Equity Finance Flashcards

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1
Q

What is capital?

A

The general term ‘capital’ is used to refer to the funds available to run the business of a company. In company law, the term ‘share capital’ relates to the money raised by the issue of shares. The share capital is contributed by investors in the company and is represented by shares that are issued to such investors.

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2
Q

How does a company fund its business?

A

There are various ways in which a company can raise funds, including by issuing shares, (ie ‘equity finance’); borrowing (ie ‘debt finance’); and/or retaining its profits for use in the business (rather than paying the profits to the shareholders).

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3
Q

what are shares?

A

A share is often described as a ‘bundle of rights’.

By investing in the share capital of any company, the investor becomes a part owner of the company and will often have voting rights in shareholder meetings. In the case of a private company, most investors make a long-term investment and will only usually get their investment back on a sale of their stake, a sale of the company itself, on a flotation, or when the company is wound up (provided sufficient funds are available).

The incentives for investing would be the receipt of income (by way of dividend) and a capital gain (by way of the growth in the value of the company, and therefore the individual shares), although neither are guaranteed.

Different classes of shares may carry different rights and entitlements. All rights and entitlements in relation to shares of all classes are set out in the Articles. It is imperative to check these.

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4
Q

Share capital structure

A

Section 542(1) CA 2006 provides that the shares in a limited company having a share capital must have a fixed nominal value. Section 542(2) CA 2006 provides that any allotment of a share that does not have a fixed nominal value is void. The nominal or par value of a share is the minimum subscription price for that share.

It represents a unit of ownership rather than the actual value of the share. Common nominal values for ordinary shares are 1p, 5p or £1.

Section 580 CA 2006 provides that a share may not be allotted/issued by a company at a discount to its nominal value.

However, a share may be allotted/issued for more than its nominal value, and the excess over nominal value is known as the ‘premium’. The market value will often be much higher than the nominal value of the share.

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5
Q

Issued Shares

A

The amount of shares in issue at any time is known as the issued share capital (‘ISC’). This is the amount of share capital that will be shown in the company’s balance sheet in its accounts. This was the same under CA 1985. A company’s ISC is made up of:

  • shares purchased by the first members of the company, known as the ‘subscriber shares’; and
  • further shares issued after the company has been incorporated, to new or existing shareholders. New shares can be issued at any time provided that the correct procedures are followed.
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6
Q

Allotted Shares

A

Shares are said to be allotted when a person acquires the unconditional right to be included in the company’s register of members in respect of those shares. This term is often used interchangeably with the issue of shares but the terms have different meanings. There is no statutory definition of ‘issue’, but it has been held that shares are only issued and form part of a company’s issued share capital once the shareholder has actually been registered as such in the company’s register of members, and their title has become complete. Full legal title to shares is only achieved once a person’s name is entered in the company’s register of members.

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7
Q

Called-up/Paid-up Shares

A

immediately. The amount of nominal capital paid is known as the ‘paid-up share capital’. The amount outstanding can be demanded by the company at any time. Once demanded, the payment has been ‘called’. It is increasingly rare for shareholders not to pay the full nominal value of their shares on issue.

The definition of ‘called-up share capital’ in s 547 CA 2006 is the aggregate amount of the calls made on a company’s shares and the existing paid-up share capital. Given that shares are rarely not fully paid up, this term is not regularly used.

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8
Q

Treasury shares

A

These are shares that have been bought back by the company itself and are held by the company ‘in treasury’. Treasury shares are issued shares being held by the company in its own name, and the company can subsequently sell those shares out of treasury.

Note that although such a sale of shares is a transfer, not an issue, of shares, s 561 CA 2006 pre-emption rights (see s 560(3) CA 2006) and s 573 CA 2006 disapplication of pre-emption rights will apply.

The company can also choose to cancel treasury shares at any time or transfer them to an employee share scheme.

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9
Q

Classes of shares

A

Ordinary shares

Redeemable shares

Preference shares

Non-voting shares

Employees’ shares

Cumulative shares

Convertible shares

Deferred shares

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10
Q

Ordinary shares

A

Ordinary shares the most common form of share and are the default position: if a company’s shares are issued without differentiation, they will be ordinary shares.

Ordinary shares carry a right to vote in general meetings, a right to a dividend if one is declared and a right to a portion of any surplus assets of the company on a winding-up. A company may have more than one class of ordinary share, with differing rights, and perhaps differing nominal values.

Ordinary shares are defined in s 560(1) CA 2006 as “shares other than shares that as respects dividends and capital carry a right to participate only up to a specified amount in a distribution”. This negative definition illustrates the point that ordinary shares are the default position and are shares that have an unlimited right to participate in dividends and in surplus capital when a company is wound up. These shareholders receive a fraction of the dividend and capital in accordance with their shareholding.

