Shareholders, particularly institutional shareholders and the voting advisory services that support them, have traditionally taken a strict approach to the grant of share authorities and disapplication of pre-emption rights by public companies. This has developed widely accepted levels of both share authority and disapplication of pre-emption rights, which institutional shareholders will accept and vote in favour of, while cautioning boards of the public companies in which they invest of seeking overly generous authorities which are unlikely to be supported.
These limits are clearly an appropriate protection against the erosion of value through dilution during normal market conditions, but with Covid-19 placing increasing pressures on businesses and their respective finances, there is a clear risk that these traditional limitations may no longer be appropriate, and may have the unintended consequence of severely constraining a business’ access to capital when it is needed the most. Therefore the protection of value through preventing dilution has to be balanced with the need for businesses to access additional capital, whether to strengthen the balance sheet or to provide much needed additional cash to cater for significant decreases in cashflow during the disruption, and therefore the ability for businesses to continue through the lean times presented by Covid-19.
Increased disapplication of pre-emption rights
This has been recognised by the Pre-Emption Group (PEG) (a group comprising representatives of listed companies, investors and intermediaries) which issued a statement on 1 April 2020 setting out its view on the potential relaxation of the usual limits on the disapplication of pre-emption rights for new share issuances. The PEG’s 2015 Statement of Principles provide for a limit 5% of issued share capital for general corporate purposes, with an additional 5% for specified acquisitions or investments.The PEG recommended that investors consider supporting, on a case by case basis,a relaxation of the 5% limit to up to 20% of the relevant company’s issued share capital. For companies, this is not necessarily a free pass for a large disapplication of pre-emption rights. The Pre-Emption Group states that:
- the authority and the particular circumstances of the company need to be fully explained, in particular covering how this authority will support stakeholders (which is wider than shareholders, and would include customers, suppliers, its workforce and the like);
- proper consultation should be undertaken with a representative sample of the company’s major shareholders (noting that any companies issuing up to 20% of their capital would be expected to disclose alongside the issuance information about the consultation undertaken prior to the issuance and the efforts made to respect pre-emptive rights, given the time available);
- as far as possible, the issue should be made on a soft pre-emptive basis (i.e. while not formally pre-emptive, the shares should be offered to existing shareholders first, potentially in approximate proportion to their shareholdings in the company); and
- the company’s management should be involved in the allocation process.
In a letter to the chairs of FTSE 350 companies, the Investment Association (IA) has supported the approach of the Pre-Emption Group, but notes that shareholders expect management to consider their views and not just those of advisory banks, and echo the expectation of offering the placing to existing long term shareholders in the first instance. The overriding note of the IA’s approach is that of continued engagement with shareholders, impressing the importance of long term sustainability and accountability of boards.
The PEG also notes that the Statement of Principles already permits companies to request a specific disapplication of pre-emptive rights outside of the normal thresholds, and confirms that this process should continue to be respected.
The return of cash box structures?
“Cash box” structures are an option to quickly raise funds in excess of the authorised disapplication of pre-emption rights or where this has already been exhausted. A cash box structure allows a company to offer shares in the company as consideration for the acquisition of the shares in a “cash box”, usually a Jersey incorporated SPV, which has been funded for this purpose by the proceeds of a placing. Technically, this structure falls outside the restrictions on pre-emption rights as the issue of shares to acquire the “cash box” is for non-cash consideration. This approach had drawn criticism from investor groups in the past (including the PEG in its 2015 Statement of Principles) on the basis that it could be used to circumvent pre-emption rights, leading to cash box financings becoming infrequent prior to the Covid-19 crisis. Accordingly, whilst cautiously endorsing their use given current circumstances, the IA has highlighted the decision to use cash box structures will be scrutinised in the normal way at the next AGM.
However, with investors seemingly supporting cash box placings, these present an attractive option to companies seeking to raise, without further shareholder approval, more than their remaining disapplication of pre-emption rights may allow in a time efficient manner. Whilst a cash box structure will always merit a degree of consideration before being utilised, it may be the best funding option available to some companies.
Fundraising during the Covid-19 disruption
A number of companies have successfully completed fundraisings since the onset of Covid-19 related disruption, with the objective being to provide additional liquidity and balance sheet strength, and enable the respective company to both survive the disruption and be best placed to respond once conditions improve.
One of the first to raise funds during the Covid-19 period by way of a cash box placing was AIM-listed Joules Group plc, the parent company of the Joules brand. Interestingly, the fundraising was part of a package of measures to provide additional liquidity to Joules, including additional funding being made available under an existing revolving credit facility and a substantial participation (to the sum of £1.175m, or 7.8% of the total proceeds of the placing) from the directors, all of whom participated. Others, such as Hays PLC, WH Smith PLC, ASOS PLC and The Restaurant Group PLC have since followed, with varying degrees of director participation and other financing mechanisms being utilised/extended to provide the necessary funding.
Other companies, such as MJ Gleeson PLC, IMImobile PLC and Assura PLC have used their existing disapplication of pre-emption rights to facilitate the placing, though some, such as Everyman Media Group PLC, are seeking a higher disapplication
This suggests that substantial equity financings, often executed by way of a cash box structure, are being supported by the market when undertaken in conjunction with other financing measures, with directors being required to have some “skin in the game”.
For Main Market issuers, provided the issue of new shares (together with other issues made over a 12 month period) is for less than 20% of the issuer’s existing share capital, a prospectus will not be required for a share placing (including for this purpose a financing structured as a cash box placing). Note however that Main Market issuers cannot, under the Listing Rules, conduct a placing at a discount of more than 10% to the relevant shares’ middle market price unless the terms of the offer have been approved by shareholders or it is an issue for cash under a pre-existing general disapplication authority (such as the 5% authority typically granted annually at the AGM).
For AIM companies, the 20% restriction after which a prospectus must be published does not apply. An AIM company is therefore able to utilise the whole of any unused allotment authority granted at its AGM, which is typically set at a third of its share capital. This authority could be available in full to conduct a cash box financing, subject to the checks and balances set out above regarding significant disapplications of pre-emption rights. The AIM Rules also impose no limit on the discount at which any equity fundraising can be undertaken.
What does the future hold?
The Pre-Emption Group’s temporary concession will apply until 30 September 2020, at which point the Pre-Emption Group will review the reaction of investors and companies to this concession. The Pre-Emption Group also intends to conduct a wider review of the use of the additional flexibility by companies and is therefore keeping an eye on developing market practice.
For boards, it is clear that their conduct during this period is likely to be of significant importance to shareholders, and will be subject to considerable scrutiny, though the practical effect of that scrutiny may not manifest until the next AGM.