Friday interview with Stikemans lawyer Martin Langlois
We are launching a new feature today called “The Friday Interview”. Now, the idea isn’t unique, as the dead tree media has been using this tool for decades. I got the inspiration from my father, who wrote a Friday Interview column for many years — long before The Financial Post newspaper morphed into the National Pest.
We’ll do our best to bring you a weekly interview with a person whose background and/or expertise is highly relevant based upon what we are seeing “out there”. First up is lawyer Martin Langlois, of Stikeman Elliott LLP in Toronto. His specialty is corporate law with a concentration on technology companies. I asked him to be our first guinea pig for this feature given the time we’ve spent castigating the AIM Alternative Investment Market. The fact that his firm has been involved with the successful AIM IPOs of Sandvine, Redline, Redknee and Dragonwave made him the natural choice. Hope you like the new idea!
1. The AIM market has almost become a household word in “Tech Land”, particularly for initial public offerings. What are the attractions of an AIM-only listing for firms, from the vantagepoint of a lawyer?
AIM is often criticized for its light regulatory framework. I personally think that its regulatory framework is AIM’s greatest strength. It just needs to be understood by commentators and skeptics, in the same way as it is understood by the institutional investors that take advantage of it.
An AIM listed company is governed by its nominated advisor (or nomad), who provides guidance on all matters dealing with compliance to the AIM Rules, which are “principle-based”. The responsibility rests with the nomad to provide advice on how the rules should be applied in particular cases, liaising with AIM Regulation as necessary. This is a good training ground for companies that intend to list on the TSX but that first want to get their feet wet on the compliance side. In other words, an AIM listing should allow management to develop the necessary “compliance reflexes” (such as monitoring issuance of press release, insider trading, etc.) while limiting exposure. For many, AIM is not the ultimate destination but a stop that is part of a longer voyage.
Since an AIM-only listed company will typically not be a reporting issuer in Canada, it will not be subject to Canadian continuous disclosure obligations. Generally, reporting obligations under AIM do not include the equivalent of a Canadian Annual Information Form. Financial reporting is half-yearly and not quarterly. Material change reports are not filed, but there is a requirement to announce material changes, similar to that in Canada. There is no equivalent to SEDAR, whereby the pubic record of the company is available online. All these factors are attractive from a compliance cost perspective. Since, AIM does not have any minimum listing requirements and attracts small-cap companies, this is an important advantage.
2. Are there any drawbacks, either to the company’s existing Canadian shareholders or management teams? Liquidity? Extra costs vs a TSX IPO?
My personal opinion is that AIM-only listings should be treated as financing events and not as liquidity events. Once this is well understood by shareholders and management, any discussion on liquidity is put in perspective.
The typical Canadian corporation listed solely on AIM will not be a reporting issuer in Canada, and will often have 10% or more of its shares held by Canadian residents (whether factually or due to restrictions being put in place as a result of a mutual-fund corporation structure for example). As a result, its shares are not freely tradable and its Canadian shareholders will have to rely on an exemption from the prospectus requirements of the securities legislation of the province where they are resident to trade their shares. While numerous exemptions exist, the most commonly used exemptions allow the sale of the shares to an “accredited investor” or in blocks of $150,000 to a purchaser purchasing as principal.
The AIM Rules also provide for compulsory 12 month lock-ups for businesses that have not been independent and earning revenues for at least 2 years. In addition, the placing agents (or brokers) also require lock-ups. This means that it is not atypical to see lock-ups for periods extending up to 24 months on AIM.
On the cost side, while on-going compliance costs are reduced (as discussed above), the costs relating to the admission will be similar to and, in some cases, exceed the costs of a TSX listing, especially when a reorganization is required, as discussed below. These costs are however very often offset by the better valuation provided by an AIM listing (compared to that offered by VCs if an additional private round is being considered).