Although ordinary shareholders receive dividends after preference shareholders, one advantage of ordinary shares is that the entitlement of ordinary shareholders to a dividend is unrestricted.

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11
Q

Preference shares

A

A preference share may give the holder a ‘preference’ as to payment of dividend or to return of capital on a winding up of the company, or both. This means the payment will rank as higher priority than any equivalent payment to ordinary shareholders.

If there is a preference as to dividend, this will be paid before the other shareholders receive anything.

The amount of preferred dividend is usually expressed as a percentage of the par (nominal) value of the share eg 5% £1 preference shares – these shares give an entitlement to 5% of £1 per share (which equates to 5p per share) by way of dividend each year provided a dividend is declared.

If the preference shares have been issued at a premium to their par value and it is intended that a fixed dividend will be paid based on the amount subscribed for the share (ie par plus premium), the share rights must expressly state that the dividend is to be calculated as a percentage of the total subscription price per preference share.

Preference shares are normally non-voting although it is important to check the rights set out in the Articles since it is possible to issue preference shares with voting rights.

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12
Q

Cumulative preference shares

A

It is presumed that a preference share is ‘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 and 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.

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13
Q

Participating preference shares

A

‘Participating’ preference shareholders may participate, together with the holders of ordinary shares, (1) in surplus profits available for distribution after they have received their own fixed preferred dividend; and/or (2) in surplus assets of the company on a winding up. As with preference shares, participating preference shares are 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’.

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14
Q

Deferred shares

A

These carry no voting rights and no ordinary dividend but are sometimes entitled to a share of surplus profits after other dividends have been paid (presuming there is a surplus); more usually ‘deferred’ shares carry no rights at all and are used in specific circumstances where ‘worthless’ shares are required.

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15
Q

Redeemable shares

A

Redeemable shares are shares which are issued with the intention that the company will, or may wish to, at some time in the future, buy them back and cancel them.

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16
Q

Convertible shares

A

Such shares will usually carry an option to ‘convert’ into a different class of share according to stipulated criteria.

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17
Q

Variation of class rights

A

A company may issue different classes of share, as seen above. The rights attaching to each class are usually set out in the company’s Articles. In relation to any type of share, you should always 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. The court will not confirm the variation if it feels that the variation unfairly prejudices the shareholders of the class in question.

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18
Q

Dividends

A

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), and
  • 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)).

There are two types of dividend:

1.Final dividends – Final dividends are recommended by the directors and declared by the company by an ordinary resolution of the shareholders following the financial year end.

2.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. Interim dividends are often paid where the company has realised an investment.

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19
Q

What is the difference between allotting and transferring shares?

A

An allotment of shares is a contract between the company and a new/existing shareholder under which the company agrees to issue new sharesin return for the purchaser paying the subscription price.

A transfer is a contract to sell existing shares in the company between an existing shareholder and the purchaser.The company is not a party to the contract on a transfer of shares (with the exception of a sale out of treasury of treasury shares).

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20
Q

The s 755 restriction on private companies offering shares to the public

A

Under s 755 CA 2006 a private company limited by shares is prohibited from offering its shares to the public. As a result, private companies are essentially restricted to offering their shares to targeted investors only and not to the public indiscriminately.

The expression ‘offer to the public’ (as defined in s 756 CA 2006) covers offers to ‘any section of the public’ but excludes offers which are intended only for the person receiving them and offers which are a ‘private concern’ of the persons making and receiving them. This latter exclusion covers offers made to existing shareholders, employees of the company and certain family members of those persons, and offers of shares to be held under an employee’s share scheme. These excluded offers will not fall foul of the s 755 restriction.

This restriction must be considered carefully when a private company is proposing to allot shares.

You will consider the procedure to allot shares in the next element.

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21
Q

The requirement for a prospectus

A

Every time that a company offers shares you will need to consider whether it is required to publish a prospectus to would-be investors. A prospectus is an explanatory circular giving investors details about the company and about the investment itself on which to base their investment decision. A prospectus should contain all the information necessary to enable investors to make an informed assessment of the financial status of the company and the rights attaching to the shares (s 87A(2) FSMA), and preparing a prospectus is therefore an expensive and time-consuming process.

In an offer of shares by a private company, it will usually be the case that a prospectus will not be required. However, you will need to consider the rules each time.

22
Q

Financial Promotions

A

Under s 21 FSMA a financial promotion is any invitation or inducement (in the course of business) to engage in investment activity (which includes buying shares). Financial promotions are prohibited (for all companies) unless certain requirements set out in FSMA are fulfilled. Clearly this is potentially relevant when a company is considering issuing shares to investors. Communications made by a company when issuing its shares must, either be within an exemption from the s 21 FSMA prohibition or be issued or approved by an authorised person.

