Australia: COVID-19 - Mitigating the control effects of entitlement offers during a time of uncertainty

In brief

The securities market in Australia, like many other global stock markets, has experienced high levels of volatility and general uncertainty in light of the economic disruptions caused by COVID-19. Given the unprecedented nature of the coronavirus pandemic and its impact on global economies, it is difficult to predict with any certainty how long COVID-19 will continue to affect financial markets.

This provides challenges for many listed companies that need to raise equity capital in the short to medium term, particularly those that require funding on an urgent basis in order to meet upcoming debt or other contractual commitments or to simply satisfy ongoing working capital requirements.


Contents

The impacts of an uncertain market on the capital raising initiatives of listed companies include:

  • Depressed share prices: While ASX has recently responded to temporarily increase the 15% limit on placements to 25% in certain circumstances as part of a suite of temporary measures to facilitate capital raisings in response to the current health crisis as part of its package of COVID-19 capital raising reforms, for some listed companies, an institutional placement (whether accompanied by a share purchase plan offer or not) may not be sufficient to deliver the required amount of capital without shareholder approval. Accordingly, a pro rata entitlement offer (or rights issue) may be the only viable capital raising structure for companies needing to raise a significant amount of capital.
  • Limited access to professional underwriting: Secondly, uncertain trading conditions make it very difficult for some listed companies to access professional underwriting on commercially acceptable terms (or at all). This is particularly the case for capital raisings involving a retail offer component such as an entitlement offer, which may require the underwriter to be on risk for up to several weeks. This leaves many companies with no viable alternatives but to seek the support of their major shareholders, or other private investors willing to acquire a substantial interest in the company, to backstop their capital raising activities. This support is often provided through commitments to underwrite or sub-underwrite a capital raising involving an entitlement offer.

Accordingly, it will be particularly important in these circumstances for listed companies and their directors to ensure that any underwriting of an entitlement offer, particularly by a major shareholder or other private investor, is appropriately structured having regard to the guidance on control provided by the Takeovers Panel and ASIC. As the Panel has indicated on a number of occasions, including most recently in Energy Resources of Australia Limited [2019] ATP 25, the need for funds is not a safe harbour. However, it is likely to be a highly relevant consideration in the current environment.

The following guide Mitigating the control effects of entitlement offers during a time of uncertainty provides a detailed summary of factors that listed companies and their directors should consider when structuring an entitlement offer (particularly one that is underwritten) to mitigate potential control effects.

By way of summary, these factors include:

1. Ensure that the size of the entitlement offer is appropriate having regard to the funds required.
2. Price the entitlement offer at a discount to encourage participation.
3. Make the entitlement offer renounceable if rights trading likely.
4. Offer a shortfall facility that includes an equitable allocation policy.
5. Ensure there are other effective dispersion measures in place (such as a suitable spread of sub-underwriters).
6. Make genuine attempts to engage with a wide range of underwriting parties, including professional underwriters.
7. Ensure that the underwriting arrangements are properly characterised as "underwriting", such that they involve (in substance) assumption of risk by the underwriter.
8. Seek to avoid unusual or uncommercial underwriting terms.
9. Consider recent dealings in the company's shares by underwriting parties.
10. Ensure there is a proper fundraising purpose and genuine need for funds.
11. Carefully explore and consider all alternative funding options.
12. Obtain independent financial and legal advice in connection with the offer.
13. Consider the likely response of shareholders to the entitlement offer.
14. Avoid undertaking inconsistent corporate actions.
15. Establish an independent board committee where insiders are likely to be involved.
16. Ensure there is adequate disclosure of the potential control effects.

If you have questions about this topic, please contact us.

Please refer to our alerts Australian Equity Capital Raisings in light of COVID-19 and ASX and ASIC shift the goalposts for capital raisings for a summary of some recent capital raising reforms.

If you would like to draw from other global resources developed by Baker McKenzie on COVID-19, please visit our Coronavirus Resource Centre.


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