The Float Guide How to float a company on the Australian Securities Exchange

Transcription

1 The Float Guide How to float a company on the Australian Securities Exchange 6th Edition Contact: John Williamson-Noble Gilbert + Tobin, Australia jwilliamson-noble@gtlaw.com.au

2 INTRODUCTION This guide gives an overview of what is involved in listing an Australian company on the Australian Securities Exchange (ASX). It is a practical manual covering all aspects of a float from prerequisites through to life after the float. Liability limited by a scheme approved under Professional Standards Legislation.

3 Contents Executive Summary 3 Prerequisite to floating. 6 Float team 10 Getting the company ready 13 The prospectus 18 Due diligence Pricing Marketing the float. 27 Dealing with the regulators. 29 Offer period.. 30 Life after the float Conclusion 34 Float timetable 35 Liability limited by a scheme approved under Professional Standards Legislation.

4 EXECUTIVE SUMMARY Why float? Floating a company allows: the company itself to raise new capital with relative ease; and existing shareholders to sell and trade their holdings in the market. Does my company qualify? Generally, before a company can be floated on the Australian Securities Exchange (ASX) it must satisfy either: the profit test that is to say it has: conducted the same activities for the past three full financial years; aggregated profit for the past three full financial years of at least AU$1m; profit for the 12 months before listing of at least AU$400,000; and audited and unqualified accounts for the past three full financial years; or the assets test that is to say it: What will it cost? has net tangible assets at the time of listing of at least AU$2m (after deducting the costs of the float); or will have a market capitalisation on listing of at least AU$10m. As a rough guide, the costs of a float are likely to be: for floats smaller than AU$50m, ten per cent or more of the funds raised; and for floats of more than AU$50m, five per cent or less of the funds raised. How long will it take? A well-run, reasonably simple float can be completed in three months. Larger, more complex floats can take anything up to a year. Who is on the float team? The float team will include an underwriter or lead manager (who may also act as financial adviser), accountants, lawyers and others including the share registrar, PR consultants and other experts who may be commissioned to produce special reports for the prospectus (eg, for mining companies, prospectivity reports). Gilbert + Tobin iba float guide - australia hc page 1

5 Is my company ready? Before floating, a company will need to review its: structure the company must convert to a public company and adopt a share structure and constitution which comply with ASX requirements; board the board may need to be changed to include independent non-executive directors with appropriate expertise; and corporate governance procedures the company will need to put in place appropriate corporate governance procedures for a listed company. What goes in the prospectus? The company will need to put together a prospectus to issue to potential investors before it is floated. The prospectus must contain all the information about the company that investors, and their advisers, would reasonably require to make an informed assessment of: the assets and liabilities, financial position and performance, profits and losses, and prospects of the company; and the rights and liabilities attaching to the shares to be offered. Nothing else (other than some technical requirements) is required to be included and there are no confidentiality carve-outs. For commercial reasons, the prospectus usually also includes detailed background about the company's business, its directors and management and the industry in which it operates. What is due diligence? In most floats, a due diligence (or enquiry) process is conducted to make sure the prospectus complies with the legal requirements and no material information is left out of the prospectus. Generally, a due diligence committee runs the due diligence process. The committee usually consists of representatives of each of the float team members and two directors. Committee members are assigned responsibility for various areas in the due diligence, such as legal or accounting, in accordance with their expertise. The committee signs-off to the board on the due diligence just before the prospectus is issued to say that the prospectus complies with the legal requirements. What is the company worth? The underwriter/financial adviser will generally help the company to set an appropriate offer price. Often this is at a discount of ten to fifteen per cent of the price (often based on earnings multiples) at which securities of listed companies in the same industry are trading. How will the float be marketed? The process of marketing the float begins with marketing to institutions. Once the prospectus is lodged, brokers will commence marketing to their private clients and marketing to retail investors generally begins. Gilbert + Tobin iba float guide - australia hc page 2