23
Q

Transfer and transmission of shares

A

Transmission of shares is an automatic process in the event of death or bankruptcy of a shareholder as follows:

  • If a shareholder dies, their shares will automatically pass to their personal representatives.
  • If a shareholder is made bankrupt, their shares automatically vest in their trustee in bankruptcy.

Transfer

Shares may be transferred from an existing shareholder to a new shareholder by way of sale or gift.

Shareholders are free to transfer their shares subject to any restrictions in the Articles (s 544(1) CA 2006).

It is therefore important to check the Articles for any restrictions on transfer.

Some common restrictions are set out below.

24
Q

Restrictions on transfer

A

The two most common forms of restriction are:

  1. Directors’ power to refuse to register

Article 26(5) MA states: “The directors may refuse to register the transfer of a share, and if they do so, the instrument of transfer must be returned to the transferee with the notice of refusal unless they suspect that the proposed transfer may be fraudulent”.

Under s 771 CA 2006, a company must give reasons if it refuses to register a transfer.

  1. Pre-emption clauses (rights of first refusal)

Here we are looking at pre-emption rights on a transfer of shares (which should not be confused with pre-emption rights on allotmentunder s 561 CA 2006). Such rights are usually set out in the articles. CA 2006 and MA do not contain any pre-emption rights on transfer, so they must be specially inserted into the Articles of any company wishing to establish them. Pre-emption rights on transfer will often require that a shareholder wishing to sell shares must offer them to the other existing shareholders before being able to offer them to an outsider.

25
Q

Method of transfer

A

Instrument of transfer

A transfer of shares is made by way of a stock transfer form, which has to be signed by the transferor and submitted, with the share certificate, to the new shareholder (s770 CA 2006).

Legal and equitable ownership

Beneficial title to the shares passes on the execution of the stock transfer form. Legal title passes on the registration of the member as the owner of those shares in the register of members by the company (s 112 CA 2006). The company will also send the shareholder a new share certificate in this name within two months (s 776 CA 2006).

Stamp duty

The stock transfer form must be stamped before the new owner can be registered as the holder of those shares. Stamp duty is currently payable at 0.5% of the consideration rounded up to the nearest £5. No stamp duty is payable where the consideration is £1000 or less; but where the consideration is more than £1000, a minimum fee of £5 is payable.

26
Q

When issuing shares, a company needs to follow a 5-step procedure.

A
  • 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.
27
Q

STEP 1: Any cap on the number of shares that may be issued?

A

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.

A company incorporated under 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 (since 1 October 2009) will continue to have a deemed ceiling on the number of shares that can be issued, in their articles, unless such cap is removed from their Articles.

The requirement for a company to have an ASC no longer exists under CA 2006. Companies incorporated under CA 2006 will not have an authorised share capital and shareholders wishing to impose a cap to restrict the number of shares which such a company can issue will need to amend the Articles (by special resolution) to include suitable provisions.

How can the cap be removed?

For companies incorporated under CA 1985, shareholders wishing to remove or amend the deemed restriction in a company’s Articles may do so by ordinary resolution. This is 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).

Companies incorporated under CA 2006 will not have an authorised share capital. For such companies, therefore, there will be no bar to issuing shares under step 1.

The only exception would be if the company has placed a provision in its Articles limiting the number of shares that may be issued. 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.

Step 1: Summary

For step 1, you must therefore check:

  • whether any resolutions to remove, impose or change any cap, or increase the share capital, have been passed, and ensure that you have up-to-date information (particularly checking the company’s Articles); and
  • 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.

*Companies are required to file an annual confirmation statement. This confirmation statement states (‘confirms’) that the company has filed all necessary returns in the previous 12-month period (eg changes to registered address, changes to directors or company secretary etc). It also sets out any changes to share capital.

28
Q

STEP 2: Do the company’s directors need authority to allot?

A

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 be able 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, or
  • s 551 CA 2006: for all other companies, the directors will need to be granted authority to allot the new shares by the shareholders by way of ordinary resolution.

Section 550 – Private companies with only one class of share

In private companies with only one class ofshare, s 550 CA 2006 provides that directors have the automatic power to allot sharesof that same class, unless they are prohibited from doing so by the company’s Articles.

This helps many smaller companies to simplify the process of issuing shares, since no shareholder resolution is required to grant authority to directors to allot the new shares.

Note that for companies incorporated under CA 1985, an ordinary resolution is required to authorise the directors to rely on s 550 CA 2006.

All other cases: Section 551 CA 2006

If s 550 CA 2006 cannot be relied upon, directors require authority under s 551(1) CA 2006, which provides that authority may be given by a provision in the company’s Articles or by shareholder resolution. Under s 281(3), this means an ordinary resolution unless the Articles require a higher majority. You would therefore need to check the latest version of the company’s Articles and any resolutions that have been passed giving the directors authority, in order to establish whether further authority is required.

