Tapping the Equity Capital Markets in Times of Economic Uncertainty

NL Law
This short note discusses a few thoughts for Dutch issuers that are considering a capital raise in order to strengthen their balance sheet, with or without the need to publish a prospectus. Although the markets for equity issuances are currently by and large closed due to the COVID-19 situation, this is likely to change in the coming months.

We are already seeing issuers in other countries seeking to execute equity placements in Europe and elsewhere to strengthen their balance sheet due to the current economic environment. While it may be more difficult in these volatile markets to find a bank that is willing to assist with an equity raise, certainly on an underwritten basis, we do expect to see more of these transactions as time goes on. We also expect that these transactions will be more difficult to execute than under more normal circumstances. Valuations are likely to remain low for a while and yet discounts are likely to be higher than normal. We expect to see equity deals as part of larger arrangements to strengthen the balance sheet where issuers are able to paint a picture of the road forward. This is likely to involve more significant communication with the market at the time of launch of an equity transaction. This in turn will put more emphasis on due diligence prior to the launch of any deal. 

Accelerated Bookbuild transactions and other undocumented deals

If time is of the essence for an issuer in need of an equity raise, the most suitable route is pursuing an undocumented deal, i.e. without a prospectus obligation. Key is to ensure that the transaction is limited to 20% of capital and does not involve a public offering. Undocumented deals in the European market share many characteristics of PIPE (private investment in public entities) deals in the US market, including that the transaction is targeted at selected institutional investors.

The most common undocumented deal structure is an accelerated bookbuild (ABB) transaction. This comprises a placement of newly issued shares with a limited number of institutional investors in a short time period, with little to no marketing and no pre-emption rights for existing shareholders. The bookbuilding process for an ABB is generally executed very quickly, i.e. in a matter of days. An ABB requires the involvement of one or more banks to run the bookbuilding process, market the shares and place the new shares with investors.

In the current economic environment, any equity capital markets offerings will inherently face challenges given the share price levels and volatility on the equity capital markets. There are various alternative equity funding transaction structures that may mitigate some of these challenges. The alternative funding market has taken flight in the past decade. Providers of alternative funding solutions are typically able to act quickly and offer tailor-made alternatives to companies in need of funding. Alternative funding deal execution should also be less susceptible to market instability and volatility. Examples of alternative undocumented deal structures include:

  • issuance of shares to a new key investor or an existing major shareholder;
  • placement of shares underwritten by an existing shareholder or by new key investor;
  • issuance of convertible bonds to a limited number of institutional investors, a new key investor or existing major shareholder.

Which deal structure is most suitable for an issuer must be assessed on a case-by-case basis and deal structuring will require a tailor-made approach. Generally speaking, there are certain aspects issuers should bear in mind when considering executing an undocumented deal, particularly in times of financial and economic instability.

  • No prospectus obligation: In order to avoid triggering a prospectus obligation under European securities laws, the transaction should be limited to up to 20% of the existing capital and should be targeted at institutional investors only.
  • Board authorisation: Pursuing an equity raise on short notice requires that the management board of the issuer has been authorised by the general meeting to issue new shares with the exclusion of existing shareholders’ pre-emptive rights. For most Dutch listed companies this authorisation is limited to 10% of the outstanding share capital. Any issuance of new shares in excess of the existing authorisation would require obtaining a further shareholder approval at an EGM, which entails a notice period of 42 calendar days.
  • Due diligence: The parties involved in an undocumented deal – be it banks in an ABB or key investors in an alternative undocumented deal – will need to do some form of diligence exercise before signing and executing any deal. Although diligence in connection with undocumented deals is usually quite limited, issuers should expect that banks or investors will require a more extensive diligence exercise in times of financial and economic instability. This is likely to include diligence on the issuer’s liquidity, going-concern expectations and management’s expectations regarding the impact of COVID-19 on the financial results in the short and medium-to-long term.
  • Disclosure of expected consequences of COVID-19: An important consideration for any equity raising is the level and accuracy of disclosure the issuer can give with respect to the effect that the COVID-19 situation is expected to have on its liquidity position and its short to medium term results and prospects and to what extent the equity raise is expected to sufficiently address any expected liquidity shortages.
  • Dilution: Pre-emption rights are excluded in undocumented deals. Although larger shareholders may be given an opportunity to participate and avoid dilution, smaller shareholders including retail shareholders get diluted. Depending on the shareholder base of the issuer such dilution may cause concerns with certain stakeholders, such as shareholders, investor interest groups and, possibly, government agencies if the issuer has benefitted from COVID-19 government support schemes.

