Corporate Funding

Question 1

Where does corporate capital come from?

Answer 1

Corporate capital comes from the issuance of many types of securities (investments)

Question 2

What are the two main types of securities?

Answer 2

1. Debt Securities
2. Equity Securities

Question 3

What is Debt Security?

Answer 3

The corporation borrows funds and issues a debt security, which is a promise that the corporation will repay the loan with interest.

• Debt security is usually called a bond
• A debt security holder is a creditor and has no ownership interest in the corporation

Question 4

What is Equity Security?

Answer 4

An equity security is an instrument representing an investment in the corporation whereby its holder becomes a part owner of the business. Equity securities are shares of the corporation, and the investor is called a shareholder

Question 5

What are the main types of Shares?

Answer 5

1. Authorized Shares: The shares that are described in a corporation’s articles. The corporation may not sell more shares than are authorized.
2. Issued and Outstanding Shares: Shares that have been sold to investors.
3. Authorized but Unissued Shares: Shares that have been reacquired by the corporation through repurchase or redemption. These are sometimes referred to as treasury shares
4. Certified (represented by a certificate) or Uncertified Shares

Question 6

What are common shares?

Answer 6

Shareholders have an equal ownership right.

Question 7

What are the main requirements if the corporation’s stock is to be divided into classes or series within a class?

Answer 7

If shares are to be divided into classes, the articles must:

1. Prescribe the number of shares of each class
2. Prescribe a distinguishing designation for each class (e.g., “Class A preferred,” “Class B preferred,” etc.)
3. Address the rights, preferences, and limitations of each class (either immediately or a declaration that the board will determine prior to issuance)

Question 8

What is issuance?

Answer 8

An issuance of stock is when a corporation sells its own stock.

Question 9

What are Subscriptions?

Answer 9

Subscriptions are written offers to buy stock from a corporation.

Question 10

When may Subscriptions be Revoked?

Answer 10

• Preincorporation Subscription — Irrevocable for six months unless otherwise provided in the terms of the subscription agreement or unless all subscribers consent to revocation.
• Postincorporation Subscription — Revocable until accepted by the corporation. In other words, the corporation and the subscriber are obligated under a subscription agreement when the board accepts the offer.

Question 11

What is the Traditional View of Consideration for Stocks?

Answer 11

Traditionally, stock could NOT be issued by a corporation for less than the stock’s stated par value (minimum issuance price), and the consideration received for par value stock had to be held in a certain account containing at least the aggregate par value of the outstanding par value shares.

Watered Stock: On the bar exam, if you’re given par stock, watch for watered stock, which can occur when par value stock is issued for less than its par value.

Question 12

What is the MBCA Approach for Consideration for Stocks?

Answer 12

The MBCA generally DOES NOT follow the traditional par value approach and instead ALLOWS corporate directors to issue stock for whatever consideration they deem adequate.

• The MBCA also provides that the board of directors’ good faith determination as to the adequacy of the consideration received is conclusive as to whether the stock exchanged for the consideration is validly issued, fully paid, and nonassessable.

Question 13

What is a Preemptive Right?

Answer 13

A preemptive right is the right of an existing shareholder of common stock to maintain her percentage of ownership in the company by buying stock whenever there is a new issuance of stock for money

Under the MBCA, shareholders do not have a preemptive right to purchase newly issued shares to maintain their proportional ownership interest unless the articles of incorporation provide the right.

Even if the articles do provide a preemptive right, shareholders generally have no preemptive right in shares issued:

1. For consideration other than cash (for example, for services of an employee)
2. Within six months after incorporation OR
3. Without voting rights but having a distribution preference