The “Listed Issuer Financing Exemption”, known as “LIFE”, will enter into effect on November 21, 2022[i]. As its name suggests, LIFE is a prospectus exemption for distributions of securities listed for trading on a recognized Canadian stock exchange. LIFE is intended to help smaller listed issuers raise capital without incurring significant costs, a laudable objective. Technically, LIFE is comprised of amendments to National Instrument 45-106 Prospectus Exemptions (NI 45-106) [ii]. LIFE includes a number of novel features – in particular, securities issued under LIFE offerings will be available to all investors and will be freely tradeable; the typical four-month “hold period” of National Instrument 45-102 Resale of Securities, which applies to private placements such as those to “accredited investors” or with a minimum subscription amount of $150,000, will not apply to securities issued under LIFE. However, one of the many conditions which applies to LIFE – a 50% maximum level of dilution – may prove to be problematic for smaller issuers.
By way of background, there are limits on the dollar amounts that can be raised under LIFE. Specifically, under section 5A.2.1)(f) of NI 45-106, the dollar amount that an issuer may raise under a LIFE distribution, when combined with all other LIFE distributions during the preceding twelve months, cannot exceed the greater of (i) $5 million; and (ii) 10% of the aggregate market value of the issuer’s listed equity securities on the date of a news release announcing the proposed LIFE offering, subject to a maximum of $10 million (the $5 million – 10% market cap/$10 million limit). For example, a listed company with 100 million shares outstanding currently trading at $0.20, representing a market capitalization of $20 million, can raise a maximum of $5 million under LIFE, less any amount raised under LIFE during the preceding twelve months. A listed company with 100 million shares outstanding currently trading at $0.80, representing a market capitalization of $80 million, can raise a maximum of $8 million under LIFE, equal to 10% of market capitalization, less any amount raised under LIFE during the preceding twelve months. So far, so good.
LIFE then imposes an additional limit on the number of securities that can be issued, based on the level of dilution. This additional limit appears to be redundant in light of LIFE’s $5 million – 10% market cap/$10 million limit.
Under the dilution limit set out in section 5A.2.1)(h) of NI 45-106, a distribution under LIFE, when combined with all other distributions made by the issuer under LIFE during the twelve months immediately before the date of the issuance of a news release announcing the proposed LIFE distribution, cannot result in an increase of more than 50% in the issuer’s outstanding listed equity securities, as of the date that is twelve months before the date of the news release.
For example, a junior listed company with 100 million shares outstanding trading at $0.04 has a market capitalization of $4 million. Under LIFE’s $5 million – 10% market cap/$10 million rule, this junior listed company could raise a maximum of $5 million during a twelve-month period. If this junior listed company issues shares at its market price of $0.04, it would issue an additional 125 million shares in order to raise $5 million, in effect more than doubling the number of issued and outstanding shares, from 100 million to 225 million.
However, under LIFE’s dilution limit, this junior listed company cannot issue more than 50 million shares, representing 50% of the number of its outstanding shares, and even fewer shares if the number of its outstanding shares one year ago was less than 50 million. If a year ago this junior listed company had 80 million shares outstanding, it cannot issue more than 40 million shares under a new LIFE offering. If the 40 million shares are issued at the current market price of $0.04, the company will raise $1.6 million, well short of the $5 million maximum otherwise permitted under LIFE’s $5 million – 10% market cap/$10 million limit. Compared to the 100 million shares currently issued and outstanding, the 40 million shares represent 40% dilution. In this regard, it is not clear why the number of shares outstanding twelve months before the LIFE offering is relevant. At minimum, if a listed company proposes a new LIFE offering, the dilution limit should be formulated so that the company cannot issue, or make issuable, a number of securities greater than 50% of the number of securities then outstanding, when combined with all securities issued or issuable under LIFE offerings effected within the previous twelve months.
Further, if this junior listed company issues units, each comprised, for example, of one share and one warrant, it can issue only 20 million units, as the exercise of warrants could result in the issuance of an additional 20 million shares. If the units are issued at the market price of $0.04, this junior listed company will raise $800,000 (plus funds received upon the exercise of warrants, if any), again well short of LIFE’s $5 million maximum.
It is evident that the 50% dilution limit may impose a significant limit on the amount raised and have an adverse effect on financings by smaller issuers under LIFE, which runs contrary to the purpose of LIFE.
The 50% dilution limit did not appear in the original draft amendments to NI 45-106 issued by the Canadian Securities Administrators (CSA) on July 28, 2021, at which time CSA asked for comments[iii]. Rather, CSA proposed a dilution limit of 100% of the number of issued and outstanding securities as of twelve months before the date of the news release announcing a new LIFE offering. In response to a question from CSA as to whether the proposed LIFE thresholds were appropriate, one commenter “was concerned that the dilution threshold [i.e., 100%] … did not provide adequate protection for current shareholders” and suggested a lower dilution limit of 25% to 50%. Another commenter disagreed with the proposed 100% limit as it “would allow smaller issuers to double their market capitalization in any 12-month period”.
In response to these limited comments and seemingly without further consultation with stakeholders, CSA adjusted the amendments to NI 45-106 so as to reduce the allowed dilution to 50% of the issuer’s market capitalization, again as of a date twelve months before the date of the news release announcing the new LIFE offering.
LIFE’s 50% dilution limit is exceptional when one considers that the other prospectus exemptions in NI 45-106[iv] do not set any limits on dilution, whether it be the prospectus exemption for distributions to “accredited investors” (section 2.3); to family, friends and business associates (sections 2.5, 2.6 and 2.6.1); by way of offering memorandum (section 2.9); for a minimum amount of $150,000 (section 2.10); in settlement of bona fide debt (section 2.14); or in connection with a take-over bid (section 2.16). In this context, LIFE’s 50% dilution limit appears anomalous.
LIFE’s 50% dilution limit must also be weighed against the requirement in section 5A.2.1)(i) of NI 45-106 that after a LIFE offering, the issuer must have sufficient funds to meet its business objectives and all liquidity requirements for a period of twelve months. In other words, the issuer’s current resources and the amount raised under a LIFE offering must be sufficient for the next year, including liquidity needs. This may be problematic for issuers for which the 50% dilution limit applies, namely smaller issuers trading at low stock prices, the very issuers LIFE is intended to help.
CSA will no doubt monitor the use of LIFE after it enters into effect on November 21, 2022. When doing so, CSA should consult with smaller issuers and reconsider whether a dilution limit is necessary in light of the $5 million – 10% market cap/$10 million limit. At minimum, if CSA maintains the current dilution limit, it should be formulated so that it is based on the number of securities outstanding at the time of the LIFE offering rather than on the number of securities outstanding a year earlier.
[i] See: https://www.fasken.com/en/knowledge/2022/09/canadian-securities-administrators-create-an-exemption
[ii] CSA Notice of Amendments to National Instrument 45-106 Prospectus Exemptions to Introduce the Listed Issuer Financing Exemption: https://www.osc.ca/en/securities-law/instruments-rules-policies/4/45-106/csa-notice-amendments-national-instrument-45-106-prospectus-exemptions-introduce-listed-issuer
[iii] CSA Notice and Request for Comment Proposed Amendments to National Instrument 45-106 Prospectus Exemptions to introduce the Listed Issuer Financing Exemption: https://www.osc.ca/en/securities-law/instruments-rules-policies/4/45-106/csa-notice-and-request-comment-proposed-amendments-national-instrument-45-106-prospectus