Authority to allot under s 551(1) CA 2006 can only be given subject to limits in terms of both time and number of shares (s 551(3) CA 2006). This means that if the company has already granted its directors a s 551(1) CA 2006 authority, it must be checked to ensure it is still valid.

29
Q

STEP 3: Must pre-emption rights be disapplied on allotment?

A

What does a ‘pre-emption right’ mean?

It means the ‘right of first refusal’. New shares should be offered pro rata to existing shareholders before any new investor.

This is because, when a company allots shares to new shareholders, there is an effect on the proportionate ownership of the company held by the existing shareholders. Their ownership is diluted, and therefore their entitlement to dividends and voting power is also diluted.

Due to the potential dilution, s 561 CA 2006 contains pre-emption rights, which give protection to existing shareholders.

Where pre-emption rights apply, the most usual approach is for the company to request the existing shareholders to disapply these pre-emption rights by special resolution.

To what type of shares are pre-emption rights relevant?

Section 561 CA 2006 states as follows:

”(1) A company must not allot equity securities to a person on any terms unless

(a) it has made an offer to each person who holds ordinary shares in the company to allot to him on the same or more favourable terms a proportion of those securities that is as nearly as practicable equal to the proportion in nominal value held by him of the ordinary share capital of the company …”

As a result, any new ‘equity securities’ (defined ins 560 CA 2006) must be offered to the existing shareholders of a company (holding ordinary shares), in proportion to their existing shareholdings, before they can be offered to anyone outside the company.

Under s 560(1) CA 2006, ‘equity securities’ are (i) ‘ordinary shares’ or (ii) rights to subscribe for, or convert securities into, ordinary shares.

However, under s 560(1) there is a special statutory definition of ‘ordinary shares’, the meaning of which is wider than we are accustomed to in everyday parlance.

‘Ordinary shares’ are shares ‘other than shares that as respects dividends and capital carry a right to participate only up to a specified amount’ for this purpose.

This means that if a class of shares carries a right to receive dividends and, on a winding up, capital payments, and these rights are both capped, the shares will not fall within the definition of ‘equity securities’ and will not need to be offered pre-emptively.

In every other case, the shares will fall within the definition of ‘equity securities’ and be subject to pre-emption rights under s 561 CA 2006.

30
Q

Can a company disapply pre-emption rights?

A

Yes. The procedure for giving effect to pre-emption rights (which can be found in s 562 CA 2006) can be lengthy and, especially for companies with numerous shareholders, complicated to carry out.

On many occasions it will not be appropriate or desirable to follow the pre-emption rights procedure set out in CA 2006: for example, where all shareholders agree that the company ought to bring in a new shareholder. In such a case, the company would want to disapply or excludethe pre-emption rights. This is permitted in CA 2006, with the permission of the company’s existing shareholders.

In practice, companies usually use one of these two methods to disapply pre-emption rights, depending on the source of the directors’ authority to allot the shares.

  1. General disapplication of pre-emption rights

A company may disapply pre-emption rights where the directors are generally authorised for the purposes of s 551 CA 2006 by passing a special resolution or by including the disapplication in its articles, both under s 570(1) CA 2006. This is not a permanent disapplication, but attaches to a particular, pre-existing s 551 authority. In practice, this is the most common means by which companies dispense with pre-emption rights on allotment.

  1. Private companies with one class of share – disapplication by special resolution

Section 569 CA 2006 provides for disapplication of pre-emption rights for private companies with only one class of share by special resolution. Such a disapplication presupposes the directors’ authority to allot the shares derives froms 550 CA 2006 and therefore can apply for so long as the company has in issue, and allots, shares of only one class.

  1. There are other ways to disapply pre-emption rights:
  • Specific disapplication of pre-emption rights: It is possible, although uncommon, for a company to disapply pre-emption rights in relation to a specific allotment of shares (eg in relation to shares being issued to a particular person or as consideration for a specific purpose) by passing a special resolution under s 571 CA 2006 (rather than s 570 CA 2006). The procedure for specific disapplication is more cumbersome than that for a general disapplication. Directors will need to provide the company’s shareholders with a written statement explaining (i) the reasons for the specific disapplication, and (ii) the amount to be paid to the company pursuant to the allotment along with justification for the amount, under s 571(6) CA 2006. A specific disapplication under s 571 attaches to a particular, pre-existing s 551 authority.
  • Private companies – exclusion of pre-emption rights in Articles (s 567 CA 2006): Private companies can exclude statutory pre-emption rights permanently, by way of a provision in their Articles. However, companies rarely exclude pre-emption rights on a permanent basis because this would give existing shareholders no protection from dilution (there is no such provision in MA). In practice, only subsidiary companies commonly exclude statutory pre-emption provisions in their Articles.
  • Private companies with one class of share – disapplication in Articles (s 569 CA 2006): provides for disapplication of pre-emption rights for private companies with only one class of shareunder the Articles. This is also unusual in practice because it leaves existing shareholdings with no protection from dilution.
31
Q

STEP 4: Must new class rights be created for the shares?

