Reverse Acquisition
22754 CORPORATE ACCOUNTING
Spring 2016
Question -1
To put it simply, a reverse takeover (RTO) is the acquisition of a public company by shareholders in a (usually smaller) private company. An RTO can be effected by the private company’s shareholders selling their shares in the private company to the public company in exchange for the issue of shares in the public company. Alternatively, the private company can sell its business to the public company in exchange for the issue of shares in the public company to the private company. An RTO is often considered as an alternative to an initial public offering (IPO), and where the target public company is listed, an RTO can also be known as a ‘backdoor listing’.
Operating companies seeking a ‘fast track’ stock exchange listing sometimes arrange to be acquired by a smaller listed company. The listed company then issues shares to the private company shareholders in exchange for their shares in the private company. The listed company becomes the ‘legal parent’ of the operating company, which in turn becomes the ‘legal subsidiary’. If the operating company is more valuable than the listed company, the former shareholders of the operating company should receive more than 50% of the post-transaction shares in the listed company. This usually indicates that the operating company is the accounting acquirer.
A ‘backdoor listing’ is generally considered to be a cheaper, easier and quicker way to list a company on a stock exchange.
There are also a number of other reasons for using an RTO, including:
§ it may result in less share dilution (and therefore greater control) in the company for the original shareholders, than in a typical IPO;
§ to avoid triggering a change of control clause in a key contract;
§ to circumvent the blocking power of a dissenting shareholder;
§ to minimise exposure to market conditions in listing;
§ the listed company will already likely satisfy certain conditions for listing that the private company may struggle to achieve through an IPO (particularly the pre-existing spread of the listed company’s shareholder base);
§ shareholders of the private company are usually eligible for capital gains tax rollover relief if certain conditions are satisfied;
§ the funds expended to purchase the listed company will provide a tangible asset (in contrast to an IPO where the major costs of listing go to third parties and are lost).
Covata Just Completed Its Reverse Takeover On the Australian Stock Exchange. Data security company Covata completed its reverse takeover of uranium exploration shell Prime Minerals to list on the Australian Stock Exchange on Monday, raising $15 million in the process.
It’s the latest of more than a dozen reverse takeovers – and back door listings – executed by tech companies in Australia in the past 12 months, with most using the ASX’s minimum issue price of 20 cents a share. With a total market cap of $74 million, Covata is one of the biggest RTOs this year. According to its prospectus the company was looking to raise a minimum of $2.5 million.
Covata wanted to list on Australian stock exchange hence it acquired Uranium Exploration shell prime minerals. In this reverse acquisition, the legal acquirer is Covata and the legal acquiree was uranium exploration shell Prime Minerals. This deal was closed for AU $57 million. The two companies have agreed to enter into agreements with existing Cocoon option-holders to replace their existing 28,825,000 Cocoon options with existing Prime options upon successful completion of the merger. To enable Prime Minerals to re-comply with the ASX Listing Rules, it plans to conduct a capital raising under the Prospectus to raise at least AU$2.5 million and up to between AU$10-15 million — subject to shareholder approval. Upon approval of the shareholders from both companies, Covata emerged as a publicly traded entity with the available capital to support Covata’s growth strategy.
The merger between Cocoon Data and Prime Minerals is the latest in a string of reverse takeovers by local technology companies aiming to list on the ASX — with struggling ASX-listed mining companies frequently the target of such manoeuvres. Before the company listed as Covata it was known as Cocoon. Historically Cocoon has posted big losses – something the company attributes to product development.
Over the past three financial years Cocoon posted multi-million-dollar losses. In 2012 the company was hit with a total loss of more than $11.1 million, in 2013 that number was $8.376 million and at June 30 this year after tax it was a loss of $9.769 million. During 2014 the company earned tech-related revenues of less than $450,000, up from 177,000 in 2013. In the company’s prospectus it stated if it didn’t successfully raise the maximum subscription listed it may not be able to execute all of its proposed expansion and operational plans.
In terms of deals, the company has existing agreements in place with NSC Global Services and Verizon Australia to resell its product as well as TPG Telecom which previously invested in the company so it would develop four products exclusively for the telco. Covata closed trading on the ASX at 20 cents a share just after the acquisition. The company’s financial status improved a lot by raising the required fund through the stock fund raise on ASX.
