Equity Finance Flashcards
1
Q
What are the two primary methods by which companies obtain finance, and how do they differ?
A
- Equity Finance:
* Prospective shareholders invest money or property in exchange for shares.
- This involves the company creating new shares that represent ownership in the company.
- Shareholders gain voting rights and a share of future profits but take on the risk of ownership.
- Debt Finance:
* The company borrows money to fund expansion or operational needs.
- This involves a contractual obligation to repay the borrowed amount with interest.
- Debt does not dilute ownership but increases financial liabilities.
2
Q
What are the three methods of shares changing hands in a company, and how do they impact the company’s shareholding structure?
A
- Allotment:
* The company creates new shares and issues them to shareholders in exchange for payment (cash or property).
- Increases the total number of shares, potentially diluting the ownership percentage of existing shareholders.
- Transfer:
* Existing shareholders sell or gift shares to others.
* The total number of shares remains unchanged, but ownership percentages shift between transferor and transferee. - Buyback:
* The company repurchases its own shares, which are then canceled.
* Reduces the total number of shares, increasing the ownership percentage of remaining shareholders.
3
Q
During share allotment, what steps must a company follow, and how does this process affect existing shareholders?
A
- Steps in Share Allotment:
* The board decides to issue new shares, determining price and quantity.
- A resolution is passed (board or shareholder approval, depending on company type).
- Payment is received, and the shareholder’s name is entered into the register of members.
- A share certificate is issued to the new shareholder.
- Impact on Existing Shareholders:
* The percentage shareholding of existing shareholders decreases unless they acquire new shares.
- The dilution of ownership can affect voting power and profit entitlement.
4
Q
What are the critical considerations for a company when determining whether to allot shares?
A
- Constitutional Restrictions:
* Companies incorporated before 1 October 2009 may have an Authorised Share Capital (ASC) limit in their articles.
- This restriction can be removed by ordinary resolution.
- Authority of Directors:
* Private companies with one class of shares can allot shares via a board resolution under s 550 CA 2006.
- Public companies and private companies with multiple classes need shareholder approval via an ordinary resolution under s 551.
- Pre-emption Rights:
* Existing shareholders have the right to be offered new shares first to preserve their ownership percentage unless pre-emption rights are disapplied.
5
Q
What are pre-emption rights under s 561 CA 2006, why are they important, and what are the exceptions to these rights?
A
- Definition of Pre-emption Rights:
- Pre-emption rights ensure that existing shareholders have the first opportunity to buy newly allotted shares, maintaining their proportional ownership in the company. The offer must state the period for acceptance and the offer must not be withdrawn within that period, the period for acceptance cannot be less than 14 days.
- This protects shareholders from dilution of voting rights and profit entitlement.
- Importance:
* Preserves shareholder equity and control, particularly for ordinary shares that confer voting rights.
- Encourages fairness and transparency in share allocation.
- Exceptions to Pre-emption Rights:
* Bonus Shares (s 564 CA 2006): Free shares issued to shareholders based on existing holdings.
- Non-cash Consideration (s 565 CA 2006): When shares are allotted in exchange for an asset or property critical to the company’s operations.
- Employee Share Schemes (s 566 CA 2006): Shares allocated to incentivize employees or directors, bypassing pre-emption rights to target specific personnel.
- Example:
* If a company needs to acquire property from a landowner, it may allot shares directly to the landowner as consideration, avoiding pre-emption rights since no other shareholder can provide the property. - Flexibility:
* While statutory pre-emption rights apply to equity securities, they can be modified or excluded in the company’s articles or disapplied by special resolution.
6
Q
How can pre-emption rights be disapplied, and what procedural requirements must the company adhere to?
A
- Ways to Disapply Pre-emption Rights:
* Modification in Articles (s 567 CA 2006): The company’s articles may exclude statutory pre-emption rights, either generally or for specific allotments.
- Special Resolution: A special resolution can override statutory pre-emption rights, particularly under:
- s 569 CA 2006: For private companies with a single class of shares.
- s 570 CA 2006: For companies with authority to allot shares under a general resolution.
- s 571 CA 2006: For companies seeking to disapply rights for specific allotments.
- Requirements under s 571:
* Directors must provide a written statement to shareholders justifying the disapplication, which includes:
* Reason for recommendation.
* Proposed price for the shares.
* Justification for the price.
* The statement must accompany the general meeting notice or written resolution. - Penalties for Misleading Statements:
* It is an offence under s 572 CA 2006 to knowingly or recklessly provide false, misleading, or deceptive information in the directors’ statement. - Strategic Use:
* Disapplication allows flexibility to issue shares quickly to specific investors, avoiding delays caused by statutory pre-emption rights.
- Examples include raising urgent funds or targeting strategic investors.
7
Q
What are the legal requirements for payment when shares are issued, and how is the concept of issuing shares at a premium handled?
A
- Legal Requirements for Payment:
* Under Model Articles (MA) 21, shares must be fully paid at the time of issuance.
* If a company’s articles exclude MA 21, shares may be issued partly paid, but the shareholder must pay the remainder:
* When contractually obligated.
* Upon the company’s liquidation. - Shares Issued at a Premium:
* Nominal Value: The base value of a share (e.g., £1).
* Premium: If a share is issued for more than its nominal value (e.g., £1.75), the excess amount (75p) is recorded in a Share Premium Account under s 610 CA 2006. - Accounting for Premiums:
* The share premium is treated as part of the company’s capital and must be maintained in accordance with the principle of share capital maintenance.
- It cannot be distributed to shareholders as dividends but can be used for purposes like issuing bonus shares or writing off expenses related to share issuance.
- Impact on Shareholders:
* Shares issued at a premium enhance the company’s equity without diluting its value excessively, preserving existing shareholders’ interests.
