As the world finds itself in a global cash flow crisis, listed companies are feeling the financial impact of the coronavirus, evidenced by the recent number of trading announcements. However, notwithstanding market conditions, they may soon have to raise capital on an urgent and heavily discounted basis. The issue will be whether the market can digest so many capital raisings at once.
Companies that are seeking to raise such emergency capital will have a number of options available to them. Typical structures include rights issues, open offers, placings, convertibles or a combination of these. This article focuses on the principal capital raising structures that issuers might use, and some of the practical and legal considerations issuer will face, particularly in light of COVID-19
Methods of equity fundraising
A company can raise funds by issuing further shares on a pre-emptive or non pre-emptive basis. Rights issues and open offers are pre-emptive structures which are typically used for issuers seeking large amounts, whilst smaller fundraisings are usually undertaken by way of non pre-emptive structures such as cash placings or cash box placings. Convertible debt can also be used as a non pre-emptive structure.
1. Rights issue
A rights issue is an offer of shares to existing shareholders in proportion to their existing shareholdings. New shares are issued for cash and shareholders have the option either to take up their rights and buy the new shares, or sell or to trade their entitlements (known as 'nil-paid rights'). Any shares not taken up will be sold in the market and shareholders may receive a cash payment if those shares are sold for more than their subscription price (and the expenses of sale).
There is no limit on the size of a rights issue so it can be as large or as small as required to raise the funds needed. Whilst smaller rights issues can be organised without requiring shareholder approval if the issuer already has shareholder authority from its previous AGM to issue sufficient shares, the majority of rights issues will require shareholder approval.
An FCA approved prospectus will usually be required for a rights issue, for both main market and AIM quoted companies, so the time and costs associated with preparing such a prospectus often make smaller rights issues a less appealing choice, as does the relatively high administrative cost required to implement a rights issue and the trading of the nil-paid rights.
2. Open offer
An open offer is also an offer of shares to existing shareholders in proportion to their existing shareholdings. However shareholders cannot trade their entitlements as they can do in relation to rights issue. An open offer is therefore considered as being more aggressive than a rights issue as a shareholder who does not participate will be diluted, and will be unable to realise any value by way of compensation. However, an open offer is generally faster than a rights issue, enabling an issuer to raise funds more quickly, and the administrative costs are lower.
An open offer will normally require a prospectus, unless it can rely on one of the exemptions under the Prospectus Regulation Rules, the key ones being that either the offer is to less than 150 persons other than qualified investors (i.e. retail shareholders), or is for less than €8 million. Like a rights issue, depending on the size of the offer and other factors, shareholder approval may be required.
3.Compensatory open offer
A compensatory open offer is also a pre-emptive open offer to existing shareholders. Used for the first time in the UK by Lloyds Banking Group in May 2009 around the time of the previous financial crisis, under a compensatory open offer an existing shareholder who does not take up his entitlement to subscribe for new shares at a discount may instead receive a sum of money if those shares are bought by other investors at a price above the discounted rate which the shareholder would have paid. This more 'shareholder friendly' approach than a typical open offer can be useful to maintain shareholder confidence provided that institutional shareholders are willing to back it, and should allow an issuer to raise funds more quickly than a traditional rights issue.
A placing is an issue of shares for cash to selected investors on a non pre-emptive basis. Shares are placed both with existing investors and new investors. The size of a placing often depends on the issuer's annual disapplication of pre-emption rights (normally around 5-10% of the issued share capital) and authority to allot (normally one third of the issued share capital) to ensure shareholder approval is not required.
A placing is likely to be exempt from the requirement to publish a prospectus, except when main market issuers issue securities of the same class that represent more than 20% of the number of securities already admitted to listing over a 12 month period.
Cash placings can be carried out at speed, and if structured as an accelerated bookbuild, can could be completed in as little as one day. However, this needs to be assessed against the limit on the number of shares that can be issued and the funds that can be raised.
