relies on the integrity of market prices so as to allow plaintiffs to have deemed reliance on public misrepresentations or fraudulent disclosure. FINANCIAL STATEMENTS Balance Sheet - Is a statement of financial position; a snapshot in time (on a particular date) - Provides information on what the company is worth, from a “book value” perspective o Assets = Liabilities + Owner’s Equity  The fundamental accounting equation o A = L + OE o OE = A – L - Often called a “statement of financial position” - Score card of financial position Balance Sheet Terminology: - Assets – Assets are items owned by the business. In the assets section of the balance sheet, you will notice that there are current and long-term assets. o Current assets are the same as short-term assets and those are assets that are expected to be sold or turned into cash within one year. Cash is considered the most liquid of all assets, but other short-term assets include items like accounts receivable and prepaid expenses like rent or insurance.  4  Things in the balance sheet or in the order of liquidity (why current assets are listed before long-term assets as current assets are likely to be turned into cash within 12 months) o Long-term assets or non-current assets are assets not expected take more than one year to be consumed or converted into cash. Long-term assets often include items like real estate or machinery. - Accounts Receivable – Money owed by customers who purchased goods or services on credit that was provided by the company. o Money that we are supposed to receive for the invoices sent out - Current Liabilities – A current liability is a loan due to creditors within the next 12 months from the beginning date on the balance sheet. - Accounts Payable – Similar to accounts receivable, accounts payable are short-term loans, typically owed by the business from purchases made on credit from suppliers or vendors. o A liability – invoices that the business receives that must be paid - Taxes Payable – Taxes that have accrued but have not yet been paid. One example would be payroll taxes. The wages have been paid to the employee but payroll taxes haven’t been paid yet as they weren’t due at the time the balance sheet was created. - Long-term Liabilities – Similar to current liabilities, but a long-term liability is a debt that is due more than one year out from the date being reviewed on the balance sheet. o Any amounts owing by the company that are not due within the next 12 months - Retained earnings – Earnings that are reinvested in the business after the deduction of any dividends.  profits that the company has kept - Current Portion of Long-Term Debt – Amount of principal that will be due within one year of the date of the balance sheet. - Owners’ Equity – Sometimes referred to as stockholder equity, net worth or paid-in capital and is the amount owners have invested in the business minus any withdrawals (not including salaries) taken since the business began. o Amount of capital that got injected plus the retained earnings minus the dividends Income Statement - Is a statement of financial performance over time; reveals profits or losses as a result of revenues and expenses over a selected period of time - Always for a quarter or year - What were sales during the year (sales do not show up on a balance sheet) Income Statement Terminology: - Total Revenues (Gross Sales): This figure represents the amount of revenue generated by a business. - Cost of Sales or Cost of Goods Sold: Amount represents costs directly associated with making or acquiring your products. (Not all companies will need this category as service-based businesses typically don’t have a cost of sales).  5 - Gross Profit (also called gross margin): The amount of gross profit is determined by subtracting the cost of goods sold from net sales. It does not include any operating expense or income taxes. - EBITDA: A company's earnings before interest, taxes, depreciation, and amortization is an accounting measure calculated as a proxy for a company's current operating profitability as well as providing a proxy for cash flow. o Allows 2 businesses to compare between each other without considering non-cash expenses o Common acronym used General Accounting Terminology: - Generally accepted accounting principles (GAAP) refer to a common set of accounting principles, standards and procedures that companies must follow when they compile their financial statements. - In early 2006, the Canadian Accounting Standards Board decided to completely converge Canadian GAAP with international GAAP, i.e. International Financial Reporting Standards (IFRS). BOOKKEEPERS, ACCOUNTANTS AND AUDITORS - Bookkeeper: a person whose job is to keep records of the financial affairs of a business. - Accountant: an accountant is a professional of accounting or accountancy, which is the measurement, disclosure or provision of assurance about financial information. Accountants are trained in bookkeeping and in preparation, auditing and analysis of financial information. Accountants also typically prepare tax returns and provide financial advice. - Auditor: An accountant who inspects and verifies the accuracy of a company's financial statements. Hiring an Auditor: - Compilation Report: financial data and bookkeeping records are organized into financial statements. No or limited verification. - Review Engagement: preparation of a company’s financial statements, including some limited inquiry and verification services - Audit Engagement: preparation of a company’s financial statements, including reasonable inquiry and verification services (in accordance with generally accepted auditing standards, GAAS) an a professional opinion that the financial statement fairly represent the company’s financial position and performance o Normal Audit o High Risk Audit  If there is something fishy or a high risk, then can conduct a high risk audit  Heightened level of skepticism and more due diligence  Assuming that records and books are authentic o Forensic Audit  Not assuming that records and signatures are authentic - OBCA requires audited financial statements, unless the corporation is not an offering corporation and all shareholders consent. - Liability for Losses Related to Audit Opinions: typically difficult for investors to successfully sue auditors  6 YouTube Links Net Present Value (NPV) explained https://www.youtube.com/watch?v=N-lN5xORIwc CFA Level I Equity Investments - Efficient Market Hypothesis https://www.youtube.com/watch?v=NPuXzpZLefk Understanding Financial Statements and Accounting: Crash Course https://www.youtube.com/watch?v=_HK5gpg39pY Do I need a Compilation, Review or Audit? https://www.youtube.com/watch?v=s95_po97h24 Lecture 2 – The Closed System, Private Placements (Exempt Offerings) & Public Offerings Objectives of Lecture - Discuss: 1. Different types of business structures – with a focus on "corporations" and "duties of directors" 2. The Concept of the "Closed System of Securities Regulation" 3. Private Placements (Exempt Offerings) and Prospectus Offerings 4. Continuous/Timely Disclosure Obligations. Insider Trading Rules, Control Block Sales 5. Key Securities Act Definitions and other commonly used terms THE CLOSED SYSTEM The closed system is the world of prospectus offerings Different Types of Business Structures - Sole Proprietorship – owned by one person; no distinction between person and business o When you retire, the business ends - Partnership - formal arrangement by two or more parties to manage and operate a business and share its profits o Sharing liability and losses o General Partnership - no liability protection for the partners o Limited Partnership - when a partner is an investor in a business but is not involved in day-to-day operations; generally have limited liability in the company's debts and liabilities, up to the amount of capital that they have invested in the business  Want to make sure the investor (who is not involved in the decision-making) is protected from liability - Corporation - a legal entity that is separate and distinct from its owners. Corporations enjoy most of the rights and responsibilities that individuals possess: they can enter contracts, loan and borrow money, sue and be sued, hire employees, own assets, and pay taxes o Much easier to sell corporation than sole proprietorship Advantages of Incorporation - Limited Liability - Continuity of Existence = transferring the business and having it continue on - Transfer of Ownership  7 - Ability to Finance o Easier to finance the business when it is a corporation  easier to give benefits to investors that way, can get paid dividends - Separate Legal Entity - Management - Shareholders elect directors - Directors