6 There are significant restrictions on marketing the float before the prospectus is lodged with the Australian Securities and Investments Commission (ASIC). Once the prospectus is lodged, these restrictions largely fall away. What else is involved? Once the prospectus is finalised, it must be lodged with ASIC. After lodgement, the prospectus is subject to an exposure period of seven days (which ASIC may extend to 14 days). During this time the prospectus must be made available to the public but the company may not process applications from investors. After this exposure period, the company may accept and process applications. The offer period is generally three to four weeks. Before being listed on the ASX, the company must achieve a sufficient spread of shareholders. This is satisfied if the company has at least 500 shareholders holding shares worth at least AU$2,000. Alternatively, the company may have only 400 shareholders holding AU$2,000 worth of shares, so long as at least 25 per cent of the company's shares are held by the public. Will existing shareholders be able to sell? In certain circumstances, particularly for companies admitted under the assets test, the ASX will restrict or escrow shares issued before the float so that they cannot be sold for a period of up to two years after listing. Broadly: a shareholder with more than ten per cent or board representation ( related party ) will be subject to escrow for two years from the listing date; and all other pre-float shareholders will be subject to escrow for one year from the date of issue of their shares. In both cases shareholders can sell a number of shares which would allow them to recover, at the float price, the cash that was contributed to the company for the shares they hold but the rest of their shares are subject to escrow for the relevant period. In addition, for non-related parties, if the cash contributed was 80 per cent or more of the float price, there is no escrow. There are also special rules for genuine venture capitalists. Gilbert + Tobin iba float guide - australia hc page 3

7 PREREQUISITES TO FLOATING Before a company can be floated on the ASX it must satisfy ASX requirements relating to size or profitability and shareholder spread. It must also ensure that its structure and constitution are consistent with the listing rules of the ASX. Generally, a company seeking listing must prepare and issue a prospectus relating to the shares in the company being offered. The timing of the float is also important to its success. A float can be an intrusive process for a company. To avoid disruption of operations, responsibility for managing the float should be left to one or two executives so the rest of the management team can concentrate on running the business. ASX REQUIREMENTS The requirements to be listed on the ASX include: Profit test and assets test The company must satisfy either; Profit test the profit test; or the assets test. To satisfy the profit test: three years profit the company's aggregated operating profit before tax and abnormal profits (but including abnormal losses) for the last three full financial years must have been at least AU$1m; last year's profit the company's consolidated operating profit before tax and abnormal profits (but including abnormal losses) for the 12 months ending two months prior to applying for admission must exceed AU$400,000; continuing profit the company is continuing to earn profit from continuing operations up to the date of the listing application; going concern the company must be a going concern or a successor of a going concern; same business the company must have conducted the same main business activity during the last three full financial years; and unqualified accounts the company must have audited financial statements for the last three full financial years. The financial statements must not have been qualified in a way that goes to whether the company can continue as a going concern or has satisfied the profit levels required. Gilbert + Tobin iba float guide - australia hc page 4

8 Assets test To satisfy the assets test: size at the time of admission to the official list, the company must have either net tangible assets of at least AU$2m (after deducting the costs of fundraising) or a market capitalisation (based on the offer price under the prospectus) of at least AU$10m; cash position either less than half the company's total tangible assets (after raising any funds from the float) must be cash or in a form readily convertible to cash or, if half or more of the company's total tangible assets (after raising any funds from the float) are cash or in a form readily convertible to cash, the company must have commitments consistent with its business objectives to spend at least half of its cash and assets in a form readily convertible to cash. The prospectus must set out these business objectives, together with an expenditure program but legally binding commitments are not required. The ASX does not normally treat inventories and receivables as readily convertible to cash. The costs of the float can be treated as a commitment; and working capital the company's working capital must be at least AU$1.5m (which may include any budgeted revenue for the financial year after listing). Generally, the prospectus will also need to contain a statement that the company has enough working capital to carry out its stated objectives if it does not, the company must give the ASX one from an independent expert. If a new holding company is to be listed, the ASX will look at the profits and assets of the group to determine whether the new holding company satisfies the relevant test. Shareholder spread After the offer, the company must have achieved a satisfactory spread of shareholders. This will be satisfied if the company has: at least 500 shareholders, each holding shares with a value (based on the prospectus offer price) of at least AU$2,000; or at least 400 shareholders, each holding shares with a value (based on the prospectus offer price) of at least AU$2,000, so long as at least 25 per cent of the company s shares are held by persons who are not related parties of the company (that is, genuine public investors). This requirement is not met if the spread is obtained by artificial means for instance, giving shares away, offering non-recourse loans to prospective shareholders to acquire their shares or using combinations of nominee companies and names. In addition, any shares which are required to be subject to escrow by the ASX will not count towards satisfying these shareholder spread requirements. Prospectus/information memorandum Generally, the company must prepare a prospectus. It must lodge the prospectus with ASIC and issue it. The prospectus will be the document offering shares for issue to the public. The ASX will allow a company to issue an information memorandum instead of a prospectus in certain circumstances. These include where the company has not raised capital in the past three months, does not expect to raise capital in the next three months and already has the required spread of shareholders. The information memorandum still has to comply with most of Gilbert + Tobin iba float guide - australia hc page 5

