Simplifying Prospectus Requirements — Growth Prospectus
Growth prospectus is for SMEs (small and medium-sized enterprises) who are looking to raise capital via public offerings. Growth prospectus is a new term introduced in the new Prospectus Regulation (coming into force 21st of July, 2019), and it will simplify prospectus requirements for the SMEs in Europe. There are still plenty of requirements, and we’ll try to highlight some of the ESMA guidelines here.
The prospectus is a document which contains all the information about the public offering, including information about the issuer of securities (security tokens) and enables the investor to do an informed decision on whether to invest into particular offering or not. Prospectus usually contains registration document (information about the issuer), securities note (description of the issued security), and conclusion (warnings, main information, risks etc).
The investor should get all the necessary information from the prospectus, however, the requirements of the prospectus shouldn’t be overly burdensome for the issuer, which may cause the issuer to cancel the plans of doing any sort of public offering at all. The goal of the growth prospectus is just that — to optimize the requirements so they reflect the needs of the issuer and would be proportional to the offering.
Who will be able to use growth prospectus?
SMEs will be able to draft a growth prospectus, which is a simplified prospectus for smaller companies and smaller offerings. SME is a company with a maximum market capitalisation of 200m euros (under new rules, the current rule is 100m). That’s definitely sufficient for most of the companies issuing security tokens. Additionally, the growth prospectus will be allowed to be used by companies which trade on SME growth market with a market cap up to 500m euros and with maximum 499 employees, with a public offering up to 20m euros. However, SMEs which are traded on the regulated markets cannot use the growth prospectus to raise capital. The goal is to avoid creating a double regime for prospectuses (i.e some companies on the stock exchange have to create a standard prospectus while the other can create a growth prospectus).
Content of the prospectus
Below you can find considerations of content drafted by ESMA (European Securities and Markets Authority) in the Consultation Paper ( Draft technical advice on content and format of the EU Growth prospectus). I will highlight some of the points that allow the reader to understand the proposed requirements in more detail. Please note that the following text is taken out of the context of a longer document and this may cause some confusion.
Considerations on content
1. ESMA is of the view that the EU Growth registration document should include a cover note, a table of contents and a cross reference table with a list of the documents and/or information incorporated by reference. The cover note and the table of contents, although not required under Level 1, would typically form part of a prospectus as a result of market practice and from a practical point of view would provide information that is relevant to the reader of a prospectus. As set out above, the cover note should not be seen as a substitute for the summary. In terms of the cross reference table, ESMA proposes that this element should be included in the prospectus since it would be helpful to investors seeking to locate specific information that is incorporated by reference.
- ESMA has weighed the pros and cons of requiring that EU Growth prospectuses display a “warning” mentioning that the prospectus is prepared under a proportionate regime specific to SMEs and midcaps and as such its content is lighter compared to a full prospectus. However, as the disclosure regime for SMEs and midcaps is clearly set out under Level 1, ESMA considers that the requirement for a “warning” would be construed in a negative way or as a “health warning” against investing in issuers that opt to offer securities under the EU Growth regime. Nevertheless, ESMA is of the view that the cover note of the EU Growth prospectus should clearly identify the legal basis for the EU Growth prospectus by including a statement indicating that it is a prospectus drawn up pursuant to Article 15 of the Prospectus Regulation.
- ESMA considers that the persons responsible for the content of the prospectus should be set out clearly in the EU Growth prospectus in accordance with Annex IV of the Prospectus Regulation which requires that the issuer and its representatives, other individuals involved in the company’s offer as well as the persons responsible for the drawing up of the prospectus are explicitly identified. Furthermore, ESMA is of the view that this section should also contain disclosure relating to consent statements by experts and Third Party information. This section should provide investors with transparency and comfort about the persons responsible for the information included in the prospectus. Broadly similar information is contained in the admission documents prepared for the purposes of admission to trading on MTFs. This section should also include a statement setting out the competent authority who approved the prospectus and the scope of such approval.
2. Strategy and objectives. Under the high-level outline set out in Annex IV of the Prospectus Regulation the EU Growth prospectus should include information on the company’s strategy and objectives 25 related to its development and future performance, the company’s business operations, the products it makes and/or the services it provides, its investments, the factors which affect the business and relevant trend information. Based on these requirements, ESMA considers that the key objective of the current section would be to provide insight into the issuer’s business, its main objectives and strategy, describe the market and any changes to the issuer’s financial performance due to e.g. a change in its competitive position or market share and explain its vision for the future.