elect officers Disadvantages - Subject to Statutory Rules - Taxation - Expensive to maintain o Much more expensive when you are public company rather than private company - Rules in withdrawing capital Private Corporations vs. Public Corporations - Private Corporations formed by articles of incorporation, but have restrictions in their articles/charters on: o (i) the right of shareholders to transfer shares; o (ii) a limitation on the number of shareholders to not more than 50 (exclusive of current employees or former employees); and o (iii) a prohibition on inviting members of the public to subscribe for shares. - Public Corporations formed by articles of incorporation, but don’t have private company restrictions – usually companies whose shares are listed on a stock exchange or traded over-the-counter. - A Corporation is governed/regulated by: o the federal or provincial act in which it is incorporated o its own charter/articles o its by-laws, which contain rules governing:  calling of shareholder and director meetings  election/removal/qualification of directors  appointment of officers  payment of dividends  date of fiscal year end  signing authority  indemnification for acts taken in good faith (s. 136 OBCA) - Most companies are OBCA companies or CBCA companies  8 Management runs the day to day operations of the company Shareholders put in the money and in return get shares  how they get voting power. Through the shares is how they get dividends. Duties of Directors - under the OBCA section 115(1) provides…. “subject to unanimous shareholder agreement, the directors shall manage or supervise the management of the business and affairs of a corporation” o Private companies – need at least one director o Public companies – need at least three directors - Directors set company policies and pass resolutions approving corporate actions o typically approve budgets, appoint officers, the raising of capital, the declaration of dividends, significant acquisitions and dispositions o Directors can be liable for illegal acts of the Corporation done with their knowledge and consent o Directors can be liable personally for employee wages, declared dividends and government remittances Standard of Care (sets the standard for what constitutes a “reasonable director/officer”) - Section 134(1) of OBCA provides that …. “every director and officer of a corporation in exercising his or her powers and discharging his or her duties to the corporation shall, a) act honestly and in good faith with a view to the best interests of the corporation; and b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances” - Every director must act honestly and in good faith with the best interests of the corporation - You don’t have to make a perfect decision. You just need to make a decision that falls within the scope of what a reasonable person would do. BCE Inc. v. 1976  leading decision confirming director (fiduciary) duties Debentureholders SCC  in the end, directors’ fiduciary duties are owed to the corporation (not December, 2008 any particular constituency)  SCC said that directors “may” but are not required to give consideration to the interests of a range of stakeholders (shareholders, employees, suppliers, creditors, consumers, the environment), the practical effect of  9 the SCC’s decision is that directors will need to assess a range on interests when exercising their business judgment.  The decision: o characterized the fiduciary duty as a “broad, contextual concept”; o noted that “a corporation and its shareholders are entitled to maximize profits and share value, to be sure, but not by treating individual stakeholders unfairly”; o found that “the duty of the directors to act in the best interests of the corporation comprehends a duty to treat individual stakeholders affected by corporate actions fairly and equitably”; o strongly endorsed the “Business Judgment Rule”  “provided that, as here, the directors’ decisions is found to have been within the range of reasonable choices that they could have made in weighing conflicting interests, the court will not on to determine whether their decision was a perfect one”.  You don’t necessarily need to cater to the stakeholders of the company because a lot of the time their interests are competing HOWEVER you must consider and weigh all of the options Officers - responsible for day-to-day management of the Corporation - examples: o President o Chief Executive Officer (CEO) o Chief Financial Officer (CFO) o Vice President Share Capital - Authorized Shares refers to the maximum number of common or other shares that the Company can issue under its Articles  Typically most companies are structured to issue an unlimited number of common shares o All companies in their articles will say how many shares they can issue as well as the type of shares - Issued (Outstanding) Shares refers to the part of authorized capital that has been issued o What is the total amount of shares issued and out there - Market Capitalization refers to the total dollar value of a company’s shares based on current market price of its shares and its outstanding shares o Calculation of the value of your shares - Public Float for public companies, refers to that part of the issued shares that are outstanding and available for trading and not held by the Company’s officers, directors or shareholders holding over a 20% stake  10 What is a Closed System? - Refers to the limited universe in which securities can be traded if they haven’t been qualified by a prospectus - Refers to the securities regime in which all trading of securities – not simply primary distributions to the public – are caught by the broad regulatory net - Want an efficient capital market - Shouldn’t issue shares unless you have a prospectus o A prospectus allows you to make a good judgement on whether you want to invest - Can use a prospectus exemption (private placement) - Using a prospectus exemption to raise money is a closed system One major benefit of prospectus is that you get free trade in stock Basically two ways in which a company (public or private) can issue securities (whether equity (common/preferred shares) or debt (a convertible debenture, a convertible promissory note)) By exempt offering (aka private placement) By prospectus - What is a prospectus offering?: What is an exempt offering?: The issuance of The issuance of securities of a company, a securities of a company, a partnership, a trust partnership, a trust with the benefit of a major without the benefit of a prospectus, i.e. Pursuant disclosure document (a prospectus) that has been to an exemption from the prospectus receipted by a securities commission trades of requirements securities private issuers (subject to perpetual holds) Examples of exemptions: - Accredited investor exemption: you are an accredited investor if you can prove you have enough money  assume you will make sound investment decisions - Private issuer exemption - Family/friends exemptions - Offering memorandum exemption Technically a third route - seeking “discretionary relief” from a Securities Regulator - Key Instrument(s): o NI 45-106 “Prospectus Exemptions” o NI 41-101 General Prospectus Requirements  Sets out the rules on what a prospectus must look like and how it is filed  11 o NI 44-101 Short Form Prospectus Distribution - Hold Periods o NI 45-102 “Resale of Securities”  The resale rules - “Restricted Period” on resale o A person who receives it must hold it for 4 months and 1 day - “Seasoning Period” on resale o For private companies, they have a seasoning period o You cannot sell it unless it is of the later of the following period o Cannot trade the security to somebody else indefinitely until the company becomes a public company Key Securities Act Definitions (section 1(1) of OSA) “Accredited Investor” Essentially means a “sophisticated investor” who can bear of risk of loss of his/her investment;  See definition within NI 45-106 and attached in Appendix A; “Control Person” A person or company that holds more than 20% of the voting securities of an issuer; “Insider” An officer, director of a reporting issuer or over 10% shareholder; “Distribution” is (i) a trade of a security not previously issued; or (ii) a trade of securities from a control (20% or more) position; “Material Change” Means, when used in relation to an issuer, a change in the business that would be expected to have a significant effect on the market price or value of such security; See NI 51-102F3;  Change in the business operations or capital of the company  A harder threshold to hit  Need to issue a press release for a material change and need to file a material change report “Material Fact” Means, when used in relation to a security, a