8
Q
What are the administrative and filing obligations a company must meet after allotting shares?
A
- Administrative Tasks:
* Register of Members: Update to include the new shareholder’s details, reflecting the allotment.
* Share Certificates: Issue certificates to the new shareholders as proof of ownership.
* Minutes: Record resolutions and decisions in the minutes of:
* Board meetings (for decisions to allot shares).* General meetings (if shareholder approval was required). - Filing with Companies House:
* Return of Allotment: Submit a form (e.g., SH01 in the UK) to Companies House within the required timeframe (usually 1 month).
* Resolutions: File copies of any ordinary or special resolutions passed during the allotment process. - Legal Compliance:
- Ensure compliance with s 248 CA 2006 for board meeting records and s 355 CA 2006 for general meeting records.
- Failure to comply can result in penalties or invalidate the allotment.
- Transparency and Accountability:
- Proper documentation ensures transparency for stakeholders and regulators.
- It demonstrates that the company has followed due process and complied with legal requirements.
- Strategic Importance:
* Efficient administration reassures investors and regulators of the company’s governance standards, building trust in its operations.
9
Q
What is share transfer, and what are the key characteristics of this process?
A
- Definition:
* Share transfer occurs when a shareholder (the transferor) transfers ownership of shares to another person (the transferee), who may or may not be an existing shareholder.
- It is a voluntary action where ownership changes but the total number of shares in the company remains unchanged.
- Impact on Shareholding:
* The transfer shifts percentage shareholdings, affecting the balance of power and control in the company. - Legal Framework:
* Under the Companies Act 2006 (CA 2006), there are no statutory restrictions on share transfer, and pre-emption rights (offering shares to existing shareholders first) are not mandatory.
10
Q
Why might share transfers pose risks to existing shareholders, and how can these risks be mitigated?
A
- Potential Risks:
* A new transferee may disrupt the existing shareholder dynamics, causing conflict or inefficiencies.
- Disputes can arise if shareholders oppose working with the new transferee.
- Restrictions in Articles:
* To mitigate risks, companies often include restrictions in their articles of association, such as:
* Requiring board approval for certain transfers.
- Allowing transfers to family members or existing shareholders without restrictions.
- Mandating that shares be offered to existing shareholders first, at a fair value.
- Legal Limitation:
* Articles cannot completely prohibit a shareholder from selling shares but can control the registration process of the transferee, which affects their official shareholder status.
11
Q
How do the register of members and Model Articles affect the share transfer process?
A
- Register of Members:
* A transferee becomes a legal shareholder only after their name is entered in the register of members (s 113 CA 2006).
- Until then, the transferee is a beneficial owner:
- Legal Ownership: Retained by the transferor until registration.
- Beneficial Ownership: The transferee has economic rights, such as receiving dividends and directing voting.
- Model Article 26:
- Provides boards with discretion to refuse registration of a transfer.
- This means the board has control over whether the transferee is officially recognized as a shareholder.
- Implications of Non-Registration:
* Transferee does not gain voting rights or legal ownership.
* Transferor retains legal control until registration is completed.
12
Q
What are the detailed steps involved in transferring shares, and what are the company’s obligations?
A
- Transferor’s Responsibilities:
* Complete and sign a stock transfer form.
* Deliver the share certificate and transfer form to the transferee. - Transferee’s Responsibilities:
* Pay stamp duty if the value of shares exceeds £1,000:
* Charged at 0.5% of the consideration (rounded up to the nearest £5).
* Minimum stamp duty is £5, and no stamp duty applies to gifts.
* Submit the transfer form and share certificate to the company. - Company’s Obligations:
* Issue a new share certificate in the transferee’s name within 2 months (s 776 CA 2006).
- Enter the transferee’s name in the register of members within 2 months (s 771 CA 2006).
- Notify the Registrar of Companies of ownership changes in the annual confirmation statement (CS01).
13
Q
What is transmission of shares, and how does it differ from transfer?
A
- Definition:
* Transmission is an automatic process where shares pass to another party due to:
- Death of a shareholder (to personal representatives, PRs).
- Bankruptcy (to a trustee in bankruptcy).
- Key Differences from Transfer:
* Transmission occurs automatically by law and is not a voluntary transaction.
- PRs and trustees are not shareholders unless registered, though they can receive dividends and vote on behalf of the deceased or bankrupt shareholder.
- Actions of PRs and Trustees:
* PRs or trustees may:
* Register as shareholders (subject to board approval under MA 27).
* Sell the shares directly without registration.
14
Q
What is the principle of share capital maintenance, and what are its consequences for the company?
A
- Principle:
* Share capital is the fundamental financial foundation of the company.
- It ensures protection for creditors, as this capital cannot be arbitrarily reduced or returned to shareholders.
- Consequences:
* Dividends: Can only be paid out of distributable profits, not share capital.
- Buybacks: Companies cannot generally buy back shares unless specific conditions are met.
- Exceptions to the Rule:
- Share buybacks are allowed if they follow CA 2006 procedures (s 690).
- Courts may order buybacks to resolve unfair prejudice claims (s 994).
- Capital can be returned during a winding-up, after paying creditors.
15
Q
Why might a company choose to buy back shares, and what must it consider before doing so?
A
- Reasons for Buyback:
* To help shareholders exit when external buyers are unavailable.
- To resolve conflicts by removing a disgruntled shareholder.
- To enable director retirement if shares cannot be sold externally.
- Key Considerations:
- Directors must assess financial risks, ensuring the company has sufficient distributable profits or capital.
- Directors’ duties under s 172 (promote the company’s success) and s 174 (exercise care and diligence) must be adhered to.
