Equity fundraising by public companies in a financial crisis
Companies facing serious financial difficulty are likely to find themselves considering equity financing options to augment their balance sheets.
In fast changing and challenging times, an ability to move quickly and think creatively may well determine the future viability of a company. But while speed and imagination will be important, the broader regulatory regime and the impact on existing shareholders should also be considered very carefully.
The decision to raise equity finance will be determined by a company’s directors. In doing so, directors will need to have regard to the company’s articles of association and relevant legislation, including the Companies Act 2006 (CA 2006). Listed companies are also subject to additional rules, including financial services legislation that regulates public offers of securities and disclosure.
This note outlines the various emergency fundraising structures available to UK companies. The form of equity fundraising is likely to be influenced by the legal and practical considerations set out below. The appendix to this note provides further details on the key laws, regulations and governance issues in this area.
- Authority to allot shares. Directors of public companies may allot shares only if they have appropriate authority to do so from their shareholders. Most public companies obtain authority at their AGMs to allot up to 66% of their current issued share capital, but on the basis that any amount over 33% of their current issued share capital should be issued by way of a rights issue on a fully pre-emptive basis.
- Pre-emption rights. Most premium listed public companies obtain annual authority to issue up to 5% of their current issued share capital for cash on a non-preemptive basis (with the ability to increase this by a further 5% for acquisitions or specified capital investments). AIM companies and companies with a standard listing will sometimes have authority to issue up to 20% on a non-preemptive basis, even though this may not be best practice from a corporate governance perspective. However, many companies will welcome the statement on 1 April 2020 from the Pre-Emption Group (PEG) that recommends that investors consider supporting, on a case-by-case basis, non-preemptive issuances by companies of up to 20% of their issued share capital on a temporary basis during the Covid-19 crisis. The Association for Financial Markets in Europe’s Equity Capital Markets group has also welcomed this statement.
- Discounts to market price. Premium listed public companies should not issue shares on a non-preemptive basis at a discount of more than 10% to market value unless either: (i) specific shareholder approval has been obtained; or (ii) the issue is for cash within an existing disapplication of pre-emption rights. It will be interesting to see if the Financial Conduct Authority (FCA) is willing to relax the 10% restriction in the context of the Covid-19 crisis. An issue of shares at a discount greater than 5% is generally discouraged under the Pre-Emption Group Principles (the PEG Principles).
- Authority to create a new preferential class of securities. Specific shareholder authority is required to create a new preferential class of share.
- Prospectus publication. Premium listed companies are required to produce a prospectus if they wish to issue more than 20% of their existing share capital on a rolling 12 month look back basis. Additional triggers may also apply in other situations (e.g. if the fundraising involves “an offer to the public”).
- Takeover Code: If an equity fundraising would result in a shareholder acquiring 30% or more of the voting rights in a public company, a mandatory cash offer could be required under the UK Takeover Code unless this requirement is waived by the company’s independent shareholders or the Takeover Panel grants a dispensation. See our previous article.
- Will a prospectus be required? If significant amounts of new capital are needed, it is more likely that a prospectus will be required. However, the production of a prospectus is not a straightforward exercise and companies will need to think carefully about equity fundraising structures that require one. Producing a prospectus takes time and a prospectus cannot be published without the prior approval of the FCA. Very prescriptive content requirements will also need to be complied with. Companies should be mindful that the process of producing an FCA approved prospectus from start to finish would typically take 10-12 weeks, but it might be possible to get this done more quickly. Interestingly, the FCA published a statement on 8 April 2020 that encouraged listed companies issuing new equity to recapitalise in response to the Covid-19 crisis to use the simplified form of prospectus where possible. This regime was introduced in July 2019 and is available to companies that have been admitted to trading on a regulated market or SME Growth Market for at least 18 months (although it may not be an option where the offer has a non-EU component in a jurisdiction with its own disclosure requirements (e.g. the US)). When this regime is available, certain disclosures can be dispensed with in a prospectus (e.g. operating and financial review, organisational structure, capital resources, remuneration and benefits, and board practices). But if emergency funding is required more quickly than a prospectus can be produced, companies may need to consider other structures (at least to deal with their immediate funding needs).