- ESMA is of the view that this section should provide basic details on their business model featuring several elements that are deemed essential for investors (e.g. material investments and organisational structure) to gain a better understanding of the structure of an issuer’s business, its activities and prospects and assess whether to invest. The section also asks issuers to give an overview of their principal activities and markets, an indication of significant trends together with any forward looking statements (such as profit forecasts).
- At the beginning of the section, ESMA proposes the issuer should disclose information on its “identity”. This should be simple information on who the issuer is such as legal and commercial name, legal entity identifier, place of registration, legal structure, location, address, telephone number and website. The issuer should set out its vision for the future, its financial and non-financial growth objectives and the necessary steps to move the business forward. ESMA considers that from an investor’s point of view, it is important that the issuer can articulate its own vision in such a way that it conveys a clear understanding of the business and potential challenges that it faces.
- Following the elaboration of its strategy and objectives, ESMA is of the view that the issuer should identify its industry and type of business, elaborate on the products and / or services it provides as well as the ones that have been recently introduced and describe any material investments undertaken within the period covered by the financial statements in the prospectus and (if applicable) ones that are in progress. The level of detail in this section will vary depending on the stage that the issuer is in. However, it should be comprehensive enough to explain the issuer’s purpose and its future growth goals.
- In proposing the content of this section ESMA has been mindful that, while trying to minimise disclosure requirements to what is material, much of this information is readily available to issuers and can be included in a prospectus with minimal cost. In addition, the type of information that is sought in this section is similar in many ways to that included in the presentations that management makes to investors during roadshows. Issuers will therefore be able to reuse this information in management presentations and roadshows, thereby reducing costs incurred in marketing activities associated with offers of securities.
3. Organisational structure. In terms of assessing the issuer’s investment proposal, an investor would need to have a clear understanding of the issuer’s organisational structure as this information is 26 directly linked to the issuer’s strategy and underlines the opportunities and limitations the issuer is faced with. ESMA considers that the organisational structure of the issuer may be presented in the form of a diagram. As regards information on subsidiaries and holdings, in ESMA’s view the prospectus should provide investors with a description of any such entities that are deemed material for the issuer’s operation to the extent that this topic is not already covered in the financial statements. In general, ESMA considers this requirement not to be burdensome as this information should be well known to issuers, inexpensive to produce and often part of the information that will be included in the presentation that management will give to potential investors at a roadshow.
4. Operating and financial review (OFR). Under the Prospectus Regulation the disclosure requirements in this section apply only for equity securities issued by companies with market capitalisation above EUR 200 000 000. The OFR applies where the Management Report presented and prepared in accordance with Article 19 or 29 of Directive 2013/34/EU is not included in the EU Growth prospectus.
- In general the OFR is considered costly to produce for smaller issuers, given that investors will still have extensive financial information disclosed in the prospectus. The key objective of these requirements is for the issuer to provide a balanced and comprehensive analysis of the issuer’s development and performance and highlight to investors the views of the issuer’s management on the way forward and the key drivers of the business as well as enhance investors’ understanding of the complexities facing the issuer.
5. Profit forecasts or estimates. ESMA considers that profit forecasts — if prepared with due diligence and a well-founded basis — may help investors make a reasonable assessment of the issuer and its future economic prospects. On this basis and where an issuer of equity or retail debt has published a profit forecast or estimate, ESMA proposes that this information should be presented in the EU Growth prospectus. ESMA understands that in some cases issuers may wish to disclose a profit forecast or estimate in the EU Growth prospectus, even if they there is no previously published profit forecast or estimate. In this regard, ESMA is of the view that issuers should be allowed to make such disclosure when they consider it would be pertinent information for investors.
- Under the current prospectus regime where a profit forecast is included in a prospectus there is a requirement to also include a report by independent accountants or auditors to confirm that the basis of accounting is consistent with the accounting policies of the issuer and that the forecast has been properly prepared on the basis stated. This requirement is costly and it is in ESMA’s view questionable whether these costs are justified and proportionate considering the limited comfort provided to investors by such reports. The requirement for a report and the relevant costs may also be a disincentive for including profit forecasts or estimates in a prospectus, while such information could often constitute valuable information for investors. In line with the Commission’s 27 mandate not to propose information items which would imply high costs for SMEs with only a limited added value for investors, ESMA proposes not including a requirement for a report by independent accountants or auditors on profit forecasts or estimates.
- Along with the considerations above, ESMA is of the view that the assumptions upon which the forecast or estimate has been based should be clear, understandable, specific, precise and draw the investor’s attention to those uncertain factors which could materially change the outcome of the forecast. Furthermore, ESMA considers that the prospectus should include an explanation of the calculation of the profit forecast or estimate.