9 the requirements of the Corporations Act about prospectuses, but does not need to be lodged with ASIC. Structure and operations The company's structure and operations must be appropriate for a company listed on the ASX. For the vast majority of companies, this requirement does not represent a significant hurdle. CAPITAL STRUCTURE In addition to the general requirement to ensure the company's structure and operations are appropriate for a listed company, there may be specific requirements in relation to the capital structure which must be dealt with before the float goes ahead (eg, recapitalising the company to ensure a sufficient capital base or altering rights attaching to shares to satisfy ASX requirements, particularly in relation to voting rights). In appropriate circumstances, the ASX is prepared to provide significant relief from this requirement for cooperatives, former cooperatives and mutuals. WHEN TO FLOAT There are a number of factors to take into account when deciding when to launch a float: Funding needs obviously, the most important factor where the float involves the issue of new shares by the company (and therefore the raising of new funds by the company) is the funding requirements of the company. The need for funds must be balanced against the other timing factors which may affect the success of the float. Value of market the price achieved for the shares will depend both on the general value of shares on the ASX and the specific value placed on shares in the company's industry. A well-timed float will occur when the value of shares generally on the ASX is high and when the earnings multiple for companies in the company's industry is high. Other floats the company should avoid attempting to float when there are major floats occurring which are likely to soak up available investment funds. The Christmas quiet period it is generally accepted that a company should avoid launching its offer just before or just after the Christmas break. It is probably best to avoid this, but there have been a small number of successful floats where the offer period has run across the Christmas break. COSTS OF FLOATING The cost of floating a company can be significant, both in terms of expenses incurred during the float and in lost management time. Generally the larger the float is, the more cost effective the fundraising. Broadly, the cost of raising less than AU$50m by float is likely to be ten per cent or more of the amount raised. In contrast, the cost of raising more than AU$50m by float is likely to be five per cent or less of the amount raised. TIMING A reasonably simple, well managed float can be completed within three months. More complex floats will take longer and may take up to a year to complete, although there are examples of floats which have taken up to ten years from inception to completion. Gilbert + Tobin iba float guide - australia hc page 6

10 MANAGEMENT TIME One factor often neglected in assessing the cost of a float is management time used up in the float process and the distraction caused by it. Management is likely to be involved both in strategic issues and in the due diligence process associated with the preparation of the prospectus. Managing the float properly will keep lost management time to a minimum. Those managing the business should be insulated as much as possible from the float process, with responsibility for the float being delegated to one or two members of the executive team. Gilbert + Tobin iba float guide - australia hc page 7

11 FLOAT TEAM Before starting the float process, the company will need to assemble its float team. The float team may include an underwriter (who may also act as financial adviser), accountants, lawyers and others including the share registrar, public relations consultants and other consultants who may be commissioned to produce special reports for the prospectus (eg, for mining companies, prospectivity reports). It is important to define the role of each team member at the outset and to establish what signoffs will be required from each team member. This avoids last minute surprises. UNDERWRITER/FINANCIAL ADVISER The roles of the underwriter and financial adviser in a float often overlap. The main distinction is that the underwriter will underwrite the success of the float by agreeing to provide applications for any shares not taken up by investors under the float As well as adding its endorsement to the float, the underwriter assumes the risk of the float not succeeding, in return for a fee in the range of at least 1.5 per cent (for major floats) to 5.5 per cent, or more, of the float proceeds. Whether or not to underwrite the float is one of the earliest decisions the company will have to make. Underwriting the float will, in theory, allow the company to aggressively price the float, since the company will be certain that all shares will be taken up, whether by investors or by the underwriter. Since the underwriter's risk is that not all shares will be taken up by investors and it will have to apply for those shares itself, the underwriter will be keen to ensure that the offer price is set at the level at which all shares will be taken up by investors. Approximately half the initial public offerings of shares in a company are underwritten. The balance of these are either not underwritten generally because they are too small to merit an underwriting or are offered under the book-build process described below. UNDERWRITING/BOOK-BUILD (13) * If an underwriter is appointed, the company will need to agree the terms of the underwriting with the underwriter, particularly fees and termination events ( out clauses ). This is best done early in the float process, when the underwriter signs a mandate letter which records these terms. Generally, the underwriter legally commits to underwrite the float before the start of the offer period when the prospectus is lodged with ASIC. It is at this time that the formal underwriting agreement is signed. It is more common for larger floats for a book-build process to be used instead of a traditional underwriting. Under a book-build the underwriter (or offer manager as they are called in a book-build) is not committed until the end of the float period when the float is fully subscribed. The offer manager s role is to market the offer to potential investors and build the demand for the offer. This allows the float to be priced more aggressively as the offer manager does not run the risk of having to take up any shortfall in subscriptions. *Note: reference numbers in brackets direct you to the corresponding item in the timetable at the back of this guide. ACCOUNTANTS A prospectus will include historical accounts for anything up to five years and the investigating accountant will: assist the company in preparing the accounts; Gilbert + Tobin iba float guide - australia hc page 8