5. Cashbox placing
Statutory pre-emption rights do not apply on an issue of shares for non-cash consideration. A cashbox placing is therefore structured to ensure that the issuer receives non-cash consideration by incorporating an offshore special purpose vehicle (SPV), typically a Jersey company. The transaction is structured so that the issuer issues shares as consideration for the shares in the Jersey SPV, which in turn holds the cash paid by investors, rather than issuing the shares directly for cash.
Like a normal placing, the timetable for cashbox placing is short, but with limits on the number of shares that can be issued and the proceeds that can be realised. No shareholder approvals are required, provided that the issuer has sufficient existing authority to issue shares. However, cashbox placings have been controversial in the past given they are a more aggressive variant on a placing and companies should always consider investor reaction to a procedure which can dilute their holdings beyond the percentage previously approved in general meeting.
Convertible instruments can come in different forms, such as convertible preference shares, convertible loan notes or listed convertible bonds, any of which at some stage can be converted into shares in the issuer according to a pre-arranged formula. An issue for example of convertible loan notes to a handful of investors, including a strategic investor, can be relatively quick, depending on the time taken for negotiation of the terms, whereas issuing a listed bond is likely to take more time with marketing, application for listing and the preparation and regulatory review of a disclosure document.
In either case, an issuer will need to have the relevant share authorities in place (for both the amount of shares to be allotted, and for them to be allotted on a non pre-emptive basis) at the time of the issue or the convertible instrument, not the time of its conversion, and therefore a general meeting may be required if share authorities are insufficient to cover the shares into which the instrument could convert (and a reasonable assessment will need to be taken if the formula for conversion is based on a future market price).
An issuer is able to combine the different fundraising structures above to suit its needs, and certainly in the current environment, where companies may be seeking to raise as much cash as possible, it would be prudent to consider combining both pre-emptive issues with non pre-emptive routes to funding (possibly using different discounts, as required).
Choosing the correct structure
Given the COVID-19 situation, and whilst the UK Government has promised businesses financial support over the next few months, issuers are likely to want to seek to raise emergency equity capital alongside any debt that they are taking on to shore up their balance sheet and avoid covenant breaches. For the more aggressive, it may not be an issue of survival, and instead, with some of their competitors failing and the weak pound, they may see acquisition opportunities. In any case they will therefore need to review each of the available options, considering which best fits their circumstances. Choosing the right structure will also depend on shareholder support and how quickly cash flow might dry up. Outlined below are some of the key factors that issuers will need to consider.
Issuers will need to weigh the different timetables for each offer against their funding deadline. If FCA approval of a circular or prospectus (or both) is required, this will inevitably require approval time to be built into the timetable. Shareholder approvals will also add time. Therefore if funding is needed on a particularly urgent basis, a placing may be the only feasible option.
As noted, some structures are quicker than others. In an open offer, the offer period for the new issue can run alongside the timing of the general meeting notice period, whereas the offer period in a rights issue can only begin once shareholder approval is obtained.
Minimum offer period
If shareholder approval is required, a general meeting can be called on as little as 14 clear days' notice. Once shareholder approval is given, the offer period has to be open for 14 calendar days.
If no general meeting is needed, then the offer period must be open for 14 calendar days.
10 business days
No minimum period applies and in the case of an accelerated book the period can be very short
Cash box placing
As for a placing, there is no minimum period provided no shareholder approval is required
Size of raise and pricing
Due to the limit on the number of shares that can be issued non pre-emptively, a placing may not be the best choice for a large fundraising. Instead, both rights issues and open offers have no maximum limit on the number of shares that can be issued, provided that shareholders pass (or have previously passed) a resolution granting the directors the necessary authority to allot shares. A distressed issuer can in theory then issue a multiple of its existing market capitalisation if necessary. The ability to issue a greater number of shares resulted in the number of rights issues and open offers pursued in 2009 more than doubling in comparison to any other year between 2006 and 2019, whereas the number of placings that took place in the same period remained unchanged.