- Working capital statements. Even if a company’s funding requirements can accommodate the time needed to produce a prospectus (see above), additional financial reporting considerations will need to be worked through. For instance, a prospectus must contain a working capital statement confirming that the working capital available to the company will be sufficient for at least 12 months. These statements can be difficult at any time, but even more so in circumstances of significant financial uncertainty and rapidly evolving market conditions.
On 8 April 2020, the FCA published a statement which acknowledged that the uncertainty created by the Covid-19 crisis makes the financial modelling underpinning working capital statements “uniquely challenging”. One key challenge results from the requirement under the ESMA Recommendations (which are supported by the FCA) for a working capital statement to either be unqualified (also known as “clean”) or qualified. An unqualified statement confirms that the relevant company has “sufficient working capital for its present requirements [that is for at least twelve months]”, whereas a qualified statement must begin with the confirmation that the relevant company “does not have sufficient working capital for its present requirements, [that is for at least 12 months]”. The FCA has acknowledged that investors are unlikely to find it helpful to be presented with qualified working capital statements solely as a result of the Covid-19 crisis. For this reason, the FCA has set out a different approach to working capital statements that will apply for the duration of the Covid-19 crisis. Under this approach:
- the key modelling assumptions underpinning a company’s “reasonable worst-case scenario” can be disclosed in an otherwise clean working capital statement;
- these assumptions can only be Covid-19 related; and
- there must be a statement that the working capital statement has otherwise been prepared in accordance with the ESMA Recommendations, and the technical supplement to the FCA Statement of Policy on the Covid-19 crisis.
- Shareholder approvals. If these are required to implement an equity fundraising, the practicalities of obtaining them will need to be considered carefully. For example, the disapplication of pre-emption rights will require approval by 75% of those attending and voting – whereas the authority to allot requires approval of a simple majority of those attending and voting. Although the FCA announced on 8 April 2020 that premium listed companies may apply for a dispensation from the requirement to hold a general meeting in certain circumstances in the context of Class 1 transactions and related party transactions, this is unlikely to be of practical help for most equity fundraisings that require shareholder approval.
- Holding a shareholders’ meeting. There are a range of practical difficulties in hosting a physical shareholders’ meeting given the current restrictions on movement and congregation. Careful thought is required to how a shareholders’ meeting could be convened in a valid manner (e.g. whether this can be done virtually or through attendance by proxies). See our previous article.
A rights issue is the method generally preferred by the UK investment community and involves making an offer of new shares to all shareholders in proportion to their current holdings. In theory, there is no limit to the discount that the new issues are offered at, and existing shareholders who do not take up shares can sell their “nil paid rights” to other investors. Rights issues are normally underwritten by the investment banks managing the fundraise, including sub-underwriters. Rights issues also provide a mechanism for compensation to “lazy shareholders”.
One disadvantage of a rights issue is the length of time that it can take to implement. An FCA approved prospectus will almost always be required, which has significant time and cost implications. In addition, a rights issue does not guarantee any equity outcome for a cornerstone investor unless: (i) existing shareholders relinquish rights and/or agree to sell their nil paid rights to that investor; or (ii) it is combined with a firm placing to that cornerstone investor.
Placing and open offer
A placing and open offer is similar to a rights issue in that existing shareholders can participate and avoid being diluted. This structure generally involves placing new shares with institutional investors who underwrite the fundraising, but allowing the existing shareholders to “clawback” those shares under an open offer, which enables them to take up their proportionate entitlement. If existing shareholders decide not to invest, they will be diluted and have no nil paid rights to sell and not otherwise compensated for inaction (unlike in a rights issue). This structure can sometimes involve a cornerstone investor receiving an element of firm placed shares on a non-preemptive basis (i.e. shares that are not subject “clawback”), but this would only be possible if the shareholder authorities are sufficient.
