COMPANIES—RAISING FINANCE

Question 1

Equity Finance

Answer 1

Equity fnance is a method of raising capital whereby a com-
pany sells ownership shares in the company to third parties
interested in investing in the company. The third parties give
the company money, and in exchange the company allots
shares of ownership to the third parties who thereby become members of the company.

Question 2

Initial Share Capital

Answer 2

1. before a company is formed, people will sign a mem-orandum of association in which they agree to purchase a certain number of the company’s shares at a certain price once the company is formed. These people are known as the company’s subscribers.
2. The shares will have a stated minimum value—theleast amount that the shareholders may pay for the shares.
3. Thisis known as the nominal or par value of those shares.
4. Once the company is formed, the board of directors will allot
   the agreed shares to the subscribers and receive payment
   for the shares.
5. The money received on account of the nomi-nal or par value becomes a company’s share capital—a fund of money that cannot be returned to the shareholders and which theoretically is always available to pay the company’s
   creditors.

Question 3

Additional Share Allotment

Answer 3

1. For companies incorporated after 2009, directors automatically have the power to allot additional shares provided the company has only one class of shares and there is no restriction removing this power in the articles (the model articles have no restric-tion).
2. In other situations, in order to issue additional shares,
   the directors must seek permission from the existing share-holders through an ordinary resolution.

Question 4

General Procedure for Issuing Shares

Answer 4

1. The directors will determine the price and number of shares
   to allot and will resolve to allot the shares after receiving
   an application from a person who wants to buy the shares.
2. Generally, shares are issued in exchange for cash, but the
   directors may accept property for shares as well.
   3, nUnder the model articles the full value of the shares must be paid to the company on allotment

Question 5

Issuing Shares at a Premium

Answer 5

1. In reality, the nominal or par value of shares often does
   not refect the shares’ true market value. For example, it
   is quite common for a company’s articles to provide that
   its shares shall have a nominal value of £1. If the company
   has successfully been trading for a while, it might be that
   each share now is actually worth £5. In such a case, if the
   directors decide to issue new shares, they will want to
   get as high a price as they can and not just the £1 each.
   Any amount received beyond the nominal value is** known
   as a premium.
2. The excess amount paid over and above the nominal value must be recorded separately in a share
   premium account.
3. This still constitutes share capital.
4. There are special rules regarding use of money in this ac-
   count

Question 6

Preemption Rights

Answer 6

When the company proposes to issue additional shares in ex-change for cash, unless its articles provide otherwise, those
shares must frst be ofered to the existing shareholders so
that they have the opportunity to maintain their proportional
share of ownership and voting strength in the company. This
right is known as the ‘preemption right’.

Question 7

Statutory Procedure for Preemption Rights

Answer 7

1. When a company proposes to issue ordinary shares
   for cash consideration, it must ofer the shares to the
   current shareholders (based on their proportional owner-ship)** on the terms for which the shares would be ofered in the open market**.
2. The existing shareholders must be given at least 14 days to accept. If any shareholder does not accept, the shares allocated to the shareholder may be sold in the market.

XAMPLE
A private limited company has fve shareholders: A-E. Each
shareholder owns 20 per cent of the company’s 1,000
issued shares (that’s 200 shares each). The company has
unaltered Model Articles. The directors resolve to issue an
additional 500 shares for £50 each share. Each shareholder must be ofered the opportunity to purchase 20 per cent of
the shares to be issued (that’s 100 shares) for £5,000 (100
shares x £50). Shareholders A-D agree to purchase the new shares. E decides not to purchase any new shares. The
company sells those 100 shares to F. As a result, A-D have maintained their 20 per cent ownership interest (each owns 300 of the company’s 1,500 issued shares). E’s interest is
now about 13.33 per cent (200 of 1,500 shares), and F has
about a 6.67 per cent interest (100 of 1,500 shares).

Question 8

Preemption right Inapplicable to Shares Issued for Non-Cash

Answer 8

If shares are to be issued for consideration other than
cash (for example, in exchange for a piece of land or a
piece of equipment), the preemption right does not apply.
Neither does the preemption apply to preference shares

Question 9

Preemption right May Be Disapplied by Special Resolution

Answer 9

The preemption right may be disapplied by a special
shareholder resolution.

