6 - Equity Finance Flashcards
What is capital in the context of company law?
Capital refers to the funds available to run a business.
In company law, ‘share capital’ specifically relates to the money raised by issuing shares.
This share capital is contributed by investors in exchange for shares, representing ownership in the company.
Why does a company need funds?
A company needs funds for:
- Starting the business (e.g., buying stock or machinery).
- Maintaining daily operations, also known as ‘working capital’.
- Funding expansion and growth (e.g., acquiring new premises or other businesses).
How does a company fund its business?
A company can fund its business through:
- Issuing shares (equity finance), which raises money in exchange for ownership stakes in the company.
- Borrowing money (debt finance), which must be repaid with interest.
- Retaining profits to reinvest in the business, instead of distributing them to shareholders.
What are shares in a company?
A share represents a ‘bundle of rights’ attached to ownership in the company.
By purchasing shares, the investor becomes a part-owner of the company, often with voting rights at shareholder meetings.
In private companies, shareholders usually hold their investment for the long-term and may only realise their investment on:
- Sale of their stake.
- Sale of the company.
- Company flotation.
- Company winding-up (if sufficient funds are available).
The incentive for shareholders is:
- Income from dividends.
- Capital gains through growth in company value.
Neither dividends nor capital gains are guaranteed.
Different share classes may confer varying rights and entitlements, and the exact classes and rights they confer are always outlined in the company’s Articles.
What is the share capital structure under the Companies Act 2006?
Under Section 542(1) CA 2006, shares must have a fixed nominal value. Section 542(2) states that shares without a fixed nominal value cannot be allotted, rendering such allotments void.
Nominal/Par Value:
- A unit of ownership in the company, which is not the actual market value of the share.
- Common nominal values are 1p, 5p, or £1.
Section 580 CA 2006 prohibits the allotment of shares below their nominal value, but shares can be issued above nominal value.
The amount above nominal value is referred to as the premium.
What are issued shares?
Issued shares form a company’s issued share capital (ISC).
This includes:
- Shares acquired by the first members (subscriber shares).
- Shares issued after incorporation to new or existing shareholders.
The ISC appears in the company’s balance sheet.
What are allotted shares?
Under Section 558 CA 2006, shares are considered allotted when a person has the unconditional right to be included in the company’s register of members.
Shares are often called ‘issued’ once the shareholder is registered in the company’s register of members.
However, full legal title to shares is only achieved when the shareholder’s name is entered in the register, as per Section 112(2) CA 2006.
What are called-up/paid-up shares?
Paid-up share capital refers to the portion of nominal capital that has been paid by shareholders.
If a part of the nominal value is still unpaid, the company can demand the unpaid amount, which is called the ‘call’.
Called-up share capital (as defined in Section 547 CA 2006) is the total of the paid-up capital and the amounts that the company has demanded (called) from shareholders.
What are treasury shares?
Treasury shares are shares that the company has repurchased from shareholders and holds in its own name.
These shares are not cancelled but are instead held by the company and can be:
- Resold to other investors.
- Transferred to an employee share scheme.
- Cancelled if the company decides to reduce its share capital.
Treasury shares, despite being held by the company, are subject to pre-emption rights under Sections 561 and 573 CA 2006, ensuring that existing shareholders have the first opportunity to purchase them.
What are classes of shares?
A company can issue different classes of shares with varying rights attached.
These rights typically concern:
- Voting entitlements.
- Dividend rights.
- The return of capital upon winding-up.
The rights attached to each class of shares are specified in the company’s Articles.
What are ordinary shares?
Ordinary shares are the default class of shares.
They confer rights to:
- Vote at general meetings.
- Receive dividends (if declared).
- Participate in any surplus assets upon winding-up.
Defined in Section 560(1) CA 2006 as shares with no limit on participation in dividends or capital.
Although ordinary shareholders receive dividends after preferance shareholders, one advantage of ordinary shares is that the entitlement of ordinary shares to a dividend is unresitricted.
What are preference shares?
Preference shares give shareholders priority in:
- Receiving dividends before ordinary shareholders.
- Receiving capital in the event of winding-up.
