Reverse Takeovers and Shell Companies: How Some Juniors Go Public

Introduction

The best-known way to go public is an initial public offering. In the junior resource market, many companies take another route: they merge into a company that is already listed. The listed company may be a shell with no business, a capital pool company created for the purpose, or an existing junior that is changing direction.

These transactions are ordinary and legal. They also change a company so completely that the exchanges treat the result almost like a new listing. This guide explains how reverse takeovers and shell companies work on the TSX Venture Exchange (TSXV) and the Canadian Securities Exchange (CSE), and what to read when one is announced. For background on the exchanges, see our guide to the TSX, TSXV and CSE.

After a reverse takeover, the ticker may be the same, but the company is new.

What a Reverse Takeover Is

In a normal takeover, the buyer's shareholders stay in control. In a reverse takeover (RTO), the listed company issues so many new shares to acquire a private business that the private company's owners end up controlling the combined company.

TSXV Policy 5.2 defines an RTO as a transaction or series of transactions involving an acquisition and a share issuance by the issuer that results in:

1. new shareholders holding more than 50% of the issuer's outstanding voting securities; and
2. a change of control of the issuer.

The exchange can also deem a transaction to be an RTO. The CSE uses the term fundamental change. Its Policy 8 describes such a change as effectively resulting in a new listed issuer, such that the existing disclosure record cannot be relied on to value the company's securities.

Shells and Capital Pool Companies

A shell is a listed company with little or no active business. It may be a former operating company whose project failed or was sold. On the TSXV, issuers that fall short of continued listing requirements can be transferred to the NEX board, and Policy 5.2 treats NEX issuers as generally being without active operations.

A capital pool company (CPC) is a shell by design. Under TSXV Policy 2.4, a CPC lists through a prospectus offering, raises a limited pool of money and then looks for a qualifying transaction: the acquisition of significant assets, other than cash, that would let the company meet the exchange's initial listing requirements. Until then, its only permitted business is identifying and evaluating assets or businesses. Policy 2.4 caps the CPC's total gross proceeds from seed capital, its IPO and private placements at $10 million.

The CPC rules were rewritten effective January 1, 2021. Among other changes, the TSXV dropped the automatic move to NEX for a CPC that had not completed its qualifying transaction within 24 months of listing, and raised the cap on funds a CPC can raise from $5 million to $10 million.

How the Process Works

The steps on the TSXV, in simplified form:

1. Agreement and halt. When the issuer reaches an RTO agreement, it notifies the exchange and its shares are immediately halted. Under Policy 2.4, a CPC's shares are likewise halted as soon as it reaches a qualifying transaction agreement.
2. News release. The issuer publishes the terms, the target business, the proposed insiders of the resulting issuer, any concurrent financing, and whether shareholder approval will be sought.
3. Disclosure document. An information circular (Form 3D1) if approval is sought at a meeting, or a filing statement (Form 3D2) if approval is by written consent or not required. For a CPC, the equivalent forms are 3B1 and 3B2.
4. Approval. Policy 5.2 requires prior shareholder approval unless a set of conditions is met, including that the deal is not a related party transaction and that the exchange has confirmed the issuer is without active operations. Where non-arm's length parties are involved, their votes are excluded from the approval.
5. Listing requirements and closing. The resulting issuer must meet the exchange's initial listing requirements. After final acceptance, its shares resume trading, often under a new name and symbol.

On the CSE, Policy 8 follows a similar path. Trading is halted on announcement, the fundamental change must be approved by the exchange and by security holders before completion, the disclosure must contain full, true and plain disclosure of the resulting company, and the resulting issuer must qualify as a new listing.

What Changes for Shareholders

For someone who owned the listed company before the deal:

• Your percentage shrinks. By definition, new shareholders end up with more than half the votes. See understanding dilution.
• The business changes. A shell becomes an explorer, or one kind of explorer becomes another.
• Management and the board usually change.
• The share count and structure change. Shares issued to the vendors, concurrent financings, warrants and options. The fully diluted shares calculator helps you add it up.
• Some shares are locked up. The exchanges can require escrow. The CSE, for example, requires principals of the resulting issuer to escrow their shares, with releases spread over 36 months.

For someone buying after the deal, the history of the shell matters less than the new company's assets, people and money.

What to Read in the Filing Statement

The TSXV filing statement form asks for a summary that covers, among other things, the principal terms of the transaction, the funds available and their principal purposes, selected pro forma financial information and a summary of risk factors. In the body, look for:

• The target's assets. For a mining target, the property description, geology, exploration history and any resources, with the technical report.
• Financial statements. The target's historical statements and pro forma statements for the combined company.
• Available funds and milestones. How much money the resulting issuer will have and what it plans to achieve with it.
• Insiders and principal shareholders. Who will control the company, what they paid for their shares and what is escrowed.
• Risk factors. Read them in full, not just the summary.
• Related parties. Any non-arm's length relationships between the shell's insiders and the target.

What to Check

• The halt and the timeline. How long trading may be suspended, and what conditions remain.
• The vote. Whether shareholders will vote and, if not, the company's stated reasons.
• Valuation. The value placed on the target compared with the work done on it.
• The concurrent financing. Its price, size and any warrants. See reading a junior's capital structure.
• Escrow and lock-ups. When insider and vendor shares become free to trade.
• The documents themselves. Read the information circular or filing statement on SEDAR+, and speak to your own adviser before making an investment decision.