Question -2
Takeovers and schemes of arrangements in Australia are governed by the Corporations Act and, where the bidder or target is listed, the ASX listing rules. Neither the Corporations Act nor the ASX listing rules generally require bidder shareholder approval for reverse takeovers. Whilst RTOs are not prohibited by the Corporations Act 2001 (Act), the Takeovers Panel (Panel) may declare ‘unacceptable circumstances’ have occurred in relation to an RTO, where the shareholders of the bidding company are not given the chance to approve it, particularly where the RTO has a material effect on ‘control’, or prevents rival bids. ASIC strongly suggests that it is informed if an RTO is being contemplated in order to consider whether shareholder approval is required.
In an RTO directors are bound by the same fiduciary and statutory obligations that regulate their conduct generally. Directors’ duties are particularly relevant where board action prevents alternative bids for the company and that action is not approved by shareholders.
The Corporations Act contains the primary obligations in relation to the conduct of takeover bids and schemes of arrangement in Australia. Takeover bids are governed by Chapter 6 of the Corporations Act and schemes of arrangement are governed by section 411. These provisions are primarily focussed on the impact of takeovers and schemes on control of an entity, rather than dilution of existing shareholders, and as such do not generally require a bidder to obtain shareholder approval to offer its shares as the consideration under a takeover or scheme of arrangement, regardless of the number of shares issued. This is consistent with the Corporations Act generally, which does not impose restrictions on issues of securities other than in limited circumstances.
The ASX Listing Rules impose a requirement for shareholder approval on listed companies in certain circumstances. Under Listing Rule 7.1, a listed company is prohibited from issuing, in any 12-month period, ordinary securities which represent more than 15% of the issued ordinary share capital of the company (subject to various exemptions). In relation to RTOs, Exception 5 in Listing Rule 7.2 exempts issues under an off-market bid or scheme of arrangement.
The ASX listing rules regulate the circumstances in which share issues by listed entities require shareholder approval. Listing rule 7.1 requires shareholder approval for issues of securities in excess of 15% of an entity’s existing capital over a 12-month period unless an exception applies. ASX listing rule 7.2, exception 5 provides an exception from this requirement for securities issued under an off market bid or scheme of arrangement under the Corporations Act. Therefore, shareholder approval is not required under the Listing Rules for a bidder who issues securities as consideration for an acquisition under a takeover bid or scheme of arrangement regardless of the number of shares issued. ASX listing rule 7.2, exception 6 provides a further exception for an issue of securities to fund the cash consideration for a takeover or scheme of arrangement if the terms of the issue are disclosed in the merger documents. The policy underlying these exceptions is that the imposition of a requirement for shareholder approval would put a listed bidder at a significant disadvantage to a non-listed bidder in a contested takeover situation. ASX listing rule 11.1 gives ASX discretion to require shareholder approval if an entity proposes to make a “significant change” to the “nature or scale” of its activities. Guidance Note 125 notes that this listing rule was originally inserted primarily to regulate “back door listings”.
ASX does not treat a transaction between two listed entities as a back door listing and while it can exercise its discretion in other circumstances, it is generally reluctant to do so unless there are clear and compelling policy reasons to justify that course of action. As such, listing rule 11.1 would not generally apply to a reverse takeover between two listed entities. The Guidance Note sets out the considerations reflected in this policy position which primarily relate to: • the general corporate law principle that responsibility and authority to manage the business of an entity and make decisions on its behalf rests with the directors other than in respect of matters reserved to the shareholders under the constitution, the Corporations Act and the listing rules • the additional transaction costs, delays and uncertainties that may arise and which, in some cases, may threaten the transaction’s viability or success.
ASX has considered a number of potential options in response to the requests for ASX to consider this issue including:
§ maintain the status quo
§ require shareholder approval of scrip takeovers and schemes based on the level of dilution
§ require shareholder approval for scrip takeovers based on their impact on control or other discretionary criteria. ASX observes that a case can be made for maintaining the status quo including:
§ the limited occurrences when this issue has arisen in the Australian market. As far as ASX is aware, there are, at most, only a few of these types of transactions in any year and most of these are uncontested. There have only been 2 examples in the past 7 years of reverse takeovers where concerns have been raised. In neither of these cases was the transaction successful as a counter-bidder emerged to make a superior offer
§ the primacy of the Corporations Act takeover provisions, which permit reverse takeovers without requiring bidder shareholder approval and guidance from the Takeovers Panel and ASIC, the two key regulators of takeovers in Australia, that they will not generally impose a requirement for bidder shareholder approval for reverse takeovers except where there is a change in or material effect on control
§ the costs and disadvantages to bidders who must obtain shareholder approval relative to others as discussed further below.
