Business - Equity Finance (11) Flashcards
What is equity finance?
Equity Finance: Equity finance is the raising of funds by selling shares in the Company. This is subject to strict regulation.
What is the procedure for allotment?
CDPA
Allotment: Allotment is the creation and sale of new shares, creating an unconditional right to membership (s558), subject to:
(1) Constitution: The Company constitution may restrict allotment.
(2) Directorial Authority: Directors require authority to allot shares (sometimes this is given by default).
(3) Pre-Emption Rights: Existing members may have the right to be offered new shares before non-members.
(4) Administration: A number of administrative formalities proceed allotment.
Constitution
Constitution: Company constitutions may restrict allotment (either expressly or by default, or not at all).
(1) Pre-Oct 2009 Company: Original memorandum contains an upper limit on allotment.
>This can be removed by ordinary resolution (filed at CH).
(2) Post-Oct 2009 Company: No upper limit clause. May be subject to express restriction (s28).
>Express restrictions can be created or removed by special resolution (filed at CH) (s21).
**Directorial Authority **
Directorial Authority: Shares are allotted by the board, but they may require shareholder authorisation first.
(1) One Class Private Company: Private companies with one class of share may freely allot that same class of share, provided they were incorporated since October 2009 or, if not, if the power must be activated (s550).
>Pre-Oct 2009 companies can authorise allotment by ordinary resolution.
>Express restrictions may be created or removed by special resolution (filed at CH).
(2) Other: In any other instances (new shares/public company), authorisation to allot is required (s551).
>Ordinary resolution is required (either one-off authorisation or blanket authorisation).
>Resolution must specify an upper limit, and a limitation period not exceeding 5 years.
>Resolutions must be filed at Companies House within 15 days (s29).
>Power must be renewed after the limitation period or upper limit is reached.
(3) New Class of Shares: In addition to providing power to allot by ordinary resolution, the creation of a new class of shares requires authorisation as well.
>Special resolution to create the new class (filed at CH).
>Private company with one class of shares wants to issue new preference shares. This requires a special resolution to create the shares, and then an ordinary resolution authorising the board to allot them.
(4) Board Resolution: Once authority is provided, a board resolution is required to actually allot the shares.
Pre-Emption Rights
Pre-Emption Rights: By default, existing shareholders must be offered first rights to purchase new ‘equity securities’, to the extent of their existing shareholding in the company on the same or more favourable terms than new persons (s561).
(1) Equity Securities: Ordinary shares, or the unconditional right to subscribe to new ordinary shares (s560).
Ordinary Shares: This definition is wider than usual - it means shares other than those with a fixed, capped right to dividends and capital.
>A preference share with an uncapped right to dividends, or capital on winding up, is an equity security.
>A preference share with a fixed 5% right to dividends and fixed 5% of capital on winding up is not an equity security.
(2) Acceptance Period: Existing shareholders must be given a period of acceptance, no less than 14 days (s562).
(3) Full Payment: Allotted shares must be ‘fully paid’ on receipt, unless articles provide otherwise (MA 21).
>If disapplied, the shares must be fully paid when specified or on winding-up.
(4) Disapplication: Pre-emption rights may be disapplied on a one-off basis or permanently by special resolution.
>One-class private companies allotting same class merely requires special resolution (s569).
>Other companies require a written statement of the board setting out reasons for suspension, purchase price, and justification, circulated alongside GM/WR (s571). It is an offence if the statement is false (s572).
(5) Exceptions: Pre-exemption rights do not apply in the following circumstances:
Bonus Shares: The allocation of new shares in existing percentages to shareholders from profits (s564).
Non-Cash Payment: The allocation of new shares partly or wholly for non-cash payment (s565).
Employee Scheme: The allocation of shares under an employee share scheme (s566).
Articles: Allocation where pre-emption rights are disapplied by the articles (s567).
What is the administration of allotment of shares?
Administration: A number of administration formalities accompany allotment.
(1) Internal: Internal requirements include:
Registers: Updating Register of Members and Persons of Significant Control (within 2 months).