A

When issuing new shares, a company may also wish to create a new class of shares, such as preference shares.

You considered some examples of rights typically attached to different classes of shares in element 1.

In order to create a new class of shares, it is necessary for the company, in addition to taking some or all of the steps set out previously, to insert new provisions in its Articles dealing with the rights attached to those new shares.

An alteration to the Articles, you will recall, requires a special resolution of the shareholders under s 21 CA 2006 (except with a CA 1985 company if removing a cap transferred from a company’s authorised share capital in its memorandum).

32
Q

STEP 5: Directors must pass a board resolution to allot the shares

A

The directors will resolve by board resolution to allot new shares on behalf of the company. Any requirements for shareholder resolutions must be dealt with in a general meeting before the board meeting is held at which the new shares are allotted. A general meeting will not be needed in advance of the board meeting if:

  • has no limit in its constitution on the number of shares which can be issued by the company; and
  • does not require directors’ authorisation because the company is a private company with only one class of shares and there is no restriction in the company’s Articles – s 550 CA 2006) or has already given the directors authority to allot shares; and
  • is issuing the shares to existing shareholders in proportion to their existing shareholdings and follows the procedure in s 562 CA 2006 or has already disapplied s 561 CA 2006 or is a private company and has taken advantage of s 567 CA 2006; and
  • has the relevant class rights in its Articles.
33
Q

Administrative requirements on allotment

A

Copies of resolutions to be sent to Companies House within 15 days (s 29, s 30(1), s 26(1))

*CA 1985 companies: need to file any ordinary resolution removing the cap on authorised share capital and any ordinary resolution allowing the company to use s 550 CA 2006 if passed

*Any s 551 ordinary resolution granting the directors authority to allot if passed

*All special resolutions regarding the disapplication of pre-emption rights and/or amending articles if passed

*Amended Articles must also be sent to Companies House if a new class of shares has been created and the Articles amended

Company forms to be sent to Companies House

  • Return of allotment (Form SH01) and statement of capital within one month
  • If the persons with significant control have changed as a result of allotment, the relevant forms (PSC01, PSC02, PSC04, PSC07)

Updating company registers

  • Update register of members within two months of the allotment.
  • Update PSC register if necessary

Share certificates

  • Share certificates must be prepared and sent to new shareholders within two months of thr allotment.
34
Q

To which transactions are the rules on financial assistance applicable?

A

Acquisition or sale of shares

Financial assistance is relevant when there is an acquisition (or proposed acquisition) of shares.

A share sale involves an acquisition by way of a share transfer. When a share sale is contemplated, therefore, the funding arrangements should be examined carefully to see if they fall foul of the financial assistance prohibitions.

Issue of shares

Financial assistance is also relevant on an issue of shares by a company to an investor, since that equally amounts to an acquisition of shares by the investor.

35
Q

Which companies are prohibited from giving financial assistance?

A

Sections 678(1), 678(3), 679(1) and 679(3) CA 2006 set out the basic prohibitions on the giving of financial assistance. It is important to analyse the wording of ss 678 and 679 CA 2006 very carefully to determine which companies are caught by these prohibitions.

It is first necessary to establish the identity of the company in which shares are being acquired.

  • On a share sale this will be the company which is the subject of the acquisition.
  • On an issue of shares this will be the company doing the issuing of the shares.

The company whose shares are being acquired (whether by transfer or issue) will be referred to as the target company.

It is then necessary to consider whether the target company is a public company, in which case the relevant section to consider is s 678 CA 2006, or a private company, in which case the relevant section to consider is s 679 CA 2006.

If the target company is a public company, under s 678(1) and (3) CA 2006 the prohibition on giving financial assistance applies to:

  • The target company itself; and
  • any subsidiary of the target company, whether private or public
36
Q

What does giving financial assistance mean?

A

Financial assistance is very broadly defined in s 677 CA 2006. Section 677 sets out a number of different types of transaction that may amount to financial assistance:

  • Financial assistance given by way of gift (s 677(1)(a) CA 2006).
  • Financial assistance given by way of guarantee, security or indemnity, release or waiver (s 677(1)(b) CA 2006).
  • Financial assistance given by way of loan or similar agreement (s 677(1)(c) CA 2006).
  • Any other financial assistance given by a company where the net assets of the company are reduced to a material extent by the giving of the financial assistance or the company has no net assets (s 677(1)(d) CA 2006).

Note that the last of these provides a “catch-all” for any type of transaction not expressly listed in the preceding sub-sections, if it materially reduces a company’s net assets or if the company has no net assets.

Note also that, because of the wording of s 677 CA 2006 (“financial assistance means… financial assistance given by way of…”), it is not enough that a transaction is of the type listed above – it must also actually constitute financial assistance. In other words:

  • assistance must be being given; and
  • the assistance must be financial in nature.