6. Risk factors. As set out at Level 1, in order to be included in the prospectus risk factors should be both material and specific to the issuer and should be corroborated by the content of the registration document. The obligation set out in Article 16 of the Prospectus Regulation to assess the materiality of risk factors based on the probability of their occurrence and the expected magnitude of their negative impact applies to the EU Growth prospectus as well. Considering the higher risk / reward profile of SMEs, it is especially important for persons investing in such companies to have a thorough understanding of the potential risks facing the issuer. In an effort to give more prominence to this topic, ESMA proposes that information on risk factors should be set out in a standalone section to drive the message that potential investors should carefully read its content and weigh the risks along with the expected future returns in order to make an informed decision.
- The disclosure requirement is different for non-equity issuers as in the latter case risk factors should focus on the issuer’s ability to meet its obligations. ESMA also proposes that the information on risk factors should follow the disclosure on the issuer’s strategy, performance and business environment. In this regard, investors would be able to place the risk factors in the context of the issuer’s business.
7. Corporate Governance. The purpose of this section as set out in Annex IV of the Prospectus Regulation is to provide information on the company’s directors and managers that will allow investors to assess their experience, qualifications and level of remuneration as well as their relationship with the company. In this regard, in ESMA’s view, the key objectives of this section are:
-To describe the composition and organisation of the issuer’s governance structure;
-To set out the remuneration paid to the management of the issuer.
- ESMA considers that one of the key elements that investors take into account when deciding to invest is the trustworthiness of the issuer’s management and their ability to create value for shareholders. To provide investors with sufficient information on the qualifications of senior management, ESMA proposes that the issuer should be required to present in the prospectus the persons who are responsible for the implementation of the business strategy and disclose their qualifications, management expertise and experience in order to illustrate their suitability to steer the company.
- Another element that is of particular relevance to investors is the remuneration paid to managers by the issuer and the shares (including options over shares) in the issuer held by them. As these are tools for aligning the interest of management and shareholders and an indication of management’s commitment to the issuer’s objectives and vision, the issuer should disclose information on management’s remuneration and benefits as well as shareholdings and stock options.
8. Shareholder and security holder information. Under Annex IV of the Prospectus Regulation, the EU Growth registration document should contain a section titled Shareholders’ which will inform investors of the following:
- the existence of any legal and arbitration proceedings;
- the issuer’s shareholder structure;
- the existence of conflicts of interest;
- related party transactions;
- material contracts;
- Memorandum and Articles of Association (M&A).
In ESMA’s view this section should present important features of the issuer which investors would consider when making an investment decision in order to assess the protection provided to minority shareholders and the issuer’s ability to create value for them. However, some of this information such as related party transactions would not necessarily be repeated in this section to the extent it would already be covered in the financial statements that are included in the prospectus. A cross-reference to that part of the prospectus could be provided in its place.
ESMA acknowledges that the provisions for the disclosure of notifications of major holdings under the Transparency Directive do not apply to issuers not admitted to trading on regulated markets and as such not to issuers eligible to draw up an EU Growth prospectus. However, a topic that should be addressed in the EU Growth prospectus is who owns the issuer prior to the public offer and who makes vital decisions in relation to its future. ESMA is of the view that the names of shareholders holding, directly or indirectly, more than five percent of the total voting rights and / or capital should be included in the prospectus, in so far as this information is known to the issuer. In general, information on the owners of the company is a key element that potential investors weigh up before making an investment decision. Therefore, ESMA considers that the inclusion 29 of this disclosure item in the EU Growth prospectus is not overly burdensome for issuers as it will be provided in all cases when an issuer seeks funding.
Furthermore, ESMA proposes including a number of additional topics in this section with the aim of showcasing issues that may have particular relevance for the decision to invest. The existence of conflicts of interest or significant legal and arbitration proceedings, the extent of related party transactions and whether they are concluded at arm’s length as well as the nature and impact of material contracts that the issuer has entered into, may underline areas of concern or specific challenges in the implementation of the issuer’s business plan. ESMA considers that an issuer trying to secure financing would be required to be explicit and disclose information on the aforementioned topics. Investors, on the other hand, should be mindful of this information when deciding whether to invest, as it complements the disclosure on the issuer’s strategy and prospects set out in other sections.
Memorandum and Articles of Association (M&A). In relation to M&A, ESMA is of the view that issuers who opt for the EU Growth prospectus should disclose information on their objects and purposes and where these can be found in the memorandum and articles of association. In addition, ESMA suggests that issuers disclose a brief description of the up to date M&A provisions in relation to takeover prevention measures as this information would be relevant to investors while not being overly burdensome to issuers.