fact that would reasonably be expected to have a significant effect on the market price or value of such security;  Always going to be material information  Easier threshold to hit but also attracts disclosure requirements “Misrepresentation” (i) an untrue statement of material fact; or (ii) an omission to state a material fact that is required to be stated or is necessary to make a statement not misleading; “Offering Disclosure document sometime used in a private placement – such document Memorandum” describes the business and affairs of an issuer; “Private Company” One in which: (i) the right to transfer shares is restricted in its Articles of Incorporation; (ii) has no more than 50 shareholders, exclusive of persons in employment or were formerly employed; and (iii) an invitation to “the public” to subscribe for shares is prohibited; “Private Issuer” a term for frequently used private placement exemption for private companies contained in NI ; a “Private Issuer” is an issuer that (a) is not a reporting issuer or investment fund (b) its securities are subject to transfer restrictions contained in the issuer’s Articles and which securities are beneficially held by not more than 50 persons (not including employees or former employees) and (c) has distributed its securities to a prescribed list of persons (director, officers, spouse, parent, grandparent, child, close personal friend, close business associate, an accredited investor, etc.);  12 “Reporting Issuer” a “public” company which has filed a prospectus and has received a receipt for a final prospectus and is subject to Continuous Disclosure/Timely Disclosure obligations; “Security” almost everything is a “security” (16 sub-categories as set on Appendix A); “Trade” Focus on the sale or disposition side of a security – not the purchase; essentially “and sale or disposition of a security for valuable consideration whether the terms of payment are on margin, installment or otherwise” Other Terms to be Discussed “Annual Information An annual disclosure document required to be filed on SEDAR for TSX listed companies Form” (“AIF”) and all other issuers wanting to access the short form prospectus rules; See Part 6 of NI 51-102 and NI 51-102 F2 “Best Effort Agency A form of offering in which the Agent/Dealer pledges to use its best efforts to raise Offering” funds under a prospectus or offering memorandum – to be contrasted with an underwritten offering; - A private placement can be brokered or not brokered (brokers are like banks) - Two types of brokers – underwriters and agents o Underwriters: guaranteeing that you are going to raise x dollars and if you don’t, you will buy the stock o Agents: will try their best to raise money but nothing is guaranteed “Bought Deal” A form of offering which is underwritten and often used by reporting issuers who have a current AIF filed on SEDAR which allows issuer to use the short form prospectus rules;  A type of underwritten deal and it is the most aggressive form of deal “Continuous The obligations on public companies to release promptly to a news media (wire Disclosure/Timely service) any material favourable or unfavourable information. Broad dissemination of Disclosure” news allows non-insiders to trade the issuer’s securities on the same knowledge level as company insiders;  When you are a public company, you need to make disclosure “Early Warning” A reporting mechanism for shareholders who obtain more than a 10% in a public company or who obtain incremental 2% positions in a public company. See 102.1 of the OSA and NI 62-103 – The Early Warning System and Related Take-Over Bid and Insider Reporting Issuers; - Alternate disclosure for “Eligible Institutional Investors” (pension funds, mutual funds, financial institutions, investment managers) – known as Alternative Monthly Reporting; “Final Prospectus” The final prospectus filed with Securities Regulatory Authorities which is “receipted” “FLI” Means forward looking information (and includes FOFI); Need to have cautionary language and put qualifiers in there  Put this into the prospectus as well “FOFI” Means future oriented financial information “Hold Periods/Resale Refers to the restrictions on the ability to resell a security. For a public company that Restriction” issues securities on an exempt basis, the standard hold period is 4 months and 1 day. For a private (non-public company) – the hold period is perpetual. For a public offering by way of prospectus, there is no hold period for non-controlling positions; “Information A disclosure document sent to shareholders in advance of an Annual, Special or Circular/Proxy Annual & Special Meeting of shareholders – see NI 51-102F5; Circular”  Tells what you are voting on and gives the information required to make an informed decision  13 Initial Public Offering The first offering of securities of an issuer to the public; e.g., Shopify, Sleep Country; (“IPO”) “Management A written discussion regarding an Issuer’s business and financial results, trends, risk Discussion and factors, etc; See Part 5 of NI 51-102 and 51-102F1; Analysis” (“MD&A”) “Over Allotment An option provided to an Agent/Dealer/ Investment Banker allowing them to acquire Option/Green Shoe up to 15% of the securities sold in a prospectus offering to cover over allotments; Option”  Allowed to go over by 15% “Preliminary The initial prospectus disclosure document filed with a Securities Regulatory Authority Prospectus” (e.g. OSC) in respect to the offering of a security to the public “Primary Market” Refers to securities being issued for the first time – i.e., from treasury “Red Herring” Refers to warning in RED TYPE on a preliminary prospectus that no Securities Regulatory Authority has finally approved and/or issued a receipt for a final prospectus; “Right of Rescission” The contractual right to terminate your subscription if there has been a “misrepresentation” in the disclosure document (i.e., prospectus); “Right of The contractual right of a purchaser to withdraw his purchase of securities within 2 Withdrawal” days of receiving the prospectus; “Secondary Refers to a distribution from a “control block” shareholder Issue/Offering” “Secondary Market” Refers to trading of securities already issued on a relevant stock exchange or over-the- counter market – e.g. TSX, TSX-V, NYSE “System of Electronic The data base where all reporting issuer’s public documentation (press releases, Data and Retrieval material change reports, quarterly financial information, MD&A, etc.) is filed. In U.S., Plus (“SEDAR+”)” the same system is referred to as EDGAR;  where you file all of your material change documents  If you want to know whether a company is public “Underwritten A form of offering in which the Underwriter/Dealer commits its capital and agrees to Offering” purchase a fixed number of securities – which it will then attempt to offload/sell to subscribers; “Waiting Period” The period of time (a minimum of 10 days to maximum of 90) between filing the preliminary prospectus and a final prospectus. Basic Steps Involved in a Private Placement (Exempt Offering) of Securities - The rules relating to exempt market transactions have been harmonized (since 2005) in NI 45- 106 “Prospectus Exemptions” and NI 45-102 “Resale of Securities”. - The goal of any Private Placement (“PP”) is to raise $$ for the issuer in question to help fund growth, to make an acquisition, for working capital, etc. - For a Private Company – the Steps involved include: 1. Identify the terms of the security to be sold (a common share, a preferred share, a convertible debenture, a “unit” (consisting of a common share and a warrant) 2. Identify subscribers and the private placement exemption(s) to be used – See Appendix A a. There are various “categories” of exemptions in NI 45-106, namely: b. Capital Raising Exemptions c. Transaction Exemptions d. investment Exemptions  14 e. Employee, Executive Officer, Director and Consultant Exemptions f. Miscellaneous Exemptions Examples of most common exemptions used: ““Accredited Investor Exemption” “Private Issuer Exemption” 3. Prepare subscription documents (i.e. a subscription agreement)  the binding contract that the company enters into with the subscriber 4. Arrange for closing of PP – at which time shares of other securities are issued in exchange for $$ 5. Usually no registered dealer (broker, underwriter or advisor involved) o but sometimes there is and, of course, you would have to pay for their services  typically dealers work on a percentage fee of $$ raised (e.g. between 5-8%)  could include a warrant or option as a “sweetener” o What is a “warrant” or “option”? essentially – a right to buy a security at a fixed price over a specific period of time (e.g. a warrant or option to acquire 1,000 common shares of ABC Co. at $1.00 per share for 5 years) o no reporting of PP to a stock exchange or securities commission (such as Ontario Securities Commission) o likely have need for a Shareholders Agreement (an all powerful agreement if dealing with private companies)  an agreement which sets out rights of shareholders:  setting out who gets to appoint directors and officers  what decisions require shareholders to approve vs. management to approve  restrict share transfers other that by way of agreed mechanism: o Permitted Transfers o Rights of First Refusal o Put/Call Rights o Shotgun Rights  rights on death, disability or resignation  rights of confidentiality, non-competition and non-solicitation o all securities issued will be subject to a perpetual hold (so securities are not freely tradeable)  likely no “market” for securities anyway  exemptions if permitted by shareholders agreement, could trade pursuant to another PP exemption  still in the “closed system” Discuss Interplay between NI 45-106 and NI 45-102 - First Trades subject to either (i) Section 2.5 of NI 45-102 Restricted Period Trades (4 months and 1 day hold period) OR (ii) Seasoning Period Trades (no resale restriction if reporting issuer has been a reporting issuer for at least 4 months)  15 - For a Public Company: The goal of the PP is again to raise $$ for the issuer to help fund growth, to make an acquisition or for working capital purposes, etc. - Remember – if you are a Public Company - this means you are a “reporting issuer” with at least one of the Canadian Provincial Securities Commission – and because of that you are subject to stringent rules regarding disclosure to the market place o Your disclosure documents will be filed on www.sedarplus.ca e.g. – press releases, material change reports, quarterly financial reports, annual financial reports and related MD&A, business acquisition reports, information circulars – prospectus, Annual Information Forms (AIF) - For a Public Company, the Steps involved include: 1. Identify forms of security to be sold (similar to a private company above) 2. Identify subscribers (more likely an agent, broker, investment dealer involved) 3. Obtain regulatory approval for the terms of the PP from: a. Toronto Stock Exchange (TSX – the senior exchange) b. TSX Venture Exchange (TSXV – the junior exchange) each of the TSX and TSX-V have prescribed rules governing the terms of PPs eg. maximum permitted discounts from Current Market Price, # of warrants that can be added, price and term (duration in time) of warrant, when shareholder approval may be required, etc. For example: TSXV Permitted Discounts Rules say: If Closing Price Discount Up to $0.50 25% $0.51 to $2.00 20% Above $2.00 15% Contrast with Rules of TSX same Permitted Discount Rules; shareholder approval required if you would increase by more than 25% of the number of the listed issuers securities prior to PP, if the price per security is less than the market price; if during any six month period, insiders have received listed securities, options, warrants or other entitlements greater than 10% of the number of securities outstanding prior to the date of closing of the first private placement to an insider during the six month period. 4. Prepare subscription agreement (and any collateral documents) 5. Arrange for closing of PP – at which time securities are issued in exchange for $$ o at this time, any agent (broker, investment dealer) would be paid 6. Issue Press Release to disclose terms of PP o likely file a material change report  16 7. Make Filings with the TSX/TSXV as required pursuant to conditional approval letter received in step 3 above 8. Make 45-106 F1 filings with Applicable Securities Commissions and pay fees What does the Form 45-106 F1 disclose? How does an entity become a “Reporting Issuer” (Public Company)? One of two ways: 1. File and be receipted for a prospectus; 2. Merge/amalgamate with an existing public company - Reverse Take Over (RTO) – a private company seeking to go public (the target) combines with a listed company without an active business (the shell) to form the resulting issuer. o Capital Pool Company (CPC)  Idea of creating a shell company but you go through the hoops of listing it on the TSXV and have to do the filing statement, annual financials  Need to do the bare minimum in order to be a public company  Don’t need to do much and anyone can create a CPC program  A lot of lawyers and bankers do this because they have the connections - Direct Listing via Non-Offering Prospectus - going public without selling shares through an agent or underwriter as is done in a regular IPO. An NOP qualifies the distribution of the company’s already outstanding securities to the public. When is a Prospectus required? (s. 53(1)) - “no person or company shall trade in a security on his, her or its own account or on behalf of any other person or company if the trade would be a distribution of the security, unless a preliminary prospectus and a prospectus have been filed and receipts have been issued for them by the Director” What is a Prospectus? (s.56(1)) - “a disclosure document containing full, true and plain disclosure of all material facts relating to the securities issued or proposed to be distributed” Type of Prospectus: - Long Form Prospectus o See NI 41-101 F1 “Information Required in a Prospectus” o Much more comprehensive - Short Form Prospectus o See NI 44-101 F1 “Short Form Prospectus” o Only allowed for issuers with current AIF filed and allows for documents to be “incorporated by reference” o Much quicker to do - Mutual Fund Prospectus o See NI 81-101 “Mutual Fund Prospectus Disclosure” - Shelf Distribution Prospectus o See NI 44-102 “Shelf Distributions” o Even shorter than a short form prospectus - Post Receipt Pricing Prospectus (PREP)  17 o See NI 43-103 “Post Receipt Pricing - MJDS Prospectus o See NI 71-101 “Multijurisdictional Disclosure System” A prospectus generally includes disclosure of the following: 1. Cover Page 9. Relationship between Issuer and 2. Summary Description of Business Underwriter 3. Consolidated Capitalization 10. Interest of Experts 4. Use of Proceeds 11. Promoters 5. Plan of Distribution 12. Risk Factors (the legal one) 6. Description of Securities Distributed 13. Statutory Rights of Withdrawal and 7. Prior Sales Rescission 8. Documents incorporated by reference 14. Certificate Pages Several fundamental aspects of the prospectus process are common to all forms of prospectus: - Disclosure through preliminary and final prospectus o it is like a receipt - Regulatory oversight of the process - Right of withdrawal/rescission for investors in certain circumstances - Statutory liability for misrepresentation and omissions in relation to the prospectus Four stages to the prospectus process: 1. The development and filing of a preliminary prospectus and issuance of a receipt 2. Effecting comments and changes during the “waiting period” 3. The filing of the final prospectus and issuing of a receipt 4. The “distribution” of securities once receipt is issued Prospectus Review “Passport System” (adopted by all Regulators in Canada except Ontario) - NP 11-202 “Process for Prospectus Review in Multiple Jurisdictions” - deals with coordinated review by securities regulatory authorities in multiple jurisdictions one jurisdiction will act as the “Principal Regulator” (PR) o “dual prospectus” vs “passport prospectus” - if PR is a passport regulator and prospectus is not filed in Ontario, only the PR will review; - if PR is the OSC and the prospectus is also filed in a passport jurisdiction, only the OSC will review - if PR is a passport regulator and the prospectus is filed in Ontario, the PR will review the prospectus, and the OSC, as a non-principal regulator, will coordinate the review The waiting period and review process - After filing of preliminary prospectus, there is a mandatory waiting period (no less than 10 days) until the prospectus can be finalized and a receipt issued for the final prospectus - Usually, 10 working days to get comments (shorter for the Short Form Prospectus) - Can solicit “expressions of intent” from investors with preliminary prospectus - Various types of Prospectus Reviews:  18 o based on a “Risk-Based Approach” o Basic Review o Full Review o Issue-oriented Review - Restrictions on Activities During the “Waiting Period” o “Advertising” for the most part is restricted during the Waiting Period o advertising is really limited to:  alerting the public of the existence of the preliminary prospectus  advise as to where to find the prospectus information o ability to submit expressions of interest Shelf Prospectus NI-44-102 only available