COMPANIES—RAISING FINANCE

Question 1

Equity Finance

Answer 1

1. Equity finance is a method of raising capital whereby a company sells ownership shares in the company to third parties interested in investing in the company.
2. 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

5

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

2

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. under the model articles the full value of the shares must be paid to the company on allotment

Question 5

5

Issuing Shares at a Premium

Answer 5

1. In reality, the nominal or par value of shares often does not reflect 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.
2. Any amount received beyond the nominal value is known as a premium.
3. The excess amount paid over and above the nominal value must be **recorded separately **in a share premium account.
4. This still constitutes share capital.
5. There are special rules regarding use of money in this account

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 first be offered 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

2

Statutory Procedure for Preemption Rights

Answer 7

1. When a company proposes to issue ordinary shares for cash consideration, it must offer 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.

EXAMPLE
A private limited company has 5 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 offered the opportunity to purchase 20 per cent of the shares to be issued (that’s 100 shares) for £5,000 (100shares 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 May Alter Preemptive Rights

Answer 10

A company’s articles may alter the statutory preemption right. A private company’s articles may disapply the statutory 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

3

Debt Finance

Answer 12

1. Debt finance occurs when the company borrows money to raise capital.
2. The company enters into a creditor-debtor relationship, whereby the company has borrowed funds from an ‘outside creditor’ and promises to repay the creditor.
3. 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.

Question 14

Loans

Answer 14

1. A common form of debt is a loan.
2. 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.

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

3

Mortgages

Answer 16

1. A mortgage is a loan taken over high value assets (for example, land, buildings, or machinery).
2. 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.
3. With land the right to possess and sell the asset if the lender defaults are governed by statute.

Question 17

3

Fixed Charges

Answer 17

1. A fixed charge is taken over assets which the company will own for a substantial period (for example, machinery and shares).
2. 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.
3. To protect the charge holder, the company is prohibited from disposing of, leasing, or granting a further charge on thecharged assets without the lender’s consent.

Question 18

Floating Charges

Answer 18

1. A foating charge is a charge taken over a group of assets that change regularly.
2. The clearest example is inventory.The charge hovers over the named asset (for example, inventory) but does not attach to any particular item until there is a default.
3. 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

4

Charge Must Be Registered at Companies House

Answer 20

1. A charge created by a company must be registered at Companies House within 21 days of creation.
2. A certifed copy of the charge and a fee must also be sent.
3. In addition, some charges must be registered on other specialised registers, for example, a fIxed charge over land would also be registered at Land Registry.
4. 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

3

Priority of Secured Debts

Answer 21

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

2

TAXATION IMPLICATIONS

Answer 23

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