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In our prospectus reviews, we frequently encounter acquisition related issues. Certain disclosure that is required to be included in a prospectus is set out in:
OSC staff have issued guidance related to a few issues as described below to assist issuers and their advisors on acquisition related matters. Many of the matters highlighted below would benefit from pre-file discussions with staff.
An issuer filing an IPO prospectus must include in its prospectus a three-year financial history (two years for an IPO venture issuer) of the business that investors are investing in, even if this financial history spans across multiple legal entities over the three-year period. This includes the financial history for those businesses acquired or that will likely be acquired if those businesses are in the same primary business of the issuer. This provides investors with information on the issuer's entire business, which is the subject of their investment.
In instances where there are multiple acquisitions in the same primary business of the issuer, we encourage issuers and their advisors to consult with staff on a pre-file basis to consider what financial statements of smaller immaterial acquisitions can be excluded from the prospectus. Results from applying the significance tests are not the only consideration when determining whether disclosure, including financial statements disclosure is necessary for the prospectus to contain full, true and plain disclosure. However, if the result from applying any of the significance tests is over 100% (i.e. the business represents more than half of the reporting issuer), it is important for investors to have the financial history of this business even though it is not in the same business as that of the primary business of the issuer.
Where an issuer is raising proceeds to fund an acquisition that makes up a material portion of its business, or is larger than the issuer's existing business, the issuer should consider whether the prescribed disclosure that is normally required for a significant acquisition (as that term is used in securities legislation) is sufficient for the prospectus to contain full, true and plain disclosure. Specifically, issuers with an existing annual information form should consider if their annual information form needs to be supplemented with additional disclosure in the prospectus in light of the acquisition, and whether inclusion of additional audited financial statements is necessary. Venture issuers should consider whether additional disclosure is necessary for the prospectus to contain full, true and plain disclosure even if an acquisition does not meet the applicable asset or investment significance tests. We encourage issuers and their advisors to consult with staff on a pre-file basis on these issues to determine the appropriate level of disclosure.
When an issuer makes an acquisition, there are instances where judgement is involved to determine whether the acquisition is an asset acquisition or a business acquisition. An acquisition could meet the definition of an asset acquisition under International Financial Reporting Standards, while the same acquisition could be considered a business acquisition for securities law purposes. The term "business" should be evaluated in light of the specific facts and circumstances. We generally consider the acquisition of a separate entity, a subsidiary or a division to be an acquisition of a business, and in certain circumstances a smaller component of a company may also be considered an acquisition of a business, irrespective of whether or not financial statements were previously prepared for the business. We generally view the acquisition of licenses, patents, royalties and intellectual property as “business” acquisitions for securities law purposes, as the revenue producing activity or potential revenue producing activity remains the same.
Part 8 of Companion Policy 51-102CP provides guidance in determining whether an acquisition constitutes the acquisition of a business. Specifically, in making that determination, an issuer should consider the continuity of business operations, including the following factors:
(a) whether the nature of the revenue producing activity or potential revenue producing activity will remain generally the same after the acquisition, and
(b) whether any of the physical facilities, employees, marketing systems, sales forces, customers, operating rights, production techniques or trade names are acquired by the issuer instead of remaining with the vendor after the acquisition.
If an existing issuer completes an acquisition of a business that is considered significant, the securities requirements under Part 8 of National Instrument 51-102 - Continuous Disclosure Obligations would apply.
We encourage issuers and their advisors to consult with staff on a pre-file basis if there is uncertainty as to whether the acquisition is an asset acquisition or a business acquisition for securities law purposes.
We have encountered during our reviews prospectuses that indicate that a principal purpose of the offering is for potential acquisitions, but contain little or no disclosure about these potential acquisitions. Instead, the prospectuses have contained disclosure to the effect that:
For disclosure relating to potential acquisitions that are otherwise not described in the prospectus, we may request details such as:
In the above scenario where a prospectus is filed to finance the acquisition of a proposed target, we have noted that a substantial amount of the prospectus disclosure relates to the proposed target and that an investor’s decision to participate in the prospectus offering may in large be based on the disclosure about the proposed target.
However, if the vendors have not signed the prospectus and the acquisition agreement includes a significant vendor indemnity cap, the vendors of the proposed target may have little or no liability to investors or to the issuer if there is a misrepresentation in the target-related disclosure. In some instances the vendor indemnity caps have purported to limit the vendors’ liability from 5% to 10% of the proceeds paid to the vendors.
We have questioned whether this situation undermines the statutory requirement that the prospectus contain full, true and plain disclosure of all material facts relating to the securities to be issued under the prospectus. The parties receiving the proceeds of the offering and the parties with the best information about the proposed target, namely the vendors, may not be motivated to ensure that the prospectus does in fact contain full, true and plain disclosure in relation to the proposed target.
We are concerned that, in effect, the vendors may be protected from the consequences of a misrepresentation in the disclosure relating to the proposed target, and that the risk that this disclosure may contain a misrepresentation may fall primarily on the issuer and ultimately the shareholders of the issuer, including the investors in the prospectus offering.
We recognize, however, that the issuer in an arm’s length transaction may only have a limited ability to negotiate the terms of the vendor indemnity cap and that the inclusion of the cap may have been reflected in the acquisition price for the proposed target.
In view of this, it is current practice to raise a comment as part of the review process when a prospectus indicates that the acquisition agreement includes a vendor indemnity cap. Staff will request risk factor disclosure that highlights the following facts:
(a) the disclosure represents full, true and plain disclosure, and
(b) does not contain a misrepresentation.
As stated in section 8.7(5) of Companion Policy 51-102CP, pro forma financial statements, included in a prospectus as the result of an acquisition, may only include two types of pro forma adjustments:
We have refused in the past to allow the inclusion of pro forma information in a prospectus that contains inappropriate adjustments.