12 conduct the accounting and tax due diligence on the company; advise the company on any forecasts contained in the prospectus; prepare an investigating accountant's report and in some cases, a tax sign-off letter for the prospectus; and advise generally on accounting and tax issues. Often the natural choice for accountant to a float is the company s auditor, since they may already have an intimate knowledge of the company's operations. However, it is sometimes worthwhile to bring in an independent accountant who can take a fresh view of the company s operations and who may be more suited to conducting the accounting due diligence of the company. For less well-established companies it can also help to have the endorsement of a big name accountant. LAWYERS The lawyers: advise on legal issues generally in relation to the prospectus; conduct the legal due diligence on the company; and generally prepare most of the additional information section of the prospectus, including summaries of material contracts. The lawyers will also generally be involved in drafting and negotiating the underwriting agreement with the underwriter and drafting the other documents required for the float, including the new constitution for the company, any employee share ownership plan, any dividend reinvestment plan and any service contracts required with key employees. PR CONSULTANTS A company may also engage a public relations consultant to assist the company in publicising and marketing the float. This is particularly the case in large or potentially controversial floats. The role of the public relations consultant is to ensure the company gets appropriate press coverage and to liaise with members of the media. SHARE REGISTRAR The company will need to appoint a share registrar to handle the receipt and processing of applications under the float and to maintain the share register after the float. The share registrar may also help with technical issues relating to the share register and the issue and transfer of shares during and after the float. OTHER EXPERTS Depending on the company being floated, other experts may be commissioned to advise the company or to produce special reports for the prospectus. Examples of special reports include: for mining companies, reports on the prospectivity of mining areas; and for companies with large holdings of real property assets, valuation reports. Gilbert + Tobin iba float guide - australia hc page 9

13 SIGN-OFFS AND RESPONSIBILITY (1) At the outset, it is important to set out clearly the areas of responsibility of each of the team members. One method of achieving this is to draft letters of appointment for each team member setting out what is expected of that team member. The letter of appointment should include a form of signoff expected to be given by that team member at the end of the process. This ensures there are no last minute hitches with advisers not supplying the sign-offs needed to get the float away. Gilbert + Tobin iba float guide - australia hc page 10

14 GETTING THE COMPANY READY In addition to complying with the float prerequisites, the company will need to review its structure, board and corporate governance procedures before floating. It will also need to decide whether to put in place an employee share ownership plan, an executive option scheme and a dividend reinvestment plan. New non-executive directors should be chosen who complement the skills mix of the existing board. They should be appointed as early as possible so that they have the opportunity to get comfortable with the float process. THE BOARD There are a number of issues in relation to the board which will need to be covered in the period leading up to the float: independent directors (4) generally the market expects that a majority of the board will consist of independent directors. In many cases, this includes the chairperson. The company should try to recruit independent directors with relevant expertise, experience and contacts. The fee for an independent director of a listed company may be over AU$50,000 per year so it is important that each of them adds value. If possible, independent directors should be appointed as soon as possible in the float process so that they can understand the float and due diligence processes fully and so that the board gets used to working with those directors. Any new directors will need to become satisfied with the due diligence process because they will be liable for the prospectus; and remuneration and service contracts (4) the board will need to set remuneration levels for non-executive and executive directors. The company may also need to consider entering into service contracts with important executive directors if there are no service contracts already on foot. This is to make sure they are tied to the company for a reasonable time after the float and enter into reasonable non-compete agreements. CORPORATE GOVERNANCE The company will need to put in place appropriate corporate governance procedures for a listed company. These will need to be disclosed by the company in its annual report after listing. The company will need to comply with the ASX Corporate Governance Guidelines set out in the Listing Rules or disclose in its annual reports the extent of any non-compliance. EMPLOYEE SHARE OWNERSHIP PLAN (8) Many companies being floated establish an employee share ownership plan (ESOP) for their employees. An ESOP gives employees the opportunity to become part-owners of the company and have a financial interest in its success. There are a number of ways that ESOPs can be structured an outline of the more common structures is listed below. There are a number of advantages and disadvantages associated with each structure these are listed in the table on page 16. Gilbert + Tobin iba float guide - australia hc page 11

