Explore the intricate advisory relationship between dealers and corporations in the context of financing and issuing securities. Learn about the roles, advisory services, key considerations, and protective provisions involved in these financial transactions.
When a corporation decides to undertake financing, it secures the services of a dealer. Selecting a lead dealer involves various considerations about the dealer’s reputation for providing advisory services on timing, amount, and pricing of an issue. As well, the lead dealer provides advice on issue distribution, after-issue market support, and after-issue market informational support. Obtaining a reputable dealer also tends to result in better market acceptance of the issue and cheaper financing for the issuing corporation.
When negotiations for a new issue of securities begin between the dealer and corporate issuer, the dealer normally prepares a thorough assessment of the corporation and its industry. The study includes the corporation’s position within the industry, financial record, financial structure, and future prospects. All risk factors associated with the industry and the company are closely observed. This assessment is known as a due diligence report.
Various experts in appropriate fields such as engineers, geologists, management professionals, or chartered accountants may be consulted. Following this comprehensive study, the dealer determines whether the corporation is a suitable candidate for a new issue and decides if they will proceed as the lead dealer.
The dealer may choose to act either as a principal or an agent for the corporate financing. Regardless, the issuing corporation relies on the dealer’s advice and guidance to design the various features of the securities. This advisory relationship parallels the professional relationship between a lawyer and a client.
Once solidified, the dealer may become the broker of record with the right of first refusal on new financings planned by the corporation.
The lead dealer’s corporate finance team plays a vital role in designing the new issue and advising the corporation on the best market strategy. The corporation aims to ensure that new securities align with its capitalization strategy and that restrictive provisions do not hamper future decision-making.
The dealer’s recommendations are based on a variety of factors including current market conditions, investor preferences, the impact of financing options on the corporation’s existing capitalization, and future earnings stability. Table 12.3 provides a summary of considerations for issuing different types of securities:
| Type of Security | Advantages | Disadvantages |
|---|---|---|
| Bonds | Lower interest rate | Less flexible due to asset pledges |
| Suitable for institutions requiring secured debt | Problematic in mergers due to asset pledges | |
| Debentures | No specific pledges or liens | Higher coupon rate than bonds |
| Lower cost at issue | Regular interest payments required | |
| Preferred Shares | Considered equity, increasing debt capacity | High issuance cost due to after-tax dividend payments |
| Non-payment of dividends does not trigger default | Dividend omission can lead to voting rights for preferred shareholders | |
| Common Shares | No obligation to pay dividends | Dilution of existing shareholders’ equity |
| No repayment of capital required | Dividends paid from after-tax dollars are expensive |
The dealer provides advisory services on the security’s specific attributes, for example, interest rates, redemption processes, and various protective provisions.
These provisions, known as protective provisions, trust deed restrictions, or covenants, are safeguards for security holders in case the issuers’ financial conditions change. For different securities, these clauses have different terminologies:
To ensure the accuracy of the due diligence report and the final advisory recommendation, dealers sometimes consult with experts from sectors related to the corporation’s business. This helps in understanding the operational and financial intricacies of the corporation.
What factors do dealers consider in the due diligence process? Dealers analyze the corporation’s industry standing, financial health, growth prospects, and associated risks. They may also consult experts as part of this comprehensive assessment.
What is the difference between acting as a principal and acting as an agent in financing? Acting as a principal means using their own resources to finance the corporation, while acting as an agent involves arranging financing between the corporation and third-party investors.
How do protective provisions benefit investors? Protective provisions offer safeguards against financial deterioration of the issuer and protect the investors’ interests by imposing operational and financial restrictions on the issuer.
Why might a corporation choose to issue debentures instead of bonds? Corporations may prefer to issue debentures over bonds because they provide more flexibility since they are not secured by specific assets and have lower initial costs at issuance.
Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC® exam practice questions designed to reinforce the key concepts covered in our free Canadian Securities Course. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨
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