Provisions in the Listing Rules and PEG Principles can limit the discount to 10% or 5%, unless extensive consultation takes place. Although the timetable is slightly shorter than a rights issue, a prospectus is invariably required.
Placing without prospectus
A company which has authority from shareholders to issue shares on a non-preemptive basis for cash can do so simply by issuing an announcement and entering into a subscription agreement with an investor (or by getting an investment bank to build a book of investors). This is by far the easiest and quickest method to raise equity finance but the amount that can be raised is limited by the available shareholder authorities and, for companies listed on London’s Main Market, will be limited to 19.9% unless a prospectus is to be published.
A cashbox placing is an alternative method of raising new funds that is characterised as an issue for “non-cash” consideration for the purposes of CA 2006. As the fundraising constitutes an issue for “non-cash” consideration, the statutory pre-emption rights under CA 2006 do not apply which means that a company which only has authority to issue 5% on a non-preemptive offer can potentially upsize the placing. These structures involve the listed company issuing shares to new institutional investors as consideration for the shares in an offshore special purpose vehicle (usually incorporated in Jersey) that has received cash paid by the new investors. If structured correctly, cashbox placings can also be used to create distributable reserves using the merger relief provisions under the CA 2006.
The fundraising announced by SSP Group plc on 25 March 2020 has been structured as a cashbox placing. Under the terms of this fundraising, SSP was able to issue, on a non-preemptive basis, new shares which represented up to 19.99% of its previously existing share capital.
The main advantage of this structure is speed. Provided that the company has sufficient existing shareholder authorities to issue new shares under the cashbox placing, the need to call a shareholder meeting can be avoided. But if a shareholder meeting is required, it should not be necessary to pass a special resolution to disapply pre-emption rights (instead an ordinary resolution to obtain sufficient authority to allot shares should be sufficient). If a premium listed company wants to issue more than 20% of their existing share capital under a cashbox placing, a prospectus would also be required.
Cashbox placings have, however, attracted controversy within the wider investment community in the past. Investor reaction should therefore be considered carefully before pursuing a cashbox placing.
Outside the UK, private equity investors often invest into public companies by acquiring preferred shares, convertible bonds and, in some cases, ordinary shares in combination with the issue of warrants. This structure is commonly referred to as private investment into public equity (PIPEs).
One high-profile example of a PIPE during the last global financial crisis was Warren Buffet’s Berkshire Hathaway investment of $5bn of preferred stock (which paid a 10% dividend) into Goldman Sachs. The preferred stock enabled Goldman Sachs to redeem the stock, which it did in 2011. In addition, Berkshire Hathaway received warrants to purchase up to $5bn of common stock in Goldman Sachs (which were exercised by Berkshire Hathaway in 2013).
Meanwhile in the current financial crisis, Carnival Corporation has raised more than $6 billion, most of it in high-yield senior debt. The fundraising involved a $4 billion offering of five-year senior secured bonds priced at just under par with an annual coupon of 11.5%. As an investment grade company, its existing debt arrangements did not prevent it from adding senior debt, and it was able to grant security over its vessels. Carnival also sold $500 million worth of common stock and $1.75 billion of convertible bonds, which attracted a 5.75% annual coupon. This multi-layered financing approach might be a template for other impacted businesses.
To date, PIPEs have been much less prevalent in the UK market. This is primarily due to features in the UK market which can deter the types of investors that invest in PIPEs in the US, such as:
- the limits that apply on the ability of directors to issue new ordinary equity for cash and new classes of preference shares and convertible debt;
- the market abuse regime in the UK which imposes strict restrictions in relation to the dissemination of inside information on a selective basis (e.g. to a controlling shareholder which agrees to become a strategic investor);
- in the case of companies with a premium listing, the requirement to have in place a relationship agreement with their controlling shareholders in order to maintain a degree of independence between the controlling shareholder and listed company; and
- other UK regulatory and corporate governance considerations (particularly the PEG Principles, which are widely supported by the UK investment community).
However, notwithstanding this, companies in serious financial difficulty will want to be open minded regarding their equity funding options. In doing so, they may find themselves considering structures with characteristics similar to those listed below.