It has been held that these terms should be given their ordinary meaning, bearing in mind the commercial realities of the transaction eg actions which merely “smooth the path to the acquisition“ (such as the payment, by a subsidiary of the target, of due diligence fees incurred by the buyer) have been held to amount to financial assistance.

Financial assistance is covered by the rules whether it is direct (eg a loan given to the buyer of shares) orindirect (eg a guarantee given to a bank in relation to a loan made by the bank to a buyer of shares).

Financial assistance is also covered by the rules whether it is given before or at the same time as the acquisition (s 678(1) and s 679(1) CA 2006), or after the acquisition (s 678(3) and s 679(3) CA 2006).

Finally, to fall within the statutory provisions, the financial assistance must be being given for the purpose of the acquisition (or, if given after the acquisition, for the purpose of reducing or discharging a liability incurred for the purpose of the acquisition), ie the company giving the assistance must have intended to facilitate the acquisition.

37
Q

Are there any exceptions to the prohibition?

A

The “purpose” exceptions

Sections 678(2), 678(4), 679(2) and s 679(4) CA 2006 set out “purpose” exceptions in relation to ss 678(1), 678(3), 679(1) and s 679(3) CA 2006 respectively.

Essentially, the purpose exception states that the giving of financial assistance will not be unlawful if the principal purpose in giving it is not for the purpose of the acquisition or if that purpose (the acquisition) is only an incidental part of some larger purpose.

It should be noted however that because of its narrow application as stated in case law and because of the very serious consequences of giving unlawful financial assistance, this exemption is not normally relied upon.

The unconditional exceptions

Section 681 CA 2006 lists a number of specific types of transaction which will be exempt from the ss 678 and 679 CA 2006 prohibitions, eg dividend payments (s 681(2)(a) CA 2006).

The conditional exceptions

Section 682lists a number of specific types of transaction which will be exempt from the ss 678 and 679CA 2006 prohibitions provided certain conditions are met.

These transactions include, for example:

  • Money lending in the ordinary course of business (s 682(2)(a) CA 2006).
  • Assistance in respect of employee share schemes (s 682(2)(b) CA 2006).

The conditions are that (i)the company giving the assistance is a private company or (ii) the company giving the assistance is a public company and the net assets of that company are not reduced by the giving of the assistance or to the extent that they are reduced the assistance is provided out of distributable profits (s 682(1) CA 2006).

It is important to note that, to fall within the s 682 CA 2006 exception, a transaction must be of a type listed in s 682(2) CA 2006 and fulfill the conditions contained in s682(1) CA 2006.

38
Q

What are the consequences of carrying out prohibited financial assistance?

A

Under s 680 CA 2006, breach of s 678 or s 679 CA 2006is an offence whichcan lead to penalties for:

  • the company (a fine) and
  • the officers of the company (fine/imprisonment).

In addition to the criminal penalties, under case law the transaction amounting to prohibited financial assistance (eg the loan made the buyer) would be void and the wider transaction (eg the share acquisition itself) may be void as well.

39
Q

Maintenance of share capital

A

Once a shareholder has decided to invest in shares in a company, that investment cannot normally be returned to the shareholder. In other words, a company is not usually permitted to return capital to its shareholders – all payments by a company to its shareholders should be made out of distributable profits.

The shareholders’ investment in a company is recorded in the accounts in the bottom half of the balance sheet. Generally speaking, a company cannot release the sums represented in the equity account and the share premium account to return value to shareholders. The money represented in these accounts may be used to carry on the business of the company as working capital but generally it cannot be returned to the shareholders while the company is a going concern. This is known as the doctrine of maintenance of share capital.

This is primarily for the benefit of the company’s creditors. It is a fundamental and long-established concept of company law that the share capital of a company is seen as a permanent fund available to its creditors. In practice, many private companies have only a small issued share capital, so this capital maintenance regime is of little relevance.

40
Q

Consequences of the principle of maintenance of share capital

A

The principle of maintenance of share capital has a number of important consequences, in particular:

  • Dividends may only be paid out of distributable profits, not capital (s 830(1)), and
  • Companies generally must not purchase their own shares.

However, there are some exceptions to these rules. For example:

  • A company may buyback its own shares (or redeem redeemable shares) provided it follows the procedures set out in CA 2006, and
  • A company may purchase its own shares where a court order is made for this following a successful shareholder petition for unfair prejudice.
41
Q

Redemption and buyback of shares

A

There are two types of situation when a company can effectively buy its own shares:

  • redemption of redeemable shares; and
  • purchase of own shares (‘buyback’).

One reason a company may wish to do this is that (in a private company) a shareholder may want to leave and cannot find a buyer for their shares. Shareholders in private companies are prohibited from offering their shares to the public.

