Equity Finance

Question 1

What are the two main ways companies can obtain finance?

Answer 1

Prospective shareholders pay money or give property to the company in return for shares (equity finance)

Companies borrow money (debt finance)

Question 2

What is the broad difference between allotment, transfer and buyback of shares?

Answer 2

Allotment = a company decides to create shares and give them to an existing/new shareholder in return for payment

• Company issues share certificate + enters the person on the register of members or amends their entry to show increased shareholding
• Payment can be either money or property; company must get consideration for shares

Transfer = existing shareholders sells or gives shares to another existing/new shareholder

• Total number of shares is the same, but the owners have changed

Buyback = company buys back shares and ‘reabsorbs’ them, so the total number of shares decreases

• The bought back shares are cancelled

Question 3

How do allotment, transfer and buyback of shares affect shareholders’ shareholding percentages?

Answer 3

All three methods of shares changing hands will change the percentage shareholding of other shareholders, which can affect their powers

• Allotment = shares increase + percentage goes down for everyone else
• Buyback = shares decrease + percentage goes up for everyone else

There are restrictions on allotment and buyback, but not so much for transfers, as shareholders not involved in the transfer won’t see a change in percentage shareholding

Question 4

What is the difference between the nominal value and market value of shares, when considering allotments and transfers?

Answer 4

Nominal value – when a company is created, shares are sold for this value, often £1 per share; remains the same as the company progresses

Market value – differs based on whether the company has made a profit or loss

• If the market value of the shares is higher than the nominal value, the company usually keeps the nominal value the same, but sells the shares with an added premium (to reach the market value)
• The company then gets the nominal value (£1) and the added premium (£4), so they receive £5 per share, which might be its current market value
• The premium goes into the company’s share premium account on the balance sheet

Question 5

What is the difference between ‘alloting’ and ‘issuing’ shares?

Answer 5

Company allots shares when the shares have been transferred, paid for + board has passed a resolution to register the transfer

Company issues shares when the name of the shareholder has been entered on the register of members

Board decides the price and how many shares it wants to allot

Question 6

What are the three key issues to consider when a company decides to allot shares?

Answer 6

1) Are there any constitutional restrictions on allotment?

2) Do the directors have authority to allot shares?

3) Are there any pre-emption rights?

Question 7

What constitutional restrictions on allotment might a company have?

Answer 7

Companies may have an upper limit on the number of shares a company can have, called the authorised share capital (ASC)

For companies incorporated prior to 1 October 2009, check whether they have updated their articles since that date. If not, the shareholders will need to pass an ordinary resolution to remove the ASC.

For all companies, check the company’s articles for a limit on the number of shares the company can have. If there is such a limit, change the articles by special resolution.

Question 8

Do directors of private companies with one class of shares have the authority to allot shares?

Answer 8

1) Companies incorporated under CA 2006 which have one class of shares before and after the allotment – directors can allot shares via board resolution under s550 (no shareholder involvement needed)

• Articles might restrict this power

2) Companies incorporated pre-CA 2006 – shareholders need to pass an ordinary resolution to activate s550 above

Question 9

Do directors of public companies and private companies with more than one class of shares have the authority to allot shares?

Answer 9

They have authority under s551 CA 2006

Public companies and private companies with more than one class of shares before or after allotment – ordinary resolution needed before company can allot shares

• This must state max number of shares directors can allot and date on which authority to allot will expire (maximum of 5 years from date of ordinary resolution)
• Authority can be renewed by a further ordinary resolution

Authority to allot might come from the articles on incorporation, with a max 5 year expiry date too

Ordinary resolutions under s551 must be filed at Companies House

• They are an exception to the rule that articles can only be amended by special resolution

Question 10

What are pre-emption rights?

Answer 10

Pre-emption rights are rights of first refusal over shares being allotted

Under s561, a company must offer ordinary shares (which give owners right to vote) to existing shareholders first, in a number which will enable them to preserve their percentage shareholding in the company

• This prevents their voting powers from being diluted

When offered shares via pre-emption rights, offer must state period for acceptance and offer cannot be withdrawn in that time

• Period of acceptance cannot be less than 14 days
• If any/all shareholders don’t accept, directors can offer them to other buyers

Question 11

Give an example scenario of pre-emption rights

Answer 11

Example – A has 600 shares; B has 300 and C has 100 (1000 total)

Board wants to allot 500 more – pre-emption rights apply so board must first offer:

• 300 to A (60%)
• 150 to B (30%)
• 50 to C (10%)

Question 12

In what situations will pre-emption rights not apply?

Answer 12

1) Allotment of bonus shares/preference shares

• Alloting of mixture of ordinary and preference shares would mean that preemption rights still apply

2) Allotment where consideration is non-cash (property)

• Ensures they get that specific thing, which someone else cannot offer

3) Shares held, allotted or transferred pursuant to an employee share scheme

Question 13

What is the difference between ordinary and preference shares?

Answer 13

Ordinary shares give you a right to share in the profits of the company and usually give voting rights

• They have pre emption rights attached to them

Preference shares may allow you a specified dividend (fixed amount or fixed rate of interest) or might give priority to those holding preference shares on winding up/liquidation.

• They have no pre emption rights attached to them

Question