to senior issuers. Allows an issuer to file a prospectus and leave it “on the shelf” for up to 25 months Any time in that period, the issuer can take the securities “off the shelf” and distribute them Advantage of a shelf prospectus is that in order to distribute the securities, only a “supplement” updating information is required, which does not require regulatory review MJDS NI-71-101 Multijurisdictional Disclosure System Allows issuers in US and Canada to effect a cross border offering using the same disclosure forms when selling securities in each other’s markets Stringent eligibility requirements Material Fact and Material Changes (after filing of Preliminary Prospectus and Final) - From NI-41-101: o 6.5 (1) Except in Ontario, if, after a receipt for a preliminary prospectus is issued but before a receipt for the final prospectus is issued, a material adverse change occurs, an amendment to the preliminary prospectus must be filed as soon as practicable, but in any event within 10 days after the day the change occurs. - [Note: In Ontario, s. 57(1) of the Securities Act (Ontario) imposes a similar requirement to file an amendment to a preliminary prospectus where there has been a material adverse change.] Amendment to a final prospectus: - 6.6(a) Except in Ontario, if, after a receipt for a final prospectus is issued, but before the completion of the distribution under the final prospectus, a material change occurs, an issuer must file an amendment to the final prospectus as soon as practicable, but in any event within 10 days after the day the change occurs. - [Note: In Ontario, subsection 57(1) of the Securities Act (Ontario) imposes a similar requirement to file an amendment to a final prospect - Both definitions are defined with reference to whether the change or fact “would reasonably be expected to have a significant effect on the market price or value of a security” o a “market impact” standard of materiality - Discuss YGM Magnex International, Inc. , 26 OSCB 5285  19 o “the test for materiality in the Act is objective and is one of “market impact”. An investor wants to know facts that would reasonably be expected to significantly affect the market price or value of securities”. Future Oriented Financial Information (FOFI)/Forward Looking Information (FLI) - Financial forecasting can be included in a prospectus, but can be risky, in terms of both content and appropriate cautions provided - If provide FLI disclosure, an issuer must: I. identify the FLI II. caution users that actual results may vary and identify material risk factors that could cause the actual results to differ III. states the material factors or assumptions to develop the FLI IV. describes the issuer’s policy for updating FLI - Discuss Kerr v. Danier Leather Inc. 2007 SCC 44 Material Change and Material Fact - The distinction between “material change” and “material fact” is deliberate and policy-based, as explained by a former chairman of the OSC: - The term “material fact” is necessary when an issuer is publishing a disclosure document, such as a prospectus or take-over bid circular, where all material information concerning the issuer at a point in time is published in one document which is convenient to the investor. - The term “material change” is limited to a change in the business, operations or capital of the issuer. This is an attempt to relieve reporting issuers of the obligation to continually interpret external political, economic and social developments as they may affect the affairs of the issuer, unless the external change will result in a change in the business, operations or capital of the issuer, in which case, timely disclosure of the change must be made. Control Block Sales and Resale Rules - Securities laws impose more onerous resale rules for control blocks who wish to sell their securities and do not qualify for a prospectus exemption Steps in Conducting a Public Offering: - Either for the first time (IPO) - Or subsequent offering a GOING PUBLIC PROCESS: Preparation:  20 - A long process - Structural and other changes are considered (e.g., do you need to amend the Articles of the Company) - Preparations to commence well before drafting of the offering document (prospectus) - What do you need to prepare for? o Disclosure of your business to regulators and the public o Full due diligence review by underwriters o Public company level audit o Three years of audited financial statements o Transition to IFRS o Future life as public company Preparation – Best Practices: - Preparatory Steps o Capital Structure  review articles and by-laws  review capitalization (share capital) records for completeness o Material contracts  Related party transactions  contracts with management  contracts on which the business is substantially dependent  confidentiality issues/redaction o Third Party consents o Outstanding litigation - Independent Directors o OSC requirements - Board Committees and Charters o audit committee o corporate governance and nominating committee o compensation committee - Adopt new policies o insider trading o code of conduct/ethics o whistleblower o disclosure - Indemnification and D&O insurance - Disclosure Controls & Procedures (DC&P) and Internal Control of Financial Repository (ICFR) and Sarbanes-Oxley (SOX) compliance - Retain a transfer agent prior to this year’s AGM Preparation – possible need for Annual General Meeting (AGM) - Items of special business to consider o remove transfer restrictions in Articles  requires two thirds approval of shareholders  21 o adopt a public company stock option plan o amend shareholders agreement to clarify that pre-emptive rights to not apply to an IPO  requires two thirds approval of shareholders o amend quorum requirement in by-laws  requires director resolution, followed by shareholder ratification by a simple majority o share consolidation (range) to meet minimum listing price for listed exchange  Requires two thirds approval of shareholders Planning the Offering: - Planning – Items to Consider: o Assembling the team members  Management  Auditors  Lawyers  Underwriters (who will conduct road shows)  Investor relations  Amounts to be paid to underwriters (typically a % paid in cash and most often an “over-allotment” option  Printers o Pre-filing meeting with the TSX/Confidential review by NASDAQ Execution - IPO Process and Timeline o Meeting with regulators  drafting prelim prospectus  business financial and accounting due diligence  filing of prelim prospectus  regulatory review and revising prospectus  prep marketing materials  print US and CDN prelim prospectus  road show  pricing  filing final prospectus  closing - Prospectus Content o Financial Statements o Risk Factors o Use of Proceeds o MD&A o Executive Compensation o History of Business o Material Contracts o Plan of Distribution o Forward Looking Information (including FOFI) Life as a Public Company – “Continuous/Timely Disclosure” - Significant disclosure obligations (substantially laid out in NI 51-102 – Continuous Disclosure Obligations): o Annual Audited Financial Statements (due 120 days after year end for non-venture issuers/140 days for venture issuers)  22 o Interim Financial Statements (due 45 days after fiscal quarter for non-venture issuers/60 days for venture issuers) o Proxy Solicitation and Information Circulars o Business Acquisition Reports o MD&A o CEO & CFO Certifications o Annual Reports (AIF/20-F) - Public disclosure of all “material information” o “Material Information” is defined to be information relating to the business and affairs of an issuer that results or would reasonably likely to result in a significant change in the market price or value of the issuer’s listed securities - Annual Shareholder Meetings and Proxy Solicitation - Insider Reporting & Restrictions on Trading o Black-out periods o Escrow of principal’s securities/lock-ups - Secondary Market Liability for misrepresentations - Advantages of Going Public: (exam question) o Increased liquidity for shareholders o To facilitate growth by acquisition o Attract and retain talented people o Prestige - Disadvantages of going public: (exam question) o Loss of control o Loss of privacy o High cost to go public and ongoing reporting requirements o Increased risk of director liability o Risk of takeover MINING Metals and Mining Demand - The demand for metals increases as wealth increases - As people move into “middle class” they begin to purchase appliances, housing, equipment, electronics, automobiles etc. The demand curve rises steeply - At some point people have provided for all their basic and luxury metal needs - The demand curve flattens as the global population continues to increase, demand will also increase Impact