Minutes: Recording board minutes (s248) and general minutes (s355).
(2) External: External requirements include:
Special Resolutions: Special resolutions filed with Companies House (within 15 days).
Ordinary Resolutions: Ordinary resolutions to remove upper limit/authorise allotment powers (15 days).
Share Certificates: Share certificates prepared and issued (within 2 months).
Allotment Form: Allotment and statement of capital filed at Companies House on Form SH01 (1 month).
PSC Forms: Notification of PSC changes Forms PSC01/02/04/04 to Companies House (14 days).
What is the procedure for transfer of shares?
Transfer: Shareholders can sell or gift shares to other persons (subject to company articles). The company does not profit.
(1) Transfer Form: Transferor signs stock transfer form, and provides this to the transferee or company (ss770-772).
(2) Registration and Certificate: Company must register the new shareholder on the Register of Members and issue them a share certificate as proof of ownership within 2 months (ss771-776).
>Registrar of Members is updated of changes in annual confirmation statement (Form CS01).
(3) Article Restrictions: Articles may restrict shareholding percentages, or require board approval, or require shareholders to apply pre-emption rights.
>If the board refuses to register the new member, the old member holds the shares on constructive trust for the new member. They must vote according to their demands, and pay them any dividends earned.
(4) Stamp Duty: Share sales exceeding £1,000 are subject to 0.5% stamp duty (rounded to nearest £5).
How are shares transmitted?
Transmission: Shares are transmitted if a shareholder dies or becomes bankrupt. They vest in a PR or trustee, who will not become a shareholder unless they seek registration, but are entitled to dividends, and can sell them in a fiduciary capacity.
How are dividends called?
Dividends: Companies can distribute dividends to shareholders, to incentivise their purchase and reward investors.
(1) Available Profits: Dividends must be distributed from available profits (s830).
>(Accumulated+Realised Profits)-(Accumulated+Realised Losses). This is Profit and Loss.
>Previous year profits can be carried over if current available profits are insufficient.
(2) Board Meeting Sandwich: A board meeting sandwich must occur.
BM 1: Board decides on level of dividend and resolves to call GM/WR (MA 30).
GM: Shareholders must approve the dividend by ordinary resolution, but cannot set the level.
BM 2: Board enters into the dividend transaction.
How is share capital maintained?
Maintaining Share Capital: Companies are required to maintain their share capital (the money raised by allotment).
(1) Capital: Capital is the nominal value of shares issued (companies can also charge a premium on top of this, known as share profit). It is a debt owed to creditors, which cannot be refunded or spent.
(2) Exceptions: Companies can spend capital only in three instances.
Buyback: Buyback of shares through the correct procedure (s690).
Unfair Prejudice Order: Buyback of shares pursuant to a court unfair prejudice order (s994).
Winding Up: Capital can be given to creditors or, if surplus remains, shareholders on winding up.
What is the procedure for buyback of shares?
Buyback: Buyback is the process of repurchasing shares from shareholders, and cancelling them thereafter (s690). This is subject to directors’ duties and strict legislation. The following process is off-market buyback (stock-market beyond scope):
(1) Articles: The articles must not prevent buyback (s690).
(2) Full Payment: Shares must be fully paid for at point of buyback (s691).
(3) Source of Funds: Shares must be funded from distributable profits or the proceeds of a recent share issue made expressly for buyback funding (s692). In stricter circumstances, capital may be used.
(4) Authorisation: Shareholder authorisation must be provided (below).
(5) Inspection: A copy of the buyback contract or its written terms must be kept at office/SAIL for 10 years (s702).
Profit Buyback
Profit Buyback: Shares may be repurchased through distributable profits.
(1) Distributable Profits: Realised Profits - Realised Losses (s830). This is the Profit/Loss Reserve.
(2) Considerations: There must be: a) no article restrictions; b) sufficient cash; and c) directors’ duty compliant.
(3) Board Meeting Sandwich: There must be a board meeting sandwich.
BM 1: Board approves method of finance, draft contract, and calls GM/WR.
>Draft memorandum must be at RO for 15 days pre-GM, or circulated with WR (s696).