In conclusion:

  • Pros: An undocumented deal enables the issuer to raise capital in a quick, flexible and relatively cheap (in terms of deal costs) way.
  • Cons: The issuer can only raise a limited amount of capital (usually up to 10% as a result of issuers’ limited authorisations) in an undocumented deal. In addition, undocumented deals are generally dilutive to existing shareholders, in particular to retail investors, since pre-emption rights are excluded.

Rights offering

Undocumented deals are suitable for raising a limited amount of capital within a short period of time. Issuers who are in need of more capital to strengthen their balance sheet may consider pursuing a rights offering, which prevents existing shareholders from being diluted against their will. A rights offering is a more elaborate process and takes longer to execute than an undocumented deal. There are certain aspects issuers should bear in mind when considering a rights offering to attract new capital, especially in distressed situations:

  • 42-day notice period general meeting: Any issuance of capital in excess of 10% or 20% of the share capital (depending on the existing board authorisation) requires shareholder approval. This involves convening a general meeting with a minimum notice period of 42 calendar days.
  • Prospectus obligation: admitting 20% or more of an issuer’s share capital to listing triggers a prospectus obligation.
    • Timing: A rights offering generally takes a few months to execute. Two important drivers for the timetable are: (i) the organisation of the general meeting of shareholders to approve the rights offering; and (ii) the preparation of the prospectus. The prospectus for a rights offering is likely to qualify for a simplified disclosure regime, because certain information is already considered to be in the market as a result of the issuer’s ongoing disclosure obligations as a listed company. Among other things, the prospectus does not have to include certain chapters such as the operating and financial review, and only needs to include historical financial information from the past twelve months (rather than three years).
    • Prospectus disclosure: Prospectus disclosure in times of economic uncertainty is a delicate and precise exercise and will be subject to higher scrutiny. In addition to standard prospectus disclosure, an issuer in financial uncertainty – e.g. due to the COVID-19 situation – will need to include additional disclosure on the expected impact of the situation on its business and its prospects as well as the issuer’s liquidity needs and resources. The prospectus must be approved by the AFM, which generally takes six to eight weeks from first filing of a draft prospectus until final approval.
    • Working capital statement: The prospectus must include a working capital statement, confirming that in the issuer’s opinion its working capital is sufficient for its present requirements (i.e. for at least 12 months following the date of the prospectus) or, if not, how the issuer proposes to provide the additional working capital needed. Particularly under the current circumstances, the underwriting banks will want to perform a thorough diligence exercise on the working capital statement.
  • Due diligence: The diligence exercise for a rights offering will be more elaborate than for an undocumented deal: any material findings will need to be properly disclosed in the prospectus.

In conclusion:

  • Pros: The issuer can raise more capital in a rights offering compared to an undocumented deal. In addition, existing shareholders are not diluted against their will.
  • Cons: A rights offering is a more elaborate process and takes longer to execute than an undocumented deal. The process of drafting the prospectus and getting it approved by the AFM will take a few months and requires a full and robust diligence exercise.

More about the coronavirus

You can read more publications on the impact of the coronavirus on our website. Here you will also find a list of contacts within our office who can advise you with questions about the implications of the coronavirus for your company.