of China and India: - There will continue to be a significant increase in demand for metals by China, India, and Indonesia as their GDP per capita increases - Eventually, as these economies move towards saturation levels (the point at which consumption per capita does not increase income levels), the global demand for metals will begin to level out  23 Mining Methods: - Open-Pit o Cheaper o Logistically Simpler o Faster production - Underground o Orebody is too deep to be profitable by open-pit o Higher grades or quality of the orebody The Main Players - Junior Exploration Companies o Focused on finding mineral and metal deposits and selling or partnering with a senior mining company o Usually small publically owned companies o Funds raised through the public market - Senior (Major) Mining Companies o Search for new mineral or metal deposits to expand existing mines or develop new mines o Usually large public companies o Resources to develop, construct, and operate a mine Fundamentals of Mining and the Mining Phases - Exploration (5 to 30 years) o Pre-Discovery o Post-Discovery - Evaluation (6 to 10 years) - Construction (2 to 5 years) - Operation (10 to 50 years) - Closure (20+ years) Value of a Single Mine: Mining Agreements Introduction to Royalties - Traditional equity-related types of mining finance have become very difficult to access for most mining issuers - Traditional secured debt financing is available to advanced projects but not for junior mining companies  24 - In many cases mining companies must turn to alternative types of financing in order to survive - Common types of royalties include: Net Smelter Rights, Royalty Streams, Gross Royalties, and Net Profit Interest o The most common are net smelter rights and net profit interest - You pay an up front fee to the company and in return the company will give you a percent back Royalty Payment and Rights - A royalty is a payment to a royalty holder by a property owner - Typically the payment is based on a percentage of the minerals or other products produced or the revenue or profits generated from the property - Royalties are not working interests in a property o Royalties don’t share the liability or costs in running - Royalty holders are not responsible for operating or capital costs or environmental or reclamation liabilities Net Smelter Returns (NSRs) - NRSs are the gross revenues produced from a property less certain allowable deductions o Allowable deductions generally include the following:  Transportation costs incurred by the operator in moving product from the property to the refinery or smelter  All costs and expenses incurred by the operator in connection with refinement or smelting  All royalties and taxes levied by any applicable governmental authority - NSRs are by far the most common type of royalty in the mining sector and they pay out a percentage of the net smelter returns produced from a property - Key NSR Terms: o Royalty %  The typical NSR is between 0.5% to 3%  It is rare for there to be greater than a 3% NSR on a property  Many NSRs are granted to prospectors in return for the early-stage properties they discovered; others are granted by issuers in respect of more developed projects as a financing tool o Scope of Royalty Properties  NSRs usually apply to specific properties but may also apply to an area of interest as depicted on a map  When drafting an NSR as purchaser’s counsel, it is critical that the NSR clearly applies to any properties that are in the future substituted for the original royalty property as a result of extensions, reclassifications or other modifications of the original royalty property o Security  Security is sometimes required by NSR purchasers to further protect or cement a royalty interest  The obligations of the payor under the NSR to the holder may be backstopped by security in favour of the holder over the mining project’s assets and production. This is especially the case in expensive financing royalties  25  Security provides the royalty purchaser with some protection in the event the payor defaults under the royalty agreement or if the payor becomes insolvent  Your preference is not secure o Buy Back Rights  A buy back right allows a mining company to re-acquire a portion of the royalty for a specified price during a specific period of time  While not a novel term in these types of transactions, companies have been increasingly pushing for such rights  Buy back rights give issuers optionality to reduce the percentage of this upside that is being sold  Often royalties have buy back rights Introduction to Streaming Transactions - Another form of alternative financing for mining companies - A big upfront payment for the future production of a commodity - The sale of a right to the future production of a commodity (usually by-product) - Mine operator is able to raise significant capital by selling by-product - Price is pre-determined for future production so ensures fixed costs - Purchase Price: o The purchase price for a stream typically consists of two elements:  An upfront payment, and  A significantly discounted price per ounce/tonne of commodity delivered under the stream in the future - Advantages for Sellers: o Streaming transactions provide several advantages or benefits to the seller, including the following:  the ability to raise substantial capital off the back of a by-product  immediate monetization of non-core production  the ability to grow through exploration, capital, production expansions or acquisitions  an alternative to traditional debt or equity - Disadvantages for Sellers: o Streaming transactions also have certain disadvantages to the seller, including the following:  the seller may lose considerable upside on its project  the seller may be penalized if certain conditions are not satisfied  the stream has the potential to interfere with or complicate subsequent financing alternatives  streams often require security which can impede subsequent security-related financings  the stream could result in loss of project in the event of default - Advantages for Purchasers: o Streaming transactions provide several advantages or benefits to the stream purchaser, including the following:  26  pure upside to increases in the commodity price  avoids variations in operating costs reducing downside risk  no ongoing capital expenditure or exploration, yet benefits from production and exploration growth  long term supply of product - Disadvantages for Purchasers: o Streaming transactions offer very few disadvantages to the stream purchaser o The greatest risk to the stream purchaser is that the mining project underlying the stream fails to achieve targeted production. o There may also be tax risks depending on how the stream investment is structured o Relationship is purely contractual and therefore a stream purchaser does not benefit from the usual rights that are afforded to the shareholders of the mining company, such as voting rights Legal Overview of the Mining Industry Land Tenure - Land tenure is the types of land - There are three basic types of mining tenure that can be acquired in Ontario: o a mining claim; o a mining lease; and o a freehold interest in land. (i.e. a patent)  whether you own it or not Mineral Interests - Unpatented Mining Claims o Mining claims that are “staked” and recorded are generally referred to as ‘unpatented’ mining claims - Mineral Licenses of Occupation o Similar rights to an unpatented mining claim except that the license is granted directly by the government Standards of Disclosure for Mineral Projects - Bre-X Scandal - Ontario Securities Commission (OSC) Response o National Instrument 43-101 - Standards of Disclosure for Mineral Projects (NI 43-101) NI 43-101 - Basics o Setting the standards for disclosure  Technical Reports  Qualified Person - Application o NI 43 – 101 applies to any issuer that discloses scientific or technical information to the public about a mineral project  27 - Qualified Person o A qualified person is defined in NI 43-101 as an individual who meets the following criteria:  Is an engineer or geoscientist with a university degree, or equivalent accreditation, in an area of geoscience, or engineering, relating to mineral exploration or mining. o Has at least five years of experience in mineral exploration, mine development or operation, mineral project assessment, or any combination of these, that is relevant to the person’s professional degree or area of practice. o Has experience relevant to the subject matter of the mineral project and the technical report. o Is in good standing with a professional association. - Technical Reports o Disclosure of scientific and technical information regarding a mineral project o Detailed