While AIM offers great benefits, listing Canadian companies on AIM only can present a challenge. The shares of Canadian corporations are considered “taxable Canadian property” or “TCP” for tax purposes. As a result, non-residents of Canada are subject to Canadian tax when they dispose of shares of Canadian corporations which constitute TCP, unless the shares are listed on a prescribed stock exchange. AIM is not a prescribed stock exchange. Accordingly, sales of such shares through AIM by persons not resident in Canada will result in Canadian capital gains tax and will require such persons to obtain clearance certificates (commonly known as s.116 certificates) from the Canada Revenue Agency and file Canadian tax returns in respect of each sale of shares even if the sale is treaty-protected. This is impractical in connection with trades on an exchange, particularly for all the new shareholders of who might acquire shares in connection with an AIM listing. There are ways to get around this problem, the most common one being to convert the corporation into a mutual-fund corporation. The recent budget may remediate this problem in part by removing the need for a s.116 certificate for shares being sold on AIM. The proposal has however come up short as it did not address the TCP issue.
3. What did the recent federal budget mean when it talked about “free trade” for securities?
Think of this as an expanded version of the Multijurisdictional Disclosure System, currently in place with the US.
This proposal would ultimately allow Canadian investors to directly access securities listed on foreign exchanges through a Canadian or a foreign broker, where the foreign exchange or the foreign broker is recognized by Canadian regulators as being regulated in an acceptable manner for investor protection. Conversely, foreign investors in all participating jurisdictions would be allowed to invest directly in the securities listed on Canadian exchanges such as the TSX and TSX Venture Exchange through their domestic broker or a Canadian broker.
All of this is subject to putting in place effective investor protection and legal and information-sharing arrangements that support effective enforcement. Bilateral discussions are being pursued with the United States and have also been initiated in the broader G7 forum. Don’t hold your breath.
4. The federal government appears to be treating interest charged on debt used to acquire foreign companies in a manner that’s different from the domestic ones. Is this an accurate read of the proposal in the recent federal budget?
Yes, the 2007 budget proposes to eliminate the deductibility of interest on debt incurred by Canadian corporations to finance foreign subsidiaries. The ostensible concern is that Canadian corporations could borrow funds, invest those funds in a foreign affiliate and earn exempt dividends which would not be taxed in Canada. These restrictions represent a sea change in Canada’s approach to international tax policy and it remains to be seen what impact these changes may have on the global competitiveness of Canadian multi-national enterprises.
5. There is a school of thought that software firms shouldn’t actually try to register patents, for fear that the risks outway whatever benefits there might be should they ever get one registered. What do you advise clients?
I tend to agree. Even assuming that software can be patented (which is the subject of a debate in itself, depending on where you live), I share the view that copyright and trade secret laws offer adequate protection for software. The main disadvantages with the patent system is that the invention must be described in such a way so as to be able of being reproduced and this description is generally made available to the public within 18 months from the date of filing. This means that the key features will be made available to competitors. Where such feature can be easily reversed-engineered (such as when dealing with the business process implemented by the software), the decision to file may be an easier one but when the invention is not (such as in the case of a proprietary algorithm), I generally recommend that client abstain from filing.
Also, I have yet to see any VC or underwriter that has expressed some real concern if a firm does not file for patent protection for its software. Most are just happy to have software that is free from open source!
6. How big does a firm have to be before it makes economic sense to attempt to get patents in jurisdictions other than Canada/USA, such as Germany for example?
The main concept to understand is that a patent does not give a person the right to sell or make an invention, it gives that person the right to prevent someone else from doing so. Therefore, determining where to file a patent should be done in view of the competitive landscape. This means that a firm should not only consider where its biggest market lies (such as the United States) but also, where its main competitors have manufacturing activities so as to strike at the heart of such activities. Most law firms that specialize in patent procurement have, over the last few years, begun to offer IP management services that assist companies in determining how to best invest their IP budget. Best of all, such services may be provided free of charge in some cases as a way to attract the drafting and prosecution work.
7. One last question. What’s on your iPod?
iPod? I am all about convergence and listen to my music on my new LG Prada phone. iPhone beater.
Thanks, Martin, for the cogent perspectives.