15 Tax free shares A company can provide up to AU$1,000 worth of free shares to each Australian tax resident employee in the company with an adjusted taxable income of AU$180,000 or less without any tax needing to be paid on those shares. There are a number of conditions that must be satisfied for employees to be eligible for the exemption including that employees must be restricted from disposing of the shares for at least three years and the offer must be made on the same terms to at least three-quarters of permanent Australian resident (36 months service) employees. This plan is ideal for general employee equity participation. Tax deferred shares A company can provide shares to Australian tax resident employees in the company without any initial tax needing to be paid on those shares in certain circumstances. Subject to meeting certain requirements, tax deferral will apply to: shares or rights obtained under an ESOP that are subject to a real risk of forfeiture and restrictions on disposal at the time of acquisition. This type of plan is ideal for a range of incentive purposes, usually for senior employees; and salary-sacrifice-based ESOPs of up to AU$5,000 worth of shares per employee in an income year where there are restrictions on disposal (at the time of acquisition). There need not be a real risk of forfeiture. Otherwise, tax will be levied up front on the discount to the shares market value. If tax deferral is available, the deferred taxing point will occur at the earliest of: Options both the real risk of forfeiture and the restrictions on disposal ceasing to apply; cessation of employment; or seven years. An alternate structure for the ESOP is for the company to issue options over unissued shares to employees. The options are usually issued for free but have an exercise price which is payable when they are exercised. The exercise price is usually set at the share price on the date the option is issued. The options are exercisable after a fixed period has elapsed for example, three years after the options are issued. If the performance conditions have been met and the company s share price has increased, the exercise price will be less than the then prevailing share price. By exercising the option in these circumstances, the employee will achieve a profit equal to the difference between the share price when the option is exercised and the exercise price. Options will be taxed in a similar manner to tax deferred shares except that if the shares which would be acquired upon exercise of the option are subject to a real risk of forfeiture and restrictions on disposal, the taxing point can be deferred until the point at which there is both no longer a real risk of the employee losing the share and no restriction on disposal of the share (unless one of the other trigger points occurs earlier). Gilbert + Tobin iba float guide - australia hc page 12

16 Generally, options are used for executive, rather than general employee, share plans. Design of appropriate offer terms is critical to meet corporate governance and investor expectations. Performance rights A performance right is a zero-priced option. That is, the exercise price is nil. As with options, performance rights are exercisable after a fixed period has elapsed for example, three years after the right has been issued subject to meeting performance and other conditions of offer. Performance rights will be taxed in the manner described for options. As with options, rights are generally used for executive, rather than general employee, share plans. Again, design of appropriate offer terms is critical to meet corporate governance and investor expectations. Fully-paid shares and loan Under this approach, the company provides loans to employees to purchase shares in the company. The shares are then used to secure repayment of the loan from the employee. As an incentive, the loan is usually provided at a low or zero interest rate. In addition, the shares may be offered at a discount to the then prevailing market price. If the loan is not repaid, the company s recourse is generally limited to the value of the shares and interest payments are often timed to coincide with dividends. Accounting Accounting standards require the assessed fair value to be charged to the income statement over the relevant service period. This is critical to the design of all ESOPs. Gilbert + Tobin iba float guide - australia hc page 13

17 ADVANTAGES/DISADVANTAGES OF ESOP APPROACHES Type of ESOP Tax free shares Tax deferred shares Immediate ownership Voting and dividend rights Immediate liquidity Yes Yes No, until expiry of escrow period Yes Yes No, until conditions of offer met Cost to company Cost to employee (*) Nil to fully paid under salary sacrifice (*) Nil to fully paid under salary sacrifice Options No No No (*) Exercise price Performance Rights Fully-paid shares and loan Individual incentive Upfront commitmen t by employee Minimum employmen t period restriction possible Employee exposed to downside Easy to administer No No No Yes Moderate Yes Yes Usually Yes Moderate Yes Low (if any) Yes No Moderate No No No (*) Nil Yes Yes Yes Yes Moderate Yes Yes No, until expiry of escrow period/repay ment of loan (*) Loan amount (dividends can be used to repay and service) Yes Yes Yes Yes (unless loan is limited recourse) No (*) Fair value charged to income statement. Gilbert + Tobin iba float guide - australia hc page 14

