Throwing a little grit into the cashbox: the Pre-Emption Group issues revised statement of principles

The Pre-Emption Group (the Group), which for many years has represented the views of institutional investors on non pre-emptive share issues by listed companies, has issued a revised statement of principles (the Revised Statement).

The Revised Statement is more detailed than the previous guidance issued by the Group, and, for the first time, expressly deals with structures designed to circumvent statutory pre-emption rights, such as “cashbox” transactions.

Whilst compliance with the Group’s guidance has never been mandatory, it is observed by the overwhelming majority of public companies and is endorsed by the Investment Association and the National Association of Pension Funds, as representatives of institutional shareholders and investment managers. As Robert Swannell, the Chairman of the Group, comments:

“The revised Statement provides a framework for early and effective dialogue between a company and its shareholders…. it’s not a rule book. The Pre-Emption Group strongly supports this focus on engagement.”

Background: the role of pre-emption rights

Pre-emption rights are given to shareholders of UK companies by the Companies Act 2006 whenever a company issues shares for cash. These rights enable shareholders to avoid dilution of their investment as a result of new share issues by requiring such new equity to be offered to existing shareholders first, pro-rata to their existing shareholdings. As the Group notes:

“Pre-emption rights are a cornerstone of UK company law and provide shareholders with inappropriate dilution of their investments”.

These statutory pre-emption rights can be disapplied by special resolution. For listed companies, this means taking annual “general” authorities at each AGM which can, where necessary, be supplemented by additional specific authorities for use in connection with a proposed transaction.

Two resolutions are usually proposed at listed company AGMs in order to obtain appropriate general authorities. First, a general “allotment” authority (requiring an ordinary resolution) to authorise the directors to allot shares (usually limited to an amount equal to one-third of a company’s existing issued share capital, sometimes increasing to two-thirds in connection with a fully pre-emptive rights issue). Second, a special resolution disapplying statutory pre-emption rights.

This second authority applies where the company is proposing to issue new shares for cash and is the focus of the Group’s guidance. Under its previous guidance, the Group expected general disapplications to be generally limited to an amount equal to 5% of the company’s current issued share capital. 

Scope and application of the Revised Statement

The Revised Statement introduces greater flexibility, in some respects, in relation to the disapplication of pre-emption rights. The Revised Statement is aimed at providing “clarity on the circumstances in which such flexibility might be appropriate”. The Revised Statement deals with the proposal and utilisation of annual general disapplication of pre-emption rights, and the proposal of specific disapplications.

The Group encourages companies to comply with the spirit, as well as the letter, of the principles set out in the Revised Statement.

To which companies does the Revised Statement apply?

The Revised Statement applies to all companies (wherever incorporated) with a Premium listing on the London Stock Exchange. Companies with a Standard or High Growth Segment listing, and those admitted to trading on AIM, “are encouraged to adopt” the principles set out in the Revised Statement.

Which types of share issue are caught?

The principles set out in the Revised Statement apply to “all issues of equity securities that are undertaken to raise cash for the issuer or its subsidiaries, irrespective of the legal form of the transaction”. The Revised Statement expressly catches “cashbox” transactions, a highly structured deal enabling a company to raise cash whilst avoiding statutory pre-emption rights through the use of a special purpose vehicle.

The Revised Statement does, however, distinguish vendor placings (where the sellers of a target business are allotted shares in the listed company, which are then sold on their behalf to placees in a transaction arranged by the company’s brokers), and excludes them from the scope of the principles, although noting the expectation that shareholders will have a right of clawback if the vendor placing exceeds 10% of a company’s issued share capital or is undertaken at a more than 5% discount. Here, “clawback” means that the shares will be placed subject to the prior right of shareholders to acquire them pre-emptively on the same terms.

Treasury shares

The Revised Statement provides that the sale of treasury shares (shares bought back by the company and held for future re-issue) should be treated as a new issue of shares (mirroring their treatment under statutory pre-emption rights), and should not be taken into account when determining the company’s issued share capital for the calculation of relevant limits.

General disapplications

Size and duration of authorities

The Revised Statement confirms the existing 5% limit on general disapplication authorities, but allows companies to take authority over a further 5% provided that the company confirms, in the AGM notice proposing the resolution, that it will be only used for an acquisition or specified capital investment which is announced contemporaneously with the issue, or which has taken place in the previous six months and is announced at the same time as the issue. Authorities should be renewed at each AGM, with the authority having a maximum duration of 15 months.

Companies admitted to trading on a regulated market will therefore be able to utilise the headroom afforded to them under the Prospectus Rules to issue further capital without requiring a prospectus (which exempts issues of up to 10% of an existing class of listed securities from the requirement) in order to fund identified transactions.

Using the authority

The Revised Statement confirms the Group’s existing guidance that, in any three-year rolling period, equity securities representing more 7.5% of its issued share capital should not be issued (excluding any shares for which specific authority is sought, or any shares allotted pursuant to the additional 5% authority for acquisitions or specified capital investments referred to above). This rolling limit captures convertible instruments, such as warrants, which should be priced at the prevailing market value at the time of issue.

Discounts

The Group expects companies to aim to ensure they are raising capital on the “best possible terms in order to avoid unnecessary dilution”. Discounts are always “of concern” and should, save in “exceptional circumstances”, be limited to a maximum of 5%, although the Group notes that “backstop” underwriting commitments on bookbuilt equity issues may attract a larger discount. The Appendix to the Revised Statement gives further information on how discounts should be calculated.

Disclosure in annual report

The company’s next annual report should contain details of any non pre-emptive issue made under general disapplication, including use of funds and any applicable discount.

Specific disapplications

The Group defines a specific disapplication as one sought for the “purpose of an identified, proposed issuance of equity securities”, noting that it is neither “possible nor desirable” to define all the circumstances in which shareholders might be willing to agree to such a disapplication. Instead, the Revised Statement sets out a (non-exhaustive) list of some general considerations that are “likely to be critical” to shareholder support. These include:

• the strength of the business case;
• the size and development stage of the company;the governance track-record of the company;
• the availability (or otherwise) of alternative financing; and
• the level of dilution (in terms of both value and control).

Early warning of a potential non pre-emptive issue is encouraged, and the Group considers that (subject to the obvious legal and regulatory issues) dialogue with major shareholders prior to an announcement “may be appropriate”.

Osborne Clarke comment

The Revised Statement is a helpful expansion of the Group’s existing guidance on capital management. By expressly bringing cashbox structures within the scope of the principles, the Group has given teeth to the dissatisfaction often expressed by institutional investors frustrated by, as they saw it, artificial structures designed to circumvent their statutory protections.

On the other side of the fence, listed companies value cashboxes for the speed of execution that they bring to transactions, especially where faced with a competitive situation where a delay of a few weeks and exposure to the uncertainty of a shareholder vote to secure the necessary disapplication could well affect its chances of securing a prized target. The additional flexibility to finance identified transactions through the non pre-emptive issue of up to 10% of a company’s issued share capital (potentially utilising all the headroom available to companies admitted to the Main Market to undertake secondary issues without the need to issue a prospectus) will go a long way to reconciling those respective views.

Source: The Pre-Emption Group, Disapplying pre-emption rights – a Statement of Principles (2015)