Dividends are typically fixed as a percentage of nominal value (e.g., 5% £1 preference shares, which equates to 5p per share) by way of dividend each year, provided a dividend is declared.
By default, preference shares are non-voting, but the company’s Articles may grant voting rights.
What are cumulative preference shares and how do they function?
- Cumulative preference shares are presumed to be ‘cumulative’ unless otherwise stated.
- This means that if a dividend is not declared for a particular year, the right to the preferred amount on the share is carried forward.
- The accumulated dividends will be paid, together with other dividends due, when there are available profits.
- If this accumulation is not desired, then the share must be expressed to be non-cumulative.
What are participating preference shares and their characteristics?
Participating preference shares allow shareholders to participate, together with the holders of ordinary shares, in:
- Surplus profits available for distribution after they have received their own fixed preferred dividend.
- Surplus assets of the company on a winding up.
As with preference shares, participating preference shares are also almost always issued with a fixed dividend and can be cumulative if stated as such in the articles of association.
Participating preference shares with these characteristics are generally called fixed rate participating cumulative preference shares.
Overall: These shareholders receive a fixed dividend, and a general dividend alongside ordinary shareholders.
Example: Company A has participating preference shares in issue which carry a right to receive a fixed preferential dividend of 5% of the par value of the shares per annum. Assuming that a dividend has been declared, the preference shareholders would be entitled to receive a dividend of 5p per share per annum before the ordinary shareholders receive any dividend. They would then also be entitled to a fraction of the remaining general dividend alongside the ordinary shareholders.
What are deferred shares and their rights?
Deferred shares carry no voting rights and no ordinary dividend.
However, they are sometimes entitled to a share of surplus profits after other dividends have been paid, assuming there is a surplus.
More usually, deferred shares carry no rights at all and are used in specific circumstances where ‘worthless’ shares are required.
What are redeemable shares and their purpose?
Redeemable shares are shares which are issued with the intention that the company will, or may wish to, buy them back and cancel them at some time in the future.
This gives companies the flexibility to manage their equity structure effectively.
What are convertible shares and their features?
Convertible shares will usually carry an option to ‘convert’ into a different class of share according to stipulated criteria.
This provides shareholders with the ability to change their investment from one class to another based on the company’s terms and conditions.
How does a variation of class rights work in relation to shares?
A company may issue different classes of shares, and it is essential to refer to the Articles to find the relevant rights attaching to a share, since there are no formal, universal definitions of different types of share.
If an attempt is made to alter the Articles of a company such that existing class rights are varied, the resolution in question will not be effective unless varied in accordance with provisions in the company’s Articles for the variation of those rights or, where Articles don’t contain such provisions, by consent in writing of holders of at least 75% of the issued shares of that class or by means of a special resolution passed at a separate general meeting of holders of that class (s 630 CA 2006).
Shareholders holding 15% of the relevant shares may, provided they did not vote in favour of the variation, apply to court within 21 days of the resolution to have a variation cancelled (s 633(2) CA 2006).
Following such application, the variation will not take effect unless and until it is confirmed by the court, which will not confirm the variation if it feels that the variation unfairly prejudices the shareholders of the class in question.
What are dividends?
The main reason for shareholders to invest in shares in a company is generally to make money.
Shareholders may receive a return on their investment in two ways:
- By receipt of dividends (income receipts).
- An increase in the capital value of the shares.
Dividends are only payable by a company if it has sufficient distributable profits (s 830(1) CA 2006).
‘Distributable profits’ means the company’s accumulated realised profits less its accumulated realised losses (s 830(2)).
What are the two types of dividend?
There are two types of dividend:
Final dividends: Recommended by the directors and declared by the company by an ordinary resolution of the shareholders following the financial year end.
Interim dividends: The articles of a company normally give the directors the power to decide to pay interim dividends if the company has sufficient distributable profits (MA 30 allows this). Interim dividends can be paid without the need for an ordinary resolution of the shareholders. They are often paid where the company has realised an investment.
Provide a summary of the introduction to shares.
The term ‘share capital’ relates to the money raised by the issue of shares.