18 DIVIDEND POLICY AND DIVIDEND REINVESTMENT PLANS Dividend policy (8) Before the company floats, it must set a dividend policy. This policy is normally set out in the prospectus and will have an impact on the pricing of the float. Generally, the directors determine what percentage of profits will be paid out as dividends. The factors which will determine this percentage include: market expectations; the effect of the proposed pay-out ratio on share pricing; and the company's on-going capital requirements and profit stream. The prospectus usually also sets out the extent to which dividends will be franked. Dividend reinvestment plans Many companies being floated establish a dividend reinvestment plan (DRP). A DRP allows a shareholder the opportunity to reinvest dividends in new shares, rather than taking the cash. The benefits of a DRP include: ongoing capital a DRP supports the ongoing capital needs of the company. Typically, 50 per cent of shareholders elect to take up shares, rather than receiving dividends in cash, where a DRP is in place. This means that 50 per cent of dividends declared by the company are re-invested in the company as new equity; and cheaper capital raising having a DRP often allows a company to raise capital more cheaply than a new issue of shares to the market. Generally, as an incentive to shareholders, shares are offered under a DRP at a discount to the prevailing market price (typically, a five to ten per cent discount). Another benefit to shareholders is the low transaction costs since no brokerage applies to the acquisition of shares under a DRP. STRUCTURE Public company (5) Since the company will have a large shareholding, it will need to convert to a public company. This will require the approval of existing shareholders and the adoption of a public company constitution. The process takes around five weeks and must be complete before the prospectus is lodged with ASIC. The constitution will also need to comply with the requirements under the ASX listing rules and be approved by the ASX. Share capital (5) The share capital of the company may need to be restructured so that: there are, or will be after the float, an appropriate number of shares on issue; there is only one class of ordinary shares on issue unless it is necessary (eg, for restriction of foreign ownership) to have separate classes; and Gilbert + Tobin iba float guide - australia hc page 1

19 the issue price of shares is at least AU$0.20 per share. Gilbert + Tobin iba float guide - australia hc page 2

20 THE PROSPECTUS The prospectus must contain all the information about the company that investors, and their advisers, would reasonably require to make an informed assessment of: the assets and liabilities, financial position and performance, profits and losses, and prospects of the company; and the rights and liabilities attaching to the shares to be offered. Nothing else (other than some technical requirements) is required to be included and there are no confidentiality carve-outs. Usually, the prospectus will also contain background on the company's business, its board and management team and the industry in which it operates, to help market the float. Forecasts and other statements about the future carry 90 per cent of the risk associated with the prospectus. Focus on these areas. For recent smaller floats, actual results were within 15 per cent of one-year forecasts only 50 per cent of the time. Failure to meet forecasts will have a significant effect on your share price. PROSPECTUS REQUIREMENTS Introduction Under the Corporations Act, a prospectus must contain all information that investors and their professional advisers would reasonably require for the purpose of making an informed assessment of: the assets and liabilities, financial position and performance, profits and losses, and prospects of the company; and the rights and liabilities attaching to the shares being offered. The test is a very wide one. The prospectus must include all information actually known to the directors and proposed directors of the company, the underwriters and brokers to the float, experts quoted in the prospectus, and others who are named in the prospectus with their consent, and anything else which falls within the test which these parties could reasonably find out. The need to include what could be reasonably discovered gives rise to the need to make reasonable enquires, that is, undertake due diligence. Other than a number of specific, technical items which are required to be included under the Corporations Act (eg, a statement that no shares will be issued on the basis of the prospectus after the expiry date specified in the prospectus and details of directors interests and experts fees), nothing else is required by law to be included in the prospectus. The information in the prospectus must be worded and presented in a clear, concise and effective manner. The Corporations Act allows companies to raise up to AU$10m over their life by means of a much shorter document an Offer Information Statement for which there is a lower disclosure standard. An Offer Information Statement would not, however, be accepted as the basis for a listing on the ASX. Gilbert + Tobin iba float guide - australia hc page 3

21 Confidentiality Information must be included in the prospectus to the extent to which it is reasonable for investors and their professional advisers to require the information in the prospectus. Important information cannot be withheld merely because it is confidential. Materiality Generally, the prospectus will focus on information that is material to investors. What information is material for the purposes of investors making an informed assessment of the company? There is no definition in the Corporations Act of what is material. However, cases in the US have held that information is material if it: significantly affects the price or value of the shares; or significantly affects an investor's decision to buy. In practice, these concepts have been adopted in Australia. The due diligence committee should, at the outset of the prospectus preparation process, set materiality guidelines to guide the drafting of the prospectus. This is to avoid wasting time and resources on non-material issues. Due diligence committees set, generally, both quantitative and qualitative guidelines: quantitative as a rule of thumb these are set at the greatest of: equity: five per cent of the value of the equity of the company; profits: five per cent of the normalised pre-tax profits of the company; and turnover: one per cent of the yearly turnover of the company. A dollar figure is then set based on these indicative percentages and all items having a dollar value above the materiality level are considered for potential incorporation in the prospectus; and qualitative not all issues will have an easily defined monetary impact on the company. Some issues will be of such a quality to be material to the company's business. For example, an issue may damage the reputation of a company so significantly that this may have a consequential detrimental impact on the company's profits which may be material. Again, material items under the qualitative test are considered for potential incorporation in the prospectus. The materiality guidelines should be made as clear as possible so they can act as effective filters on non-material issues and also to make sure that all material issues are considered. Obviously, in some cases, whether an issue should be considered for inclusion in the prospectus (especially where the issue may fall within the qualitative guidelines) will involve the judgment of the due diligence team. Where in doubt, issues should always be considered for inclusion. Gilbert + Tobin iba float guide - australia hc page 4