report intended to provide a summary of material scientific and technical information o Requirements are set out in Form 43-101F1 - Technical Report (Form 43-101F1) o Triggers for a Technical Report  Preliminary Prospectus  Information Circular  Offering Memorandum o Types of technical reports: - Materiality of a Property under NI 43-101 o “On a project material to an issuer”  Determine materiality in the context of the issuer’s overall business and financial condition as a whole  Determine how significant and important the property is to the issuer’s business in comparison to its other properties - Prohibited Disclosure o “Preliminary Feasibility Study”, “Pre-Feasibility Study”, “Feasibility Study”  28 o Economic analysis based on inferred mineral resources  Inferred resources for an exploration target  Historical estimates that are unverified Financing Mining Projects Factors Affecting the Value of a Mine - Commodity prices - "Quality" of orebody - Ability to recover valuable minerals - Access to infrastructure - Labour costs - Currency exchange rates - Mining taxation and royalties - Bankability - Geographic location Early-Stage Finance - Pre-Development Stage o High Risk and No Near-Term Value - Continuing Exploration o Equity Financing  Private Placement  IPO  Public Offering o Royalties o Joint Ventures o Debt Financing Financing Options for Mining Projects - Equity o Investment through ownership shares in the mining project o Provides capital in exchange for ownership stakes and potential returns - Royalties o Royalty agreements involve payment based on a percentage of revenue o Investors receive a share of future mining project proceeds - Joint Ventures o Collaborative partnerships where multiple parties share ownership and risks o Combines resources, expertise, and risk-sharing among project participants - Alternative Mine Finance o Diverse financing methods beyond traditional debt and equity o Tailored financial solutions to meet the unique needs of mining projects Project Finance Overview - Alternative to conventional equity and debt financing - Can be used for both greenfield and brownfield projects  29 - Utilizes project's own assets and cash flow for repayment o Sponsor may be unfamiliar with a high risk jurisdiction o Project may be large relative to Sponsor’s asset portfolio - RISK MITIGATION: o Thorough Due Diligence  Technical Assessment  Environmental Analysis  Legal and Regulatory Scrutiny o Market and Price Risks  Hedging Strategies  Off-Take Agreements o Operation Risks  Insurance Coverage Lecture 3 – Debt and Equity Financing Introduction - Corporate finance involves a variety of financial transactions relating to the raising and maintenance of capital by a corporation or company - “capital” means: o Money or cash or profits that a company makes/earns through investments o Funds that a company obtains by issuing shares o Funds that a company obtains through a loan or through issuing fixed income securities  A security can be a debt instrument - The raising of capital refers to the process whereby funds are transferred from investors to a corporation o When you decide to raise capital, you need to figure out how you are going to raise it - Two basic types of corporate financing: 1. Debt Financing 2. Equity Financing Debt Financing - “Debt” refers to the claim on a corporation’s assets (or cashflows) that is created when the corporation borrows money - “Debt Financing” occurs when: 1) The corporation enters into a loan or credit agreement with a financial institution or other lender; or 2) The corporation issues debt securities such as bonds, debentures or notes - Debt creates a debtor-creditor (or borrower-lender) contractual relationship between the corporation and the investor  30 GLOSSARY - Principal: The face amount of a debt payable on maturity, excluding interest. o The amount that you owe - Interest Rate or Coupon: A percentage that represents the current rate of borrowing. For loans, higher interest rates generally represent higher risk. Interest can be paid annually, semi-annually, quarterly or monthly, depending on how the debt is structured. o What the lender gets out of this - Fixed interest rate: A fixed interest rate holds steady throughout the term of the loan; it does not change with the market. o It stays and doesn’t fluctuate with the market - Floating interest rate: A floating interest rate, also known as a variable or adjustable rate, changes with the market over time. o Variable interest rate - Maturity Date: The date at which the principal amount of a debt is payable. Payment date can be a single fixed date or on demand. o When it is due - Secured loan: A loan protected by an asset or collateral, to which the lender holds the title. o Your loan is protected o There are different rankings - Unsecured loan: Financing instruments that are not backed by collateral. Unsecured loans involve greater risk for the lender and therefore higher costs and shorter repayment terms for the borrower. - Senior secured debt: The highest level in a company's debt structure with most certainty of repayment – receives first priority. - Subordinated security interest: The debt below the senior debt - senior secured lenders commonly permit another lender to hold a subordinated security interest in the same collateral. o You have to specifically set out in the agreement if it is subordinated - Mezzanine Debt: this type of debt sits between the top level of senior bank debt and equity ownership of a company. Mezzanine loans take more risk than senior debt because regular repayments of the mezzanine loan are made after those for senior debt. Mezzanine loans are usually of shorter duration and more expensive for borrowers, but pays a greater return to the lender.  31 o A hybrid type of debt -> debt and equity o Not good for long-term broad purposes of the loan – high risk and short term o It can often convert into equity - Pari-passu: refers to two or more loans, bonds, classes of shares having equal rights of payment or level of seniority. - Collateral: property or assets (security) that a borrower offers or pledges to secure the repayment of the debt. o The assets of the property that the borrower offers up to protect that debt - General security agreement: an agreement under which the debtor grants the lender a security interest over all of the debtor's present and after-acquired property. o Most common type of loan agreement o Once you have this, you should register it into the PPSA o “Memorializes it” - Perfected Security: registration of a personal property security interest under the Personal Property and Security Act or the “PPSA”. o How you register your personal property security interest o PPSA is for Ontario o Want to know if something is unexplained - PMSI: a purchase money security interest is a security interest or claim on property that enables a lender who provides financing for the acquisition of goods or equipment to obtain priority ranking ahead of other secured creditors. o Usually specific to the acquisition of goods - Leverage: The use of borrowed money to increase investing power. - Securities: The common name for stocks, bonds, and other investment instruments. o Can be debt instruments such as promissory notes - Fixed-Income Securities: debt securities of the issuing entity. - Bond: a long-term, fixed-obligation debt security that is secured by physical assets o Another form of a debt instrument – often secured - Debenture: Unsecured debt obligation, issued against the general credit of a corporation, rather than against a specific asset. o If it is not secured, it is issued against the general credit of a corporation - Convertible Bond/Debenture: provide the lender or the borrower with an option of exchanging the debt for equity. o Need to make sure the most basic terms are right and then compare o Then look at the convertible terms and then look at the legends as well as adjustment provisions - Indenture or Trust Deed: the legal document relating to and defining all of the legal aspects of a fixed-income security. o A longer contract which deals with the governance of the securities - Covenant: undertakings that bind the borrower to certain terms and conditions, including the conduct of its business, during the duration of the loan. o One of the drawbacks of taking a loan is that you are highly restricted in how you run your business o Covenants are things you have to do  32 o Restrictive covenants are things you cannot do - Redeemable or Callable Bonds: bond issuer has the right, but not the obligation, to pay off the bond before the maturity date. - Sinking fund: money set aside by an issuer of bonds on a regular basis, for the specific purpose of redeeming or