9. Financial Statements and key performance indicators (KPIs). ESMA is of the view that the key objectives of this section are to provide potential investors with the issuer’s up-to-date financial information, key performance indicators (KPIs) and information on dividend policy. In other words, this section should present the issuer’s past performance and sets out the “numbers” that in a way back up the issuer’s business story.
- In general, ESMA considers that the information set out in this section will provide investors with a clear understanding of the issuer’s past income generating ability, its capital structure and assets. These elements will be factored in when assessing whether to invest in the issuer. On the other hand, the issuer does not incur extra costs as this section leverages information that has already been drawn up under national law requirements. Under the Prospectus Regulation compliance with this requirement will be achieved through the inclusion of financial statements covering the last two years for equity issuers and the last year for non-equity issuers together with the audit report for each year (this could be done by incorporating them by reference under the conditions set out in Article 18 of the Prospectus Regulation). Under Annex IV of the Prospectus Regulation, the EU Growth prospectus should include financial statements covering the latest two financial years for equity issuances or the last financial year for non-equity issuances.
- Although there are SMEs and midcaps that prepare their annual financial statements in accordance with IAS/IFRS, ESMA acknowledges that a significant number would produce such under national accounting standards. As one aim is to drive down the costs of producing a prospectus, and issuers of smaller size would usually be the focus of local market participants who would be familiar with the national level of corporate reporting, ESMA proposes that, for the purposes of the EU Growth prospectus, it should be possible to use the annual financial statements prepared under national accounting standards which in some cases may not include the same level of information required under IAS/IFRS.
- ESMA is of the view that where the issuer intends to change its accounting standards framework and adopt a new one in its next published financial statements the EU Growth registration document should include at least one complete set of financial statements, including comparatives. This disclosure requirement will provide investors with financial information that will be presented in a form consistent with that which will be adopted in the issuer’s next published annual financial statements. In this regard, ESMA considers that this information to be pertinent and proposes that it should be provided by all issuers that opt for the EU Growth regime irrespective of size.
- Furthermore, this section also contains pro forma financial information as necessary and where relevant also includes information relating to an entity other than the issuer, i.e. in cases of complex financial history. As regards pro forma financial information, ESMA considers it unnecessary to draw up a building block for pro forma financial information to be used specifically by SMEs and midcap. Regarding complex financial history, ESMA is of the view that the provisions which apply to the full prospectus are equally relevant for the content of the EU Growth prospectus. Based on these considerations, ESMA considers that the revised building block for pro forma financial information and the relevant provisions for complex financial history need not be alleviated for the purposes of the EU Growth prospectus as it is important for investors to be given a minimum set of information in order to understand the complexities of specific transactions before reaching an informed decision.
- ESMA has considered whether a requirement in relation to the minimum age of financial information that is included in the prospectus would be overly burdensome to issuers. Under existing market practice potential investors would rely on updated information before reaching an investment decision and issuers are incentivised to provide such to support their business proposal. In this context ESMA considers that this disclosure item would provide valuable comfort to investors without at the same time imposing additional costs to SMEs and midcaps and proposes to include in the EU Growth prospectus a requirement regarding the age of financial information in order to avoid a situation where investor protection is compromised by the inclusion of financial information that is not up-to-date. Therefore, under the proportionate regime the age of financial information should not be older than 18 months or 16 months from the date of the registration document depending on whether audited, unaudited or no interim financial statements are included in the prospectus.
10. Key Performance Indicators (KPIs). KPIs are used by issuers, their management and industry for internal (i.e. management/corporate governance) or external (i.e. investor relations) purposes and as such they are pertinent information to investors. Under the Prospectus Regulation the EU Growth prospectus should include key performance indicators (KPIs) covering the same period as the financial statements. KPIs provide an insight into the performance of an issuer against the key drivers of the issuer’s strategy and can be financial (such as EBITDA, working capital ratio or free cash flow) and non-financial.
- In terms of balancing the interests of issuers and investors, ESMA would expect issuers to include those KPIs which they use and are material to the investment decision with the inclusion of at least one KPI based on liquidity such as current ratio, acid-test ratio, cash ratio, quick ratio, cash conversion cycle4 and at least one based on indebtedness such as debt to total assets ratio, debt to equity ratio or other measures of liquidity and indebtedness that are appropriate for the issuer and/or its industry.
- ESMA is of the view that the number of KPIs used should be relatively small and that, where possible, issuers should use KPIs which are typical in their industry or sector. Using commonly used and understood KPIs will facilitate investor understanding and allow comparability across issuers and industries.
11. Dividend policy. Where the registration document is being prepared on a standalone basis, or where an EU Growth prospectus is being used for the issuance of shares, ESMA proposes that the issuer’s dividend policy be included in this section.
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