22 Forecasts The prospectus must contain information about the prospects of the company. This legal requirement can be satisfied in a number of ways. The prospectus may merely include a narrative about the company's prospects. In the past, some prospectuses contained projections that is, estimates of future financial results based on hypothetical assumptions which are not necessarily expected to take place. Prospectuses containing projections will not be acceptable to ASIC. Any estimates of future financial results must be based on assumptions about future events and actions which the board believes are reasonable these are called forecasts. There is a current market expectation that a prospectus will contain forecasts extending between nine and eighteen months into the future. The market will generally treat a general statement about prospects (without figures) as being insufficient, although there is no statutory requirement that the prospectus include financial forecasts. The appropriate level of disclosure will depend on each company. Where the industry the company operates in is volatile and the future is uncertain it may be misleading to include any figures about the future. On the other hand, if the selling story is based on future performance of the company it may be impossible to sell the float without including figures in the form of forecasts. The assumptions underlying the forecast must be set out clearly in the prospectus and the investigating accountant is commissioned to give an opinion on the assumptions. The opinion is generally in the form of a negative assurance, that is, a confirmation that nothing has come to the attention of the accountant during the preparation for the float to suggest that the assumptions underlying the forecast are unreasonable. In addition, the market will usually expect to see a sensitivity analysis relating to key assumptions. Forecasts provide the greatest area of risk in a prospectus and should receive the greatest focus. Under the Corporations Act, if a prospectus contains a statement about a future matter and there are no reasonable grounds for making the statement, the statement is taken to be misleading. Investigating accountant s report The prospectus will include an investigating accountant's report. The report will include a review of historical financial information for the company, together with financial statements, generally for at least two to three financial years. These financial statements may be adjusted to ensure comparability with results over prior years. The review of historical information may include an audit if the accounts were not previously audited. Who drafts the prospectus? (3) Although the due diligence committee has the ultimate responsibility for drafting the prospectus, the task of coordinating the drafting is usually delegated to one of the float team members (normally the financial adviser or underwriter). Other team members will have specific responsibility for drafting sections of the prospectus, for example, the accountants will draft the investigating accountant's report and the lawyers will draft most of the additional information section. In some cases, a small group will be formed to draft the prospectus. Gilbert + Tobin iba float guide - australia hc page 5

23 Verification (10) Before the prospectus is finalised, it undergoes a process of verification. Verification involves checking each material statement of fact or opinion in the prospectus to ensure that it is accurate and, where possible, collating supporting material for that statement. It can be a tedious and time-consuming process if it is not properly managed, but it almost invariably results in material changes to the prospectus. The end-product of the verification process is a set of verification folders containing supporting material for each statement in the prospectus. Where ASIC conducts a post-lodgement audit, this supporting material will be one of the most important records examined by ASIC. It is important to make sure it is comprehensive and well-ordered. TYPICAL CONTENTS OF PROSPECTUS A typical prospectus will contain the sections set out on the following page. 1 Chairperson s letter 2 Investment overview 3 Details of the offer An introduction to investors from the Chairperson Summary of important investment information for the company, including key financial ratios Includes offer price and number of shares being offered 4 Industry background Includes a description of the industry the company operates in 5 Background on company Includes a description of the company s operations and past performance 6 Information on the board of directors and senior managers Includes experience and background of directors whether executive or nonexecutive; it also highlights staff who are important to the business and the company s corporate governance policies 7 Company financial information summary Summarises and comments on historical and forecast financial information, underlying assumptions 8 Risk factors Discussion of general and specific risks relating to the offer 9 Investigating accountant s reports Reports on historicals and prospects Gilbert + Tobin iba float guide - australia hc page 6