When the markets are volatile, issuers will need to take into account that it can be difficult to price assets, especially when an offer is in the market over a longer period of time, and investors may use this to negotiate a reduction in the price. Applying a discount to an offer price will however encourage shareholder involvement and can protect the issue against adverse market movements. However, institutional investor guidelines published by investor protection groups such as the Investment Association and Pre-Emption Group will need to be taken into account. In addition, the Listing Rules provide for a 10% limit on the discount which can be applied to a share issue (that is, a placing or open offer) without shareholder approval. However there is no maximum discount applicable to a rights issue, and indeed they are commonly made at a substantial discount. A deep discount (being a price well below the market price) should entice shareholders to follow their rights and take up their entitlement, although on the other hand shareholders may also feel pressurised into taking up their rights to avoid significant dilution.
Convertibles that are only convertible at a future date, and based on an average trading price at that time, may offer some protection against immediate price volatility, and can offer an attractive coupon in a low interest environment. Issuing such debt to investors with deep pockets on a non pre-emptive basis can be an efficient way to raise funds, but will very much depend on the issuer's existing debt position and the covenants it has in place - having to negotiate any related debt or security with other lenders will also take time.
Issuers will need to canvass their shareholders if they intend to carry out an emergency capital raising to determine if they will obtain the support required for any resolutions being sought, as well as investor demand for additional shares. Issuers will undertake a marketing programme to large institutional shareholders for rights issues or open offers, generally through an investor roadshow and discussions with management. Conducting market soundings with key shareholders before announcing a capital raising provides a useful way of assessing shareholder support, although as most institutional shareholders will only agree to be 'brought inside' shortly before the announcement, structuring decisions will generally need to be made well in advance.
Rights issues and open offer will be heavily reliant on existing investor participation and, in the case of a rights issue, to some extent on an active secondary market in nil-paid rights. Placings however can target new investors, although a combination of a rights issue or open offer with a placing can be used to cover as much of the investor base as possible, allowing existing shareholders an opportunity to participate in an issue with the certainty of placing a large amount of equity.
In the current environment there is likely to be fierce competition for new capital. The 2008/9 financial crisis saw a wave of emergency capital raisings, starting with financial institutions and spreading to the mining and then property sectors.
If a particular sector is struggling, such as aviation or hospitality and retail with COVID-19, making multiple fund raisings a likely possibility, being the first to go to the market with any equity issue can help to ensure that an issuer obtains at least its fair share of the limited demand for stock in a sector. This is turn will have a bearing on the type and timing of the choice of structure.
The impact of COVID-19
Set out below are a number of issues which arose from emergency fundraisings during the financial crisis in 2008/9, some of which to longer term market practice, and which we may see arise again over the forthcoming months.
The typical timetable for a rights issue is set out above, depending on whether a shareholders meeting is required and how long it takes to prepare any prospectus. In the current environment they need to be as short as possible where companies need to access funds very quickly with the share price fluctuating dramatically in the process, and the risk of disclosure having to be updated (which may lead to a supplementary prospectus, which in turn, affords withdrawal rights to investors). The underwriters will also look to as short a timetable as possible to mitigate their own exposure. Generally preparing to launch the issue takes the most time (although a standby underwriting agreement may help) given the time required to prepare a prospectus.
The Prospectus Regulation introduced a simplified prospectus regime for secondary issues with effect from 21 July 2019. The proportionate disclosure regime for rights issue prospectuses under the Prospectus Directive regime was not widely used. It remains to be seen whether the new simplified prospectus regime for secondary issues will now be taken up by issuers, but it is anticipated that a full prospectus will continue to be expected for larger rights issues. Commentators in the past have argued a prospectus is largely irrelevant as the main investors will already be bought in and few people will have the time to review it properly in any case. After the financial crisis, there were discussions to exempt the requirement of a prospectus on a rights issue but these were never made into law.
2009 did however result in the offer period being reduced for a rights issue from 21 days to ten business days under the Listing Rules (although 14 calendar days is required under the Companies Act 2006, so the longer of the two applies). It is unlikely that an issue can be made any quicker than this (unless there is Government intervention). Whilst there was an argument to try to make the rights issue offer period and general meeting notice period to run concurrently (with conditional trading only, pending the outcome of the general meeting), this has not occurred to date, the argument being that retail shareholders, or those without access to adequate information, who acquired nil paid rights in the market during the offer period, could be left with something worthless if the requisite shareholder resolutions were not passed.