repaying debt. - Retractable Bond: a bond which features an option for the holder to force the issuer to redeem the bond before maturity at par value o At the option of the holder - Credit Limit: the maximum amount of credit a lender is willing to extend to a borrower seeking the funds. - Facility: another word for loan taken out by a company - Institutional Investors: includes insurance companies and pension funds, which tend to invest large amounts of money over a long time horizon with lower risk appetite. - Credit ratings: a rating of the likelihood of credit default (credit-worthiness) of an investment, used by most investors to assess the comparative risk of investment opportunities. o Highest Rating = AAA = highest credit quality and the capacity for the payment of financial obligations is exceptionally high and unlikely to be adversely affected by future events o AA = superior credit quality. A = Good credit quality. Negative factors are considered manageable. o BBB = adequate credit quality. BB = speculative, non-investment grade credit quality. B = highly speculative credit quality o CCC/CC/C = very highly speculative credit quality in danger of defaulting on financial obligations o D = don’t bother – junk. Ranking of a Corporation’s Debt Commercial Loans from Financial Institutions - A loan agreement with a lender such as a bank or a credit union - Generally constitutes senior debt - May involve a single or several lenders (syndicated loan)  33 - May take a variety of forms, including term loans, revolving loans, line of credit and mortgages - May be secured or unsecured - Primary rule: Unless specified otherwise, all debt is equal or “pari passu” (all the same) o Subordinated debt must be expressly subordinated by the holders either through a subordination agreement or by the terms of debt when issued - Common types of Bank Loans: 1. Term Loan (the most basic type of loan) o This type of facility provides an agreed lump sum over a set period (the term) requiring payment at or by the end of the term. Amounts of the term loan that are repaid cannot be re-borrowed. o When the borrower needs a large amount of money at one time, for example, to fund a major acquisition, a term loan is used. Not ideal for working capital purposes.  Large in scope and good for a one time capital injection  Good for a one-time large payment o Typically, the full amount of the term loan must be drawn on the closing date. o "Delayed draw" term loans may be available to be drawn for a limited time after the loan transaction closing date and often in a specified number of draws. This is known as the availability or commitment period. If monies are not drawn during the availability period, they are no longer available to the borrower.  This is all negotiated o Other term loans can be drawn throughout the term of the loan for a specific purpose, such as to fund permitted acquisitions. o Term loans provide the borrower with certainty of funds (since they are usually drawn in full up front) and a predetermined repayment schedule. This makes a term loan a good form of financing for a borrower’s long-term capital needs, such as an acquisition of another business or new equipment. o Term loans are not ideal for financing a borrower’s seasonal or fluctuating capital needs. o Term loans usually have a term of no more than five years. If the borrower needs a longer maturity date, other forms of raising capital may be more appropriate (for example, issuing bonds, notes or equity through the capital markets). 2. Revolving Credit Loans – Revolving Credit Facility – Revolver – Operating Facility o A committed loan facility allowing a borrower to borrow (up to a limit), repay and re- borrow loans over an agreed availability period, typically 5 years.  Not the case for term loans o This is in contrast to term loans that can not be re-borrowed once paid. o Revolving credit loans are generally repaid in one payment at the end of the term of the loan, but occasionally will include scheduled commitment reductions. Borrowers may prepay revolving credit loans at any time without a prepayment fee. o Revolving credit loans provide liquidity to operate the business and are drawn when the borrower needs cash. The borrower pays a standby fee on the unused portion of the revolving credit loan, which is less than the interest rate the borrower pays on the used portion of the revolving credit loan  34  Almost on an as needed basis - Unsecured Loans o Borrowing corporation is not required to provide any security for the loan to ensure that it will be repaid o Only available to the most credit-worthy of companies with a long history of financial success and good relationships with lenders o Unsecured loans are supported by the general credit of the borrower as opposed to being secured by a perfected security interest in any pool of assets of the corporation o Typically includes:  Negative pledge of assets  Negative covenants limiting investments and other kinds of loans, leases and debt obligations  Covenants giving rise to a security agreement if the financial condition of the borrower begins to deteriorate - Secured Loans o Financial institutions frequently require that corporations provide collateral security for the loan o Collateral security may include any or all of the following:  an assignment of rights in real or personal property  an assignment of debts or moneys due to the corporation (e.g. receivables)  pledge of shares (private corporation)  cash collateral accounts o Rule of Thumb: asset or assets securing the debt must be equal to or exceed the amount of the loan  The assets you are securing should be equal to the amount of your loan o Being able to grant security to lenders should mean that a borrower is able to negotiate a lower interest rate than would be required for an unsecured loan - Broad Contents of the Loan Agreement: o Definitions section o Description of the Parties o Purpose of the loan o Provisions that describe the nature of the loan and interest terms o Conditions precedent to making the loan  Example: your GSA must be signed o Interest o Covenants o Representations and warranties o Provisions regarding default and remedies  35 - Covenants o Covenants are a method of reducing risk because they allow a lender to influence the future conduct of the borrower in ways that are considered to be beneficial to the lender. o Affirmative Covenants examples:  Maintenance of certain minimum debt-to-equity ratio  Maintenance of sufficient working capital  Maintenance of certain minimum net tangible assets : long term liabilities ratio  Maintenance of operating assets in good and working condition  Maintenance of accurate accounting books and records  Compliance with environmental or other applicable law(s)  Preparation and delivery of audited financial statements  Maintenance of corporate existence and insurance coverage  Provide immediate notice of default or risk of default to lender o Negative Covenants examples:  Restrictions on distributions to Shareholders  Restrictions on additional financing  Don’t want you to take on more debt  Restrictions on granting security to other lenders (with the exception of permitted encumbrances)  Restrictions on fundamental changes (i.e. change of control)  Restrictions on guaranteeing the indebtedness of any other party  Negative pledges (in the case of unsecured loans) - Methods of Security: 1) Obtain a recourse to a particular asset, property or fund including through: a. General Security Agreement (personal property) b. Mortgage (real property) c. Share Pledge Agreement d. Debenture e. General Assignment of Accounts Agreement 2) Obtain a Guarantee  Lender looks to another party for satisfaction in the event of default by the borrower  Getting a third party to guarantee your loan so if you get a default on it, they would pay it Fixed-Income/Debt Securities - Bonds, Debentures and Notes - Single, negotiated loan agreements for a single lender or small group of lenders - Trust Indentures/Deeds o Practical solution for when a corporation issues debt securities to the public o Special agreement entered into between the issuing corporation and an indenture trustee (typically a trust company)  36 o Indenture trustee monitors the corporate debt issuer and protects the interest of the various debtholders on a collective basis - Content of Trust Indenture/Deed: o Conditions for issuance of debt o Debt issuable in series o Fix interest, maturity date and terms for each series o Positive and negative covenants o Series specific terms and conditions o Road map to enforcement of debt and security o Debtholders can direct the Trustee to enforce o Debtholders act through majority rule o Rules regarding debtholder