24 and sensitivity analysis 10 Additional reports Reports from special experts, for example, mining engineer, technology specialist 11 Additional information Includes summaries of material contracts, material litigation, the constitution of the company, the ESOP, the DRP and other specific information required under the Corporations Act 12 Instructions to applicants and application forms DUE DILIGENCE Due diligence is the process of making enquiries to ensure that the prospectus contains all information material to investors, no material misstatements and no material omissions. Due diligence is necessary because the Corporations Act requires the prospectus to contain both information which is known and information which could reasonably be found out by making enquiries. In most floats, a due diligence committee runs the due diligence process. The committee generally consists of representatives of each of the team members and one or two directors. The committee members are assigned responsibility for various areas in the due diligence. The committee signs-off to the board on the due diligence just before the prospectus is issued to say that the prospectus complies with the legal requirements. Due diligence is one area of the float where costs have the potential to blow out. To avoid this, make sure your due diligence team is well informed about the business, understands what drives it and does not focus on insignificant issues. WHY IS DUE DILIGENCE NECESSARY? The prospectus must not only contain information known to the directors and proposed directors of the company, the underwriters and brokers to the float, experts quoted in the prospectus, and others who are named in the prospectus with their consent, but must also contain anything else which these parties could reasonably find out. Therefore, in order to ensure the prospectus satisfies the general Corporations Act disclosure test, it is important that each of these parties is involved in the process of making enquiries that is, conducting due diligence. The Corporations Act provides for both criminal and civil liability for defective prospectuses. While criminal liability is imposed primarily on the company itself, any person who aided or abetted the breach or was concerned in or party to a breach is potentially subject to criminal liability. For instance, the management team may be exposed to liability under this provision. Criminal liability only applies where the deficiency in the prospectus (eg, omission of information) is materially adverse from the point of view of an investor. The scope of persons who are subject to civil liability to compensate persons who suffer loss or damage because of a defective prospectus is broader. The company, its directors and the Gilbert + Tobin iba float guide - australia hc page 7

25 underwriters (but not sub-underwriters) to the offer are all potentially liable for any deficiency in the prospectus, regardless of whether they were actually involved in the deficiency. Experts who are quoted in the prospectus with their consent are liable for the statement attributed to them. In addition, any other person knowingly involved in the deficiency is liable. In addition to criminal and civil liability, the company is likely to suffer embarrassment and resentment if the prospectus is inaccurate or incomplete. Defences A defence against criminal and civil liability for a misleading or deceptive statement in, or omission from, the prospectus is available if the person subject to liability proves that: they made all enquiries that were reasonable in the circumstances; and after doing so, they believed on reasonable grounds that the statement was not misleading or deceptive or that there was no omission. Care must be taken to make sure that a proper due diligence system is laid down so that this defence will be available to those who can rely on it. While there is also a limited defence based on reasonable reliance on information provided by others, it will be necessary also to ensure that the process is properly supervised it is not possible to abdicate responsibility by leaving the process to junior employees. THE DUE DILIGENCE SYSTEM (2) Delegation The board of the company generally delegates the task of enquiry to a due diligence committee, which includes one or more directors. The committee engages experts, such as accountants, to do the detailed investigations for it. The committee controls and conducts the process and closely scrutinises material prepared. The committee reports to the whole board, which must: be satisfied in the first place with the adequacy of the due diligence system; receive progress reports and the final report; and address its mind to the contents of reports, question where that appears desirable and, if necessary, call for further reports or interview those more closely involved in the process. Membership The following membership is typical of a due diligence committee: a chairperson (often the company's lawyer); two directors of the company (on behalf of the company and to report to fellow directors); the investigating accountant; the underwriter; Gilbert + Tobin iba float guide - australia hc page 8

26 the company's lawyer; and other experts. Role of committee (10/11) The committee: approves the scope of the due diligence; receives regular progress reports; and where necessary, redirects the due diligence efforts, to make sure that by the end of the due diligence period a complete and thorough understanding has been obtained of all the matters relevant to the prospectus before it is finalised. At the end of the due diligence period, the committee reports to the board. The board then approves the issue of the prospectus. PROSPECTUS The prospectus is prepared simultaneously with the due diligence investigations and is amended to reflect the findings of the reports and further investigations. PAPER TRAIL The experts engagement letters, reports and sign-offs, copies of the verification materials and minutes of all committee meetings and papers are collated in files, which are presented to the board of the company and must be retained (generally by the company) until the time limit for liability has expired. CONTINUOUS DISCLOSURE The due diligence process continues until the offer of shares closes. If the process uncovers new information that is materially adverse to investors after the prospectus is lodged, but before the offer closes, the company will need to prepare and issue a supplementary prospectus disclosing the new information. After the company is listed, it has an obligation under the ASX listing rules to disclose to the ASX immediately any information likely to have a material effect on the price or value of the company's shares. The internal systems set up during the due diligence process can form the basis for the reporting lines necessary within the company to comply with these continuous disclosure requirements. Gilbert + Tobin iba float guide - australia hc page 9