If issuers do opt for rights issue, there may also be an increase in those that go the "Gazette route". This structure is used where statutory pre-emption rights have not been disapplied and the issuer has overseas shareholders to whom it wishes to avoid making the offer for practical purposes. In these circumstances, the Companies Act 2006 requires that notice of the offer, or the offer itself, must be published in the London Gazette, leading to the name. The Gazette route can be helpful to avoid a resolution to disapply the pre-emption rights, saving the issuer from having to hold a general meeting.
A study by the Rights Issue Review Group in 2009, to look at ways in which equity capital raising could be made more efficient and orderly, led to timetables for rights issues being shortened, and the then Association of British Insurers increasing the ceiling on share allotments to two-thirds of issued share capital, where the additional one-third headroom is used for fully pre-emptive rights issues. Many companies now ordinarily take such authorities at their Annual General Meeting. If they have done so at their most recent AGM, this should help in the current climate where companies want to carry out larger rights issues.
There is no limit on the maximum discount to market price at which new shares issued in a rights issue can be offered (save that shares cannot be allotted at less than their nominal value). Market practice on discounts has changed significantly since 2009, and deep discounts (of 30% to 50%) have become more acceptable as it enables more flexibility in uncertain markets and increases liquidity in trading of nil paid rights. An analysis of discounts on rights issues in 2009 showed about one-third at a discount of less than 50% to the pre-announcement price (with very few having a discount of less than 40%), one-third with a pre-announcement discount of between 50% and 60% and one third having a discount of more than 60% to the pre-announcement price.
Working capital statements and property valuation reports
The FCA will look carefully at these to ensure that they are not qualified by any other disclosure within the prospectus, as well as the risk factors, to ensure that potential discussions on requiring additional financing in the longer term do not impact on the necessity of a "clean" working capital statement. Discussions with the FCA around the risk factors and capitalisation and indebtedness statements may also delay the publication of the prospectus.
If, as in 2009, property prices are badly affected then guidance may be required by the FCA on how up-to-date a property valuation report is required to be in an issuer's prospectus, and at what date a "no material change" statement can be given.
Banks and brokers
At the time of the crisis, institutional shareholders demanded that issuers proceed with rights issues, despite the difficulties they entailed, in order to maintain their pre-emptive rights in a low pricing environment. Despite this, given the competition in the market for new money, issuers needed confidence before pressing ahead, and so some of the market sounding practices that banks and brokers operate today evolved from this set of circumstances. In the current environment, market soundings will need to be handled carefully as in a very volatile market institutions will not want to be insiders for very long, or at all, and issuers will need to work out any cleansing strategy if inside information is imparted to investors and the transaction aborts. In addition, banks and brokers will need to manage their internal conflicts if they have separate clients competing to access the same investors. Those issuers who do receive the green light from investors will still need to review carefully the termination rights in any placing or underwriting agreement, in particular any material adverse change provisions or any termination rights arising from wide scale market dislocation issues. Given the amount of funding that may be required, we would also expect to see many fundraisings carried out on a syndicated basis amongst banks and brokers to spread risk, albeit that this increases timing and complexity.
The financial crisis also saw the rise of standby underwriting agreements - these are used where the marketing has been successful but the company is still awaiting sign off on its prospectus from the regulator. A standby arrangement shows that the underwriter will support the rights issue on a fully underwritten basis on terms to be agreed (including the discount), which then enables the issuer to announce that it has secured the necessary funding.
As noted above, if an issuer has existing creditors who are amenable to it taking on additional convertible debt, and it has existing share authorities in place to cover the shares arising on conversion (or can obtain those authorities in a short period of time - for example with a general meeting on 14 clear days), then convertibles may offer a viable alternative to, or can be used in combination with, a standard equity fundraising structure. It is also possible to use a cashbox structure for convertibles to cut down on timing.