- A firm placing that gives the investor a material equity stake and a contractual right to nominate a director to the board (in order to influence the future direction of the company). In addition, a strategic or financial investor may seek warrants to subscribe for additional equity at a premium to the current market price.
- An issue of bonds that attract a high coupon (e.g. 8%) and are convertible into ordinary shares at a premium to the current market price. These bonds could be redeemable at the option of the bondholder after a fixed time period (e.g. 3 years), again at a premium to the issue price (plus unpaid interest). In addition, an issuer could include certain mandatory conversion rights (e.g. if the share price is 150% above the conversion price). The investor might also be issued warrants. Many commentators argue that Government bailouts should be structured as convertible bonds.
- An issue of a new class of preference share carrying a right to a preferential dividend, conversion terms similar to the convertible bonds, redemption rights and class consent rights for material corporate actions. This would be closer to traditional private equity style investment into private companies.
A range of equity fundraising options should be available to companies that find themselves in serious financial difficulty. However, the number of options that are available in practice will likely depend on how early companies begin to plan.
Choosing the right option will require careful thought, planning and creativity. A cashbox placing of up to 19.99% of existing share capital (where the existing disapplication authority limits 5%) could be very useful if there is a pressing business need to avoid a prospectus or shareholder meeting. In other cases, there may be material benefits to public companies in attracting investment from investment funds which may have specific expertise (as well as capital) to offer. In these circumstances, non-traditional fundraisings and PIPEs should be considered. In other cases, companies may even find themselves considering more imaginative solutions, such as changing their listing category (e.g. migrating from a premium listing to a standard listing or, perhaps more commonly, moving to the Alternative Investment Market) in order to fall within a different set of rules and achieve their immediate funding objectives.
Macfarlanes has market leading expertise advising private equity and public companies. Macfarlanes recently advised Lawrence Stroll on the recapitalisation of Aston Martin Lagonda. Under this fundraising, the consortium, led by Lawrence Stroll, will hold, in aggregate, shares representing just under a 25% stake in the company.
CA 2006 – Directors’ fiduciary duties
Directors will need to be comfortable that, compared with other available options, any fundraising will promote the success of the company for the benefit of members as a whole. For example, a fundraising that heavily dilutes existing shareholders would need to be balanced against alternatives that preserve investors’ respective holdings.
Directors must have regard to other matters, such as the likely consequences of their decision in the long term, the interests of employees and the need to foster business relationships with suppliers, customers and others.
Directors must also exercise their powers in accordance with their company’s articles and only for legitimate purposes. For example, if the primary motivation of directors when issuing shares is to dilute a particular shareholder rather than to raise equity, that would likely be an unlawful use of powers.
Helpfully, the English courts have long been reluctant to second-guess commercial decisions by company directors. This was reinforced in the recent Sharp v Blank case, which related to the recommendation from Lloyds Bank’s directors to vote in favour of the takeover of HBOS during the global financial crisis. In that case, the judge decided that the test to be applied when considering the obligations of the directors in making a recommendation to shareholders is as follows: “Could a reasonably competent chairman or executive director of a large bank reasonably reach the view (on the available information and within the timeframe required) that the Acquisition was beneficial to Lloyds and its shareholders? Or would any such director so placed of necessity have reached the view that the Acquisition was not beneficial?”
If the company is nearing insolvency, the interests of creditors become paramount, rather than those of shareholders. This makes it easier for the issuer to justify acting outside the PEG Principles to raise equity (see below for summary of PEG Principles). The Government has also recognised the impact Covid-19 has placed on directors. With this in mind, the Government has announced that it plans to temporarily suspend the wrongful trading provisions with retrospective effect from 1 March 2020 to allow directors to keep trading during Covid-19 without fear of personal liability if the company ultimately fails. This potentially gives the directors extra time to find the best refinancing solution for the business.
For further information, please see our prior briefing on the topic.
CA 2006 – authority to allot shares
Under CA 2006, directors of public companies can issue new shares only if authorised to do so by ordinary resolution (a simple majority of those attending and voting).