In order to prevent a shareholder being locked into the company with no way to sell their shares, the company can purchase or redeem the shares if they were issued as redeemable. However, because of the principle of the maintenance of share capital, there are very strict controls on the purchase or redemption of a company’s shares.

Both private and public companies may buyback their own shares or redeem redeemable shares provided they comply with the provisions of CA 2006.

42
Q

Buyback of shares

A

A buyback of shares takes place when a company purchases its own shares from an existing shareholder.

A company may decide to purchase shares from a shareholder when there is no other buyer available.

Generally, the kind of companies that you are looking at on this module will be making ‘off-market’ purchases of own shares ie the purchase of own shares will take place otherwise than on a ‘recognised investment exchange’. In this case, the company will need a contract setting out the terms of the purchase and this contract will need to be approved by the shareholders by an ordinary resolution.

Where a company uses capital to fund the buyback there is a lot more regulation and procedure.

43
Q

Buyback of shares: funding

A

There are three ways in which a company may fund a buyback of its own shares. The company may use:

Distributable profits;

Proceeds of a fresh issue of shares made for the purpose of financing the buyback; or

Capital.

However, the use of capital to fund a buyback is strictly regulated. You should note that:

  • The option to use capital is only available to private companies. A public company can never use capital to purchase its own shares;
  • Any redemption or purchase out of capital must comply with the restrictions in ss 709 - 723 CA 2006 inclusive; and
  • Companies must first use any money available either in the form of distributable profits or the proceeds of a fresh issue of shares to fund the purchase before using capital.
44
Q

Buyback of shares out of profits / proceeds of a fresh issue

A

A company may purchase its shares out of distributable profits or the proceeds of a fresh issue of shares for the purpose of the purchase provided:

The purchase of own shares is not restricted or prohibited in the company’s Articles (s 690(1)(b));The shares being purchased by the company are fully paid up (s 691(1)); andFollowing the purchase, the company must continue to have issued shares other than redeemable and treasury shares.

Section 694 sets out the procedure:

a contract to purchase own shares is required (s 694(1)); andthe terms of the contract need to be approved by ordinary resolution (s 694(2)).

The contract must be available for inspection at the company’s registered office for a period of 15 days before the GM and also at the GM. If a written resolution is used, a copy of the contract must be sent together with the copy of any written resolution (s 696(2)).

45
Q

Procedure for the buyback of shares out of profits / proceeds of a fresh issue

A

Initial steps

  • Check there is no limit in Articles on s 690 power to buyback shares
  • Prepare accounts to check there are sufficient distributable profits
  • Confirm shares are fully paid

Board Meeting

  • BR to approve the draft contract
  • BR to call a GM and approve form of notice / propose a WR
  • Contract to be made available to shareholders:
  • If GM: contract must be available for inspection at the company’s registered office for at least 15 days prior to and at GM
  • If WR: circulate contract with WR

GM / WR

  • Shareholders pass OR to approve contract.
  • Holders of shares being bought are not eligible to vote.

Board Meeting

  • BR to enter into the contract
  • BR to appoint a director(s) to sign the contract

Post meeting matters

  • File return, notice of cancellation & statement of capital within 28 days
  • Keep copy of contract for 10 years
  • Cancel shares, update register of members (and PSC register if applicable)
46
Q

Buyback of shares out of capital

A

Remember, only private companies are permitted to fund a purchase of their own shares out of capital. The following conditions apply in addition to those set out above in relation to the buyback of shares out of profits or the proceeds of a fresh issue:

The purchase of own shares out of capital is not restricted or prohibited in the company’s Articles;Check that the accounts were prepared no more than three months before the directors’ statement;Check if the company has any distributable profits available. If so, those profits (or funds from a fresh issue of shares for the purpose) must be used to fund the buyback before capital can be used (s 710);A directors’ statement of solvency must be prepared together with an auditors’ report (s 714);A special resolution to approve payment out of capital must be passed within a week after the directors sign the written statement of solvency (s 716).

47
Q

Buyback out of capital - directors’ statement of solvency and auditors’ report

A

The directors’ statement of solvency must be made no earlier than one week before the GM. The statement confirms that the company is solvent and able to pay its debts as they fall due and that it will remain solvent for a period of 12 months after the buyback (s 714).

The directors need to be careful when making this statement, since if the company does become insolvent and is wound up within one year, they may be required to contribute to the assets of the company and may face criminal sanctions if they had no reasonable grounds for making the statement of solvency.

An auditors’ report must be annexed to the written statement of solvency confirming that the auditors are not aware of anything to indicate that the directors’ opinion is not reasonable (s 714).

A copy of the directors’ statement and auditors’ report must be made available to members (sent with the written resolution or available for inspection at the GM).

