The significant decline in crude prices since late 2014 and general expectations of a “lower for longer” price environment through 2016 have had a considerable cooling effect on the ability of oil and gas issuers to raise capital through conventional channels. Further, in terms of access to bank financing, 2015 was a challenging year for oil and gas producers and other industry players affected by the prolonged downturn. The year was characterized by ever-reducing borrowing base redeterminations for almost all borrowers, together with stringent new conditions on existing loans for particularly distressed borrowers. We anticipate that 2016 will offer even tighter lending conditions. This article describes a number of capital raising avenues that may be of interest in 2016.
New Prospectus Exemptions
In an effort to facilitate more effective and efficient capital raising by issuers in Canada, the Canadian Securities Administrators has introduced a number of new capital raising prospectus exemptions to encourage greater participation by retail investors in private placements, while at the same time ensuring that the appropriate investor protection measures are in place. These prospectus exemptions include:
- in Ontario, a new offering memorandum exemption permitting issuers to raise capital from a broader range of investors, together with corresponding amendments to the existing offering memorandum exemption in Alberta, New Brunswick, Nova Scotia, Québec and Saskatchewan;
- in Alberta, British Columbia, Manitoba, New Brunswick and Saskatchewan, a new investment dealer exemption permitting issuers listed on a Canadian exchange to raise capital by distributing securities to investors who have obtained advice about the suitability of an investment from an investment dealer, subject to certain conditions; and
- modifications to the rights offering exemption intended to streamline and simplify the existing rights offering regime for public issuers.
Offering Memorandum Exemption
On January 13, 2016, amendments to National Instrument 45-106 Prospectus Exemptions provided a new exemption in Ontario for non-investment fund issuers to raise capital from individuals (other than those who qualify under the accredited investor or the family, friends and business associates exemptions):
- A non-eligible investor (i.e., an individual who does not meet certain income or asset thresholds) can invest up to a maximum of $10,000 in any 12-month period in respect of all securities purchased under the offering memorandum exemption.
- An eligible investor (i.e., an individual who meets certain income or asset thresholds) can invest up to a maximum of $30,000 in any 12-month period in respect of all securities purchased under the offering memorandum exemption, and if the eligible investor obtains advice from a registered portfolio manager, investment dealer or exempt market dealer that such investment is suitable, the limit is increased to $100,000 in any 12-month period.
There are no investment limits for non-individual investors, whether eligible or non-eligible.
Issuers cannot rely on the offering memorandum exemption to distribute specified derivatives or structured finance products. In Alberta, Nova Scotia and Saskatchewan, the offering memorandum exemption will continue to be available to non-redeemable investment funds or mutual funds. The offering memorandum exemption is not available to investment funds in New Brunswick, Ontario and Québec.
Investment Dealer Exemption
On January 14, 2016, the securities regulatory authorities in Alberta, British Columbia, Manitoba, New Brunswick and Saskatchewan announced the introduction of a new prospectus exemption for sales to purchasers advised by investment dealers.
The key features of the exemption are as follows:
- The issuer must be a reporting issuer in at least one jurisdiction in Canada with a class of equity securities listed on the TSXV, the TSX, the Canadian Securities Exchange or the Aequitas Neo Exchange Inc.
- The issuer must have filed all periodic and timely disclosure documents that it is required to file in accordance with its continuous disclosure obligations under applicable Canadian securities laws.
- The purchaser must have obtained advice regarding the suitability of the investment from a person or firm registered as an investment dealer under applicable Canadian securities laws.
- The issuer must have issued and filed a detailed news release describing the proposed offering.
The offering must be for: (i) a listed security of the issuer; (ii) a unit comprised of a listed security and a warrant of the issuer; or (iii) a security convertible into a listed security of the issuer at the investor’s sole discretion. In Alberta, purchasers have a statutory right of action; and in British Columbia, Manitoba, New Brunswick and Saskatchewan, a contractual right of action, in the event of a misrepresentation in the investor’s continuous disclosure record, whether or not the purchaser relied on such misrepresentation, must be provided to the purchaser. The issuer and the purchaser must enter into a subscription agreement containing representations from the issuer for the benefit of the investor that: (i) the issuer’s “core documents” and “documents” do not contain a misrepresentation; and (ii) there is no material fact or material change related to the issuer which has not been generally disclosed. Other than the subscription agreement, any offering material provided to a purchaser in connection with the offering must be filed with the securities regulatory authority no later than the date that the offering material is first provided to the purchaser.