GM: Shareholders must pass an ordinary resolution approving buyback (s694).
>Interested members cannot vote (s695).
BM 2: Board results to enter contract, or authorise directors to do so.
(4) Administration: Subject to internal and external administration. >Companies House notified of purchase and cancellation of own shares within 28 days (Form SH03). >Internal registers updated. >Copy/terms kept at office/SAIL for 10 years.
What is the procedure for capital buyback?
Capital Buyback: Shares may be repurchased through capital, through a stricter procedure (s709).
(1) Exhausted Profits: There must be no distributable profits, or they must be exhausted first .
>Company with £20,000 profit seeks to buyback £30,000 shares. First £20,000 must be profit, rest capital.
(2) Board Meeting Sandwich: Board Meeting Sandwich occurs, but subject to greater notice requirements.
(3) Statement of Solvency: Board makes a statement of solvency, which must be dated no more than 1 week before shareholder vote, which must also be available at the vote or circulated with the WR.
>Confirms solvency of company for up to 1 year following buyback.
>If insolvency occurs in this time, directors and interested members are personally liable for loss.
>It is a criminal offence to provide an unreasonable statement.
(4) Auditors’ Report: Solvency statement must be annexed to an auditors’ report, confirming that the statement is not unreasonable, also available at GM or circulated with WR (s714).
(5) Shareholder Resolution: Two shareholders’ resolutions are required (s716).
>Interested shareholders cannot vote (ss712-717).
Buyback Approval: Buyback approved by ordinary resolution.
Capital Approval: Use of capital approved by special resolution.
(6) Post-Resolution Notices: Following effective resolution, further notices are required.
London Gazette: Notice in London Gazette within 7 days (s719).
>Specifies use of capital, date of resolution, location of solvency statement and auditors’ report.
>Provides creditors 5 weeks to object to buyback.
National Newspaper/Personal Notice: Notice in national newspaper, or given to each creditor (s719).
(7) Pre-Buyback Administration: There are a number of administrative formalities prior to buyback.
>Solvency statement and auditors’ report filed at Companies House before buyback (s719).
>Copy of solvency statement and auditors’ reports kept at office/SAIL for 5 weeks after SR (s720).
>Special Resolution filed at CH within 15 days of SR.
(8) Buyback: Buyback must occur between 5 and 7 weeks of SR (after creditor objection period expires) (s723).
(9) Post-Buyback Administration: There are a number of administrative formalities following buyback.
>Companies House notified of purchase and cancellation of own shares within 28 days (Form SH03).
>Internal registers updated.
>Copy/terms kept at office/SAIL for 10 years.
How does equity finance compare to debt finance?
Risk of Investment
Shares are riskier (downturn means dividends less likely, and capital value decreases)
Debts are safer as a contractual liability, and will often be secured to guarantee repayment.
Involvement
Shareholders have voting rights.
Lender has no say in company operations.
Repayment
Shares are not generally repaid by the company, but can be sold to others.
Loan capital must be repaid, sometimes on demand.
Restrictions on Sale
Share transfer may be governed by company articles. Directors have discretion to refuse registration.
Lenders may sell debentures to third parties - company articles cannot restrict this right.
Capital Value of Investment
Share value may rise and fall as the company succeeds.
Capital value of the loan generally remains constant - income is the benefit.
Statutory Controls
Equity finance is tightly controlled by CA 2006.
Debt finance is governed by contract law, so can be more flexible.
Payment of Income
Company pays dividends only if profits are available, and has discretion in any case.
Debt interest must be paid according to terms of loan, regardless of profits.
Tax Treatment of Income
Dividend payments are not tax deductible for the company.
Loan interest repayment is tax deductible for the company.
Cost
The cost of equity is the likely return to a new shareholder.
The cost of debt is the interest rate charged to the company. Consider tax savings.
Existing Restrictions
Articles may restrict company’s ability to issue shares.
Terms of loan agreement may restrict taking of new loans/require consent.
Existing Capital Structure
If a company has high debt, it may only be able to obtain equity (‘high gearing’).