48
Q

Buyback out of capital – notification requirements

A

Within seven days of the passing of the special resolution approving the payment out of capital, under s 719 CA 2006 the company must give notice to its creditors by:

Publishing a notice in the Gazette. The notice must state:

  • that the company has approved a payment out of capital for the purpose of purchasing its own shares;
  • where the directors’ statement and auditors’ report are available for inspection; and
  • that any creditor of the company may, at any time within the five weeks immediately following the date of the resolution, apply to the court under s 721 CA 2006 for an order preventing the payment.

Publishing a notice in the same form as the Gazette notice in an appropriate national newspaper, or give notice in writing to each of its creditors, andFiling copies of the directors’ statement and auditors’ report at Companies House. This is so that any interested creditor may inspect these.

49
Q

Buyback out of capital - timing

A

The share purchase can take place no earlier than five weeks, and no later than seven weeks, after the date of the special resolution (s 723 CA 2006).

This period cannot be reduced even if the special resolution is passed unanimously – the five week delay is designed to enable shareholders and/or creditors of the company to object to the payment out of capital by lodging an application at court for cancellation of the resolution (s 721 CA 2006).

The seven week longstop period is intended to ensure that the view formed by the directors in their statutory declaration as to the solvency of the company is still likely to be accurate at the time the share purchase is made.

Within 28 days of the date on which the shares that are bought back are delivered to the company, the company must send a return to Companies House under s 707(1) CA 2006 and a notice of cancellation under s 708(1) CA 2006, together with a statement of capital (s 708(2) CA 2006).

50
Q

Procedure for the buyback of shares out of capital

A

Initial steps

  • Check there is no limit in Articles on s 690 power to buyback shares or s 709 power to use capital to fund the buyback
  • No earlier than three months before the directors prepare the statement of solvency, prepare accounts to ascertain available profits
  • Confirm shares are fully paid

Board Meeting

  • BR to approve the directors’ statement of solvency (‘DSS’) and the auditors’ report (‘AR’)
  • BR to approve the draft contract
  • BR to call a GM and approve form of notice / propose a WR
  • Contract to be made available to shareholders:
  • If GM: contract must be available for inspection at company’s registered office for at least 15 days prior to and at GM
  • If WR: circulate contract with WR
  • DSS and AR must be signed no earlier than one week before the GM or the passing of the WR

WR

  • Circulate WR with contract, DSS and AR.
  • SR to approve payment out of capital and OR to approve contract.
  • Holders of shares being bought back are not eligible to vote.

ALTERNATIVELY GM

  • Shareholders pass OR to approve contract.
  • Shareholders pass SR to approve payment out of capital.
  • Holders of shares being bought are not eligible to vote.
  • Contract, DSS and AR must be available at the meeting.

Following GM / WR

  • Within 7 days: place notices in Gazette and national newspaper and file DSS and AR at Companies House.
  • Within 15 days: file SR at Companies House.
  • For five weeks after date of SR: creditors and shareholders have right to object. Copies of DSS and AR must be available for inspection at company’s registered office.

Board Meeting

  • BR to enter into the contract.
  • BR to appoint a director(s) to sign the contract.
  • Payment out of capital must take place between 5-7 weeks after SR passed.

Post meeting matters

  • File return, notice of cancellation & statement of capital within 28 days.
  • Keep copy of contract for 10 years.
  • Cancel shares, update register of members (and PSC register if applicable).
51
Q

Summary of procedure for buyback of shares using profits / proceeds / capital

A

Buyback out of profits and/or proceeds of a fresh issue of shares

  • Check Articles for any prohibition on buyback
  • Verify distributable profits
  • Terms of buyback must be set out in a contract - must be available for inspection at least 15 days before GM and at GM itself (or circulated with written resolution)
  • Shareholders must approve the contract by OR

Buyback out of capital (PRIVATE companies only)

  • Check Articles for any prohibition on buyback and on use of capital
  • Terms of buyback must be set out in a contract (day display/send out with WR)
  • DSS and AR; accounts (<3 mths old)
  • Shareholders must approve the contract by OR
  • Shareholders must approve the payment out of capital by SR
  • Detailed notification requirements for creditors
52
Q

Redemption of redeemable shares

A

Redeemable shares are shares which are issued as redeemable shares.

Redeemable shares effectively give the holder temporary membership in the company. They are issued to be redeemed on the occurrence of certain circumstances (for example by providing for redemption on a fixed date and at a fixed price) or may be redeemed at the option of the issuing company or the shareholder.

All details of the redemption, including date of redemption and the price to be paid at that date, will either be in the Articles or determined by the directors.

As a result, a contract is not required to redeem shares, irrespective of the source of funding used. This is because the terms of the redemption have already been set out in the company’s Articles (or determined by the directors) prior to the shares being allotted.

Where a company uses capital to fund the redemption there is a lot more regulation and procedure. The procedure is very similar to the buyback of shares out of capital.