A share is a ‘bundle of rights’ in a company that often provide voting rights. Shares (and the rights attaching to them) can broadly be categorised into six groups:
- Ordinary shares;
- Preference shares;
- Participating preference shares;
- Deferred shares;
- Redeemable shares; and
- Convertible shares.
There are no statutory definitions of different types of shares. The rights attaching to shares are set out in the company’s Articles.
What is the difference between alotting and transferring shares?
Allotment of shares is a contract between the company and a new or existing shareholder under which the company agrees to issue new shares in return for the purchaser paying the subscription price.
Transfer of shares is a contract to sell existing shares in the company between an existing shareholder and the purchaser, with the company not being a party to this contract (except for a sale out of treasury shares).
What are the considerations regarding the restriction on allotment of shares under s 755 CA 2006?
Under s 755 CA 2006, a private company limited by shares is prohibited from offering its shares to the public, restricting it to targeted investors only.
The expression ‘offer to the public’ (defined in s 756 CA 2006) covers offers to ‘any section of the public’ but excludes offers intended only for the recipient or those considered a ‘private concern’ of the persons involved.
Offers made to existing shareholders, employees, and certain family members, as well as shares held under employee share schemes are also permitted.
This restriction must be carefully considered when a private company proposes to allot shares.
What is the requirement for a prospectus when offering shares?
When a company offers shares, it is essential to determine if a prospectus must be published for would-be investors.
A prospectus is an explanatory circular providing details about the company and the investment to help investors make informed decisions. It should contain all necessary information about the company’s financial status and the rights attached to the shares (s 87A(2) FSMA).
Preparing a prospectus is usually expensive and time-consuming.
In the case of a private company offering shares, a prospectus is typically not required, but rules should be carefully considered each time.
What are the considerations regarding financial promotions when issuing shares?
Under s 21 FSMA (amended by FSMA 2023), a financial promotion is any invitation or inducement (in the course of business) to engage in investment activity, including buying shares.
Financial promotions are prohibited unless specific requirements in the FSMA are met, which is crucial when a company considers issuing shares.
Communications by a company when issuing shares must either fall within an exemption from the s 21 FSMA prohibition or be approved by an authorised person appointed by the FCA.
What is the process for the transfer and transmission of shares?
Transmission of shares occurs automatically upon the death or bankruptcy of a shareholder:
- If a shareholder dies, their shares automatically pass to their personal representatives.
- If a shareholder is made bankrupt, their shares automatically vest in their trustee in bankruptcy.
Transfer of shares can occur from an existing shareholder to a new shareholder through sale or gift, subject to any restrictions in the Articles (s 544(1) CA 2006).
What are the common restrictions on the transfer of shares as per Article 26(5) MA?
Two common forms of restriction on share transfers are:
Directors’ power to refuse to register: Article 26(5) MA states that directors may refuse to register a share transfer, returning the instrument of transfer with a notice of refusal unless they suspect fraud.
A company must give reasons if it refuses to register a transfer.
Pre-emption clauses (rights of first refusal): Pre-emption rights on transfer require that a shareholder wishing to sell must offer their shares to existing shareholders before offering them to outsiders. These rights must be specifically included in the Articles, as CA 2006 and MA do not contain automatic pre-emption rights on transfer.
What methods are used for the transfer of shares?
A transfer of shares is made using a stock transfer form, which must be signed by the transferor and submitted, along with the share certificate, to the new shareholder (s 770 CA 2006).
Legal and equitable ownership:
- Beneficial title to the shares passes upon execution of the stock transfer form.
- Legal title passes upon registration of the member as the owner of those shares in the register of members by the company (s 112 CA 2006).
- The company must send the new shareholder a share certificate within two months (s 776 CA 2006).
Stamp duty: The stock transfer form must be stamped before registration, with stamp duty payable by the buyer at 0.5% of the consideration rounded up to the nearest £5. No stamp duty is payable if consideration is £1,000 or less; a minimum fee of £5 applies if more than £1,000.
Provide a summary of the allotment, transfer, and transmission of shares.
- It is possible for a company to allot new shares or for existing shares to be transferred between shareholders by way of sale or gift.