Modifications to the Existing Rights Offering Exemption
Amendments to the prospectus-exempt rights offering regime in Canada intended to streamline and simplify the process for rights offerings for non-investment fund reporting issuers came into effect on December 8, 2015. The amendments, among other things, remove the requirement for issuers to obtain approval from securities regulatory authorities of an extensive rights offering circular and increase the number of securities that can be issued by way of a rights offering on a prospectus-exempt basis from 25% to 100% of the issuer’s already outstanding securities in any 12-month period. Other key features of the new prospectus-exempt rights offering regime include:
- An issuer is required to file and send to its security holders a notice in the prescribed form providing basic disclosure in respect of the rights offering in a “question and answer” format. While the issuer is still required to prepare and file a simplified rights offering circular in the prescribed form on SEDAR, the circular is not required to be sent to security holders. It is sufficient for the rights offering notice being sent to security holders to indicate that the circular may be accessed on SEDAR.
- Security holders must be provided with at least 21 days and not more than 90 days to exercise their rights following mailing of the rights offering notice.
- Statutory liability for secondary market disclosure has been extended to include the acquisition of securities under a rights offering, providing purchasers with rights of action against the issuer and its directors for damages resulting from a misrepresentation in the rights offering circular or other continuous disclosure documents of the issuer.
Debt Financing and Sale-Leaseback Structures
While most borrowers in the oil and gas industry have had difficulty accessing bank loan financing in the prolonged low price environment, borrowers in the midstream space have had greater success in accessing debt financing because they are somewhat insulated from commodities markets due to their fee-for-service structure.
Others have successfully pursued sale-leaseback transactions to take valuable, capital-intensive assets off their balance sheets while continuing to be able to operate the asset and maintain profits. A sale-leaseback is an asset sale combined with the immediate long-term lease of the same asset. This permits the selling company to free up cash on its balance sheet for more critical investments or for debt repayment, as well as take advantage of potential tax deductions, and at the same time immediately permit the company to continue to operate with the applicable asset. From the buyer’s perspective, the purchase and immediate long-term lease of the asset provides certain, stable rental cash flow.
On the whole, the prolonged downturn in oil and gas commodities pricing suggests that new debt capital will be strongly conditioned and hard to come by from traditional bank lenders, particularly for upstream borrowers. Disposition of non-core assets and reliance on equity funding is increasingly being relied on pending market correction.
Private Equity and Pension Fund Investment
Private equity and pension fund investment in the energy sector typically contemplates an equity line structure implemented on a private placement basis comprised of: (i) a commitment by the investor, or group of investors, to invest a certain amount of money in equity securities of the company over a period of time (typically up to five years); (ii) “capital call” procedures that enable relatively quick deployment of the committed amounts from time to time on a pro rata basis among the committed investors (that include penalty provisions for an individual investor’s failure to fund an approved capital call); (iii) governance rights for the major investors, typically with increasing powers for investors over 10% and 20% ownership thresholds, providing for, among other things, board nomination rights, information rights and specified approval rights; (iv) a unanimous shareholder agreement setting forth the rights of the respective shareholders, including pre-emptive rights, drag-along rights and piggy-back financing rights; and (v) a long-term equity incentive structure for the founders, directors and senior management team that is less focussed on salary and bonuses in the near term, and more focussed on long-term gains that benefit all shareholders on a future liquidity event or initial public offering.
Special provisions may be included in the securities subscribed for by the private equity or pension fund investors, and in some cases the founders, under the equity line that provide for a required rate of return upon a payout of all shareholders in relation to a future liquidity event, combined with a waterfall structure where those shareholders are paid their rate of return first and the excess is distributed amongst all the shareholders.
This type of funding structure is best suited to start-up companies with strong, experienced management teams, typically who have had significant senior experience in the industry. It is well suited to funding acquisitions as well as significant capital expenditure programs over time, often in the hundreds of millions of dollars. There have been many examples in the energy sector over the past 10 years (and beyond) of companies who have used this structure with tremendous success, and Osler has represented numerous companies, private equity firms, and pension funds that have utilized, and continue to utilize, this funding structure.