ASX would appreciate feedback from stakeholders on their view about the nature and extent of the problem and whether it warrants consideration of changes to the listing rules. For the purpose of this consultation, if the feedback received is that a problem exists and there is sufficient impetus for regulatory reform, for the reasons set out below, ASX is outlining a consultation proposal based on dilution which would require a bidder to seek shareholder approval where there is scrip for scrip offer and the issue of new securities exceeds 100% of the bidder’s existing share capital. This policy change would be achieved by an additional carve-out from listing rule 7.2, exception 5 where the securities to be issued to target shareholders exceed 100% of existing capital. For consistency, ASX considers that an equivalent carve-out should also be applied to listing rule 7.2, exception 6, which provides an exception for issues of securities to fund cash consideration for takeovers and schemes 8 . As with existing listing rule 7.1 approvals, approval would be by majority vote of bidder shareholders. ASX would appreciate feedback on whether changes to existing voting exclusions or disclosure requirements for listing rule 7.1 approvals should be made. ASX considers that this option represents the best balance between the interests of the entities involved and their shareholders.
Question – 3
Australian Stock Exchange (ASX)-listed Prime Metals, an exploratory uranium mining company, will acquire Cocoon Data for A$57m (US$53m, £30m, €39m) in an all-stock transaction. Prime Metals will be merged with Cocoon's Covata security business, and the merged entity will be listed as Covata Limited on the ASX by September.
Upon successful completion of the merger, existing Cocoon option-holders can replace their 28,825,000 Cocoon options with existing Prime options.
In these transactions, the pre-combination shareholders of the operating company typically obtain a majority (controlling) interest, with the pre-combination shareholders of the listed shell company retaining a minority (non-controlling) interest. This usually indicates that the operating company is the accounting acquirer.
If the listed company is the accounting acquiree, the next step is to determine whether it is a 'business' as defined in AASB 3. In our view, the listed company is not a business if its activities are limited to managing cash balances and filing obligations. Further analysis will be needed if the listed company undertakes other activities and holds other assets and liabilities. Determining whether the listed company is a business in these more complex situations typically requires judgement.
An acquisition in which an operating company obtains effective control over a listed company that is not a business is not a business combination. It is therefore outside the scope of AASB 3. In a reverse takeover, shareholders of the private company purchase control of the public company and then merge it with the private company. The private company shareholders receive a substantial majority of the shares of the public company and control of its board of directors. The transaction can be accomplished within weeks. If the target company is an SEC-registered company, the private company does not go through an expensive and time-consuming review with state and federal regulators because this process was completed beforehand with the public company.
In the case of Cotava, the transaction involved the private and public company exchanging information on each other, negotiating the merger terms, and signing a share exchange agreement. At the closing, the public company issued a substantial majority of its shares and board control to the shareholders of the private company. The private company's shareholders paid for acquiring control of the public company by contributing their shares in the private company to the public company that they know control. This share exchange and change of control completed the reverse takeover, transforming the formerly privately held company into a publicly held company.
It is highly unusual to preserve any benefit from the tax loss carry forward in a small public company. The tax regulations normally reduce the loss carry forward by the percentage of the change in control. In a well-structured reverse merger, the private company should end up with 95% or more of the stock after the merger, thus reducing the tax loss carry-forward by this amount.
Question 4
A reverse takeover (RTO) is a type of merger that private companies use become publicly traded without resorting to an initial public offering (IPO). Initially, the private company buys enough shares to control a publicly traded company. The private company's shareholder then uses its shares in the private company to exchange for shares in the public company. At this point, the private company has effectively become a publicly traded company. An RTO is also known as a reverse merger or a reverse IPO.
With this type of merger, the private company does not need to pay the expensive fees associated with arranging an IPO. However, the company does not acquire any additional funds through the merger, and it must have enough funds to complete the transaction on its own.
While not a requirement of an RTO, the name of the publicly traded company involved is often changed as part of the process. Additionally, the corporate restructuring of one or both of the merging companies are adjusted to meet the new business design.
It is not uncommon for the publicly traded company to have had little, if any, recent activity, existing as more of a shell corporation. This allows the private company to shift its operations into the shell of the public entity with relative ease, all while avoiding the costs, regulatory requirements and time constraints associated with an IPO. While a traditional IPO may require months or years to complete, an RTO may be complete within weeks.
The advantages of public trading status include the possibility of commanding a higher price for a later offering of the company's securities. Going public through a reverse takeover allows a privately held company to become publicly held at a lesser cost, and with less stock dilution than through an initial public offering (IPO). While the process of going public and raising capital is combined in an IPO, in a reverse takeover, these two functions are separate. A company can go public without raising additional capital. Separating these two functions greatly simplifies the process.