- Private limited companies are prohibited from offering shares to the public.
- When a shareholder is seeking to transfer shares, the Articles must always be checked to ensure there are no restrictions on transfer or pre-emption rights.
- Transfer of shares is effected by the transferor signing a stock transfer form and giving this to the transferee together with the share certificate.
- Stamp duty is payable on transfer of shares at 0.5% (subject to a minimum payment of £5) where the sale price exceeds £1,000.
- Transmission of shares is an automatic process in the event of death or bankruptcy of a shareholder.
When issuing shares, what is the five step procedure that companies must follow?
- Step 1 – check whether there is a cap on the amount of shares that can be issued by the company.
- Step 2 – check whether company directors need authority to allot the shares.
- Step 3 – are the shares equity securities? You will be able to work this out by looking at the dividend and capital payout on the shares. If both are capped, the share is not an equity security and therefore pre-emption rights are not relevant. If the shares are equity securities, consider whether the company needs to disapply pre-emption rights.
- Step 4 – is the company creating a new class of share? If so, the Articles will need to be amended to incorporate the new class rights.
- Step 5 – Board will resolve to allot the shares. This step will always be required, regardless of the other steps.
Following step 1, what is the significance of checking for a cap on the number of shares that may be issued before issuing new shares?
Before issuing new shares, you must check the company’s Articles for any cap or limit on the number of shares that may be issued. If this is to be exceeded, the cap must be removed, or the limit increased.
CA 1985 - Will originally have had an authorised share capital (‘ASC’) which acted as a ceiling on the number of shares it could issue. These companies will continue to have an ASC unless such cap is removed from their Articles.
CA 2006 - The requirement to have an ASC no longer exists under CA 2006. Shareholders wishing to impose a cap and restrict the number of shares that such a company can issue will need to amend the Articles by special resolution to include suitable provisions.
Following step 1, how can the cap on the number of shares be removed for companies incorporated under CA 1985 and CA 2006?
CA 1985 - Shareholders wishing to remove or amend the deemed restriction in a company’s Articles may do so by ordinary resolution, despite the fact that removing such a deemed restriction involves changing the Articles, which would normally require a special resolution under s 21(1) CA 2006.
Any such deemed restriction will also fall away as a consequence of the company adopting, wholesale, new Articles (such as MA) which do not include provision for any cap (applying s 21(1) CA 2006).
CA 2006 - Will not have an authorised share capital, meaning there will be no bar to issuing shares under step 1 unless a specific restriction exists in the Articles.
If such a restriction exists, it can be removed, or the limit increased, by special resolution under s 21(1) CA 2006.
Under s 617(2)(a) CA 2006, each time a company issues shares, its share capital increases automatically.
What are the key points to summarise for Step 1 in the share issuance process?
Check whether any resolutions to remove, impose or change any cap, or increase the share capital, have been passed.
Ensure that you have up-to-date information, particularly checking the company’s Articles.
Verify whether any shares have been issued by checking the register of members or the most recent confirmation statement filed at Companies House and any subsequent forms filed on allotments of shares (using Form SH01 under s 555 CA 2006).
If the company does not have a limit on its share capital or if there are sufficient unissued shares available within any cap for a proposed new issue, the company can proceed to step 2.
In Step 2, do the company’s directors need authority to allot shares?
Directors are responsible for the actual allotment of shares to a shareholder and they must resolve by board resolution to make an allotment.
However, they may need to have the prior authority of the shareholders to do this.
Section 549 CA 2006 provides that the directors of a company must not exercise any power of the company to allot shares in the company except in accordance with:
- s 550 CA 2006: For private companies with only one class of shares in existence, the directors will have automatic authority to allot new shares of the same class unless they are prohibited from doing so by the company’s Articles. This simplifies the process for many smaller companies, as no shareholder resolution is required to grant authority to directors to allot new shares.
For companies incorporated under CA 1985, an ordinary resolution is required to authorise the directors to rely on s 550 CA 2006.
- s 551 CA 2006: For all other companies, the directors will need to be granted authority to allot the new shares by the shareholders through an ordinary resolution.