An issue of new shares for cash on a non-preemptive basis requires a special resolution (75% of those attending and voting) to dis-apply pre-emption rights.
Most public companies obtain authority at their AGMs to:
- allot up to 66% of their current issued share capital, but on the basis that any amount over 33% of their current issued share capital should only be applied to fully pre-emptive rights issues; and
- issue between 5% and 20% of their existing share capital for cash on a non-preemptive basis.
CA 2006 – prohibition on financial assistance
A public company cannot give financial assistance for the purchase of its own shares. This issue was considered extensively in the context of the fundraising that Barclays Bank obtained from certain investors in 2008 to avoid a Government bailout. In that case, it was alleged by the Serious Fraud Office that Barclays Bank had committed unlawful financial assistance in relation to a $3bn loan from Barclays Bank to Qatar in the same year.
Careful thought must be given to the structure and commercial terms of equity investments by strategic financial investors.
The Pre-emption Group (PEG) Statement of Principles issued by the FRC
Although no prescriptive limits are set out in the PEG Principles as regards the extent of discount or dilution for a specific (as opposed to a general) disapplication of pre-emption rights, Part 3 of the guidelines stresses the importance of dialogue with shareholders and justification for the issue of shares.
Many companies will welcome the statement on 1 April 2020 from PEG that recommends that investors consider supporting, on a case-by-case basis, non-preemptive issuances by companies of up to 20% of their issued share capital on a temporary basis during the Covid-19 crisis. This should make it easier for companies to use cashbox placings.
Institutional shareholders may have a preference for a rights issue, which would enable nil-paid rights to be traded.
Companies with a premium listing are subject to pre-emption requirements but these do not apply if a special resolution has been passed under CA 2006 to dis-apply statutory pre-emption rights.
Premium-listed public companies should not issue shares on a non-preemptive basis at a discount of more than 10% to market value unless: (i) specific shareholder approval has been obtained; or (ii) the share issue is for cash within an existing disapplication of pre-emption rights.
Extensive disclosure requirements apply if premium-listed companies are required to issue a circular when seeking additional shareholder authorities. The purpose of this is to ensure shareholders understand the implications.
Controlling (30%+) shareholders in companies with a premium listing are expected to enter into a relationship agreement with the issuer to ensure its independence. A cornerstone or strategic investor may wish to insist that a premium listed company moves to a standard listing (or Alternative Investment Market) so that there is no requirement for such a relationship agreement and it can have greater influence.
Special “related party” rules also apply to transactions between significant shareholders and the issuer.
If following the issue of new shares, a shareholder will end up controlling 30% or more of the issuer’s voting rights, an ordinary resolution of the company’s independent shareholders must be passed to waive the requirement for the new controller to make a cash offer to the shareholders at the issue price (a “whitewash” resolution).
The Takeover Panel can give dispensations for companies in serious financial difficulty. See our previous article.
Corporate Governance Code
Companies are expected to have a majority of independent non-executive directors (INEDs) and an independent Chairman. These are not legally binding requirements, although deviations do need to be justified and might need to be phased out when the immediate crisis which justified deviation has passed.
Lender consents and waivers
Companies should also consider whether their funding plans have any implications under their existing debt financing arrangements – for instance, whether any lender consents or waivers may be required. This may be particularly relevant if companies plan to issue convertible bonds or other similar instruments.
Anti-trust and change of control analysis
If a shareholder will obtain a significant stake in the company after the fundraising, it is prudent to assess whether:
- the transaction would trigger the requirement for any merger clearances in certain jurisdictions; or
- any change of control provisions in the company’s business would be triggered (e.g. existing bank debt).
Other regulatory change of control analysis
If the company operates certain regulated businesses then it may need approval from a regulatory body (such as the FCA or the Prudential Regulation Authority) before it can become a controller.
Depending on the size and/or nature of the fundraising, the company may need to issue a prospectus in connection with the issue of new shares.
This requires FCA approval and will lengthen the timetable significantly.