In addition, a reverse takeover is less susceptible to market conditions. Conventional IPOs are risky for companies to undertake because the deal relies on market conditions, over which senior management has little control. If the market is off, the underwriter may pull the offering. The market also does not need to plunge wholesale. If a company in registration participates in an industry that's making unfavourable headlines, investors may shy away from the deal. In a reverse takeover, since the deal rests solely between those controlling the public and private companies, market conditions have little bearing on the situation.
The process for a conventional IPO can last for a year or more. When a company transitions from an entrepreneurial venture to a public company fit for outside ownership, how time is spent by strategic managers can be beneficial or detrimental. Time spent in meetings and drafting sessions related to an IPO can have a disastrous effect on the growth upon which the offering is predicated, and may even nullify it. In addition, during the many months it takes to put an IPO together, market conditions can deteriorate, making the completion of an IPO unfavourable. By contrast, a reverse takeover can be completed in as little as thirty days.
The greater number of financing options available to publicly held companies is a primary reason to undergo a reverse takeover. These financing options include:
§ The issuance of additional stock in a secondary offering.
§ An exercise of warrants, where stockholders have the right to purchase additional shares in a company at predetermined prices. When many shareholders with warrants exercise their option to purchase additional shares, the company receives an infusion of capital.
§ Other investors are more likely to invest in a company via a private offering of stock when a mechanism to sell their stock is in place should the company be successful.
In addition, the now-publicly held company obtains the benefits of public trading of its securities:
§ Increased liquidity of company stock.
§ Possible higher company valuation.
§ Greater access to capital markets.
§ Ability to acquire other companies through stock transactions.
§ Ability to use stock incentive plans to attract and retain employees.
Question -5
According to AASB3, applying the acquisition method requires: (a) identifying the acquirer; (b) determining the acquisition date; (c) recognising and measuring the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; and (d) recognising and measuring goodwill or a gain from a bargain purchase. Identifying the acquirer For each business combination, one of the combining entities shall be identified as the acquirer. The guidance in AASB 127 shall be used to identify the acquirer – the entity that obtains control of the acquiree. If a business combination has occurred but applying the guidance in AASB 127 does not clearly indicate which of the combining entities is the acquirer, the factors in paragraphs B14-B18 shall be considered in making that determination.
In measuring the fair value of the equity instruments granted, we think that management would apply by analogy the guidance in paragraph B20 of IFRS 3 to measure the consideration transferred. The deemed issue of shares would be based on the number of equity interests that the accounting acquirer would have had to issue to the owners of the legal parent (the shell entity/the dormant company) so that they would have the same percentage of equity interests in the combined entity that would result from a reverse acquisition. Paragraph B20 of IFRS 3 states that (emphasis added): In a reverse acquisition, the accounting acquirer usually issues no consideration for the acquiree. Instead, the accounting acquiree usually issues its equity shares to the owners of the accounting acquirer. Accordingly, the acquisition-date fair value of the consideration transferred by the accounting acquirer for its interest in the accounting acquiree is based on the number of equity interests the legal subsidiary would have had to issue to give the owners of the legal parent the same percentage equity interest in the combined entity that results from the reverse acquisition. The fair value of the number of equity interests calculated in that way can be used as the fair value of consideration transferred in exchange for the acquiree.
From our analysis we determined that IFRS 3 does not give specific guidance on accounting for transactions in which the accounting acquiree is not a business. We then concluded that the guidance in IFRS 2 and some of the guidance in IFRS 3 would be applicable to account for the transactions analysed. In the scenario, the legal acquirer also went through above processes and went for questions for business combinations. Overall, it is indicated that reverse acquisition was quite important for Covata in order to improve its financial strength and also to register through back order process because it takes less time to do the same. There were followed required Australian Exchange rules and regulations for backorder or reverse merge process so that there were not any issues in the entire process. AASB3 has special regulations to follow for the such kind of reverse transfer or reverse acquisitions. This also took less time for listing at Australian stock exchange as compared to the fresh entire process for an individual company to register on Australian stock exchange (ASX).
References
http://www.asx.com.au/documents/rules/gn12_changes_to_activities.pdf
http://www2.deloitte.com/ng/en/pages/audit/articles/financial-reporting/accounting-for-reverse-acquisition-part1.html
http://www.aasb.gov.au/admin/file/content105/c9/AASB3_03-08_COMPoct10_01-11.pdf