Question 10

Articles MayAlter Preemptive Rights

Answer 10

A company’s articles may alter the statutory preemption
right. A private company’s articles may disapply the stat-
utory preemption right altogether. However, the Model
Articles do not alter the statutory right.

Question 11

Transfer of Shares

Answer 11

The ability of an existing
shareholder to sell their shares is governed by the articles of the company. The model articles for private companies grant the directors an absolute power to refuse to allow a transfer of shares. The procedure is set out in the chart that follows.

Question 12

Debt Finance

Answer 12

Debt finance occurs when the company borrows money
to raise capital. The company enters into a creditor-debtor
relationship, whereby the company has borrowed funds from
an ‘outside creditor’ and promises to repay the creditor. The
debt holder has no ownership interest in the company.

Question 13

Directors Have Power to Borrow

Answer 13

The directors have the power to decide to borrow money
on behalf of the company unless there are restrictions on
borrowing in the company’s articles. T

Question 14

Loans

Answer 14

A common form of debt is a loan. A loan is a contract between the company and a lender. The lender can be a bank
or an individual, and in many small companies, a director or
shareholder may lend money to the company. T

Question 15

Secured vs Unsecured Loans

Answer 15

A loan can be secured by collateral or unsecured. (Collateral is property the debtor agrees the creditor can take to
satisfy the loan in the event the debtor defaults in paying
back the loan.)

Question 16

Mortgages

Answer 16

A mortgage is a loan taken over high value assets (for example, land, buildings, or machinery). Apart from land, the
legal ownership of the asset is transferred to the lender,
and if the company defaults, then the lender will exercise the right to immediate possession of the asset. With
land the right to possess and sell the asset if the lender
defaults are governed by statute.

Question 17

Fixed Charges

Answer 17

A fixed charge is taken over assets which the company will
own for a substantial period (for example, machinery and
shares). If a company breaches the loan terms, or goes into
receivership or liquidation, the charge holder has the right to sell the asset and recover the outstanding sum owed. To
protect the charge holder, the company is prohibited from
disposing of, leasing, or granting a further charge on the
charged assets without the lender’s consent.

Question 18

Floating Charges

Answer 18

A foating charge is a charge taken over a group of as-
sets that change regularly. The clearest example is inven-
tory.The charge hovers
over the named asset (for example, inventory) but does
not attach to any particular item until there is a default.
At that time, the charge crystallises and attaches to the
individual items that comprise the asset that is subject to
a foating lien.

Question 20

Charge Must Be Registered at Companies House

Answer 20

A charge created by a company must be registered at
Companies House within 21 days of creation. A certi-
fed copy of the charge and a fee must also be sent. In
addition, some charges must be registered on other
specialised registers, for example, a fxed charge over
land would also be registered at Land Registry. Failure
to register the charge at Companies House renders the charge void against a liquidator or administrator of the
company and against the company’s other creditors.

Question 21

Priority of Secured Debts

Answer 21

Fixed charges over the same asset take priority in date order of their creation, so long as they were validly reg-
istered at Companies House. Floating charges over the same assets take priority in date order of their creation, so long as they were validly registered at Companies
House.A fxed charge will take priority over a foating
charge over the same asset, even if the foating charge was created before the fxed charge.

Question 22

Debt Securities

Answer 22

A debt security is a document which evidences a loan made
to a company and which may be traded. The holder of the
debt security is entitled to interest and repayment of the loan as provided in the security. Conceptually, it is a tradable ‘IOU’ (I Owe You) issued by the company in return for cash. The
IOUs must be repaid by the company at an agreed future
date.

Question 23

TAXATION IMPLICATIONS

Answer 23

The tax liability of companies is governed by the corporation
tax regime, and companies pay corporation tax on their prof-
its. Shareholders who invest in a company by way of shares will be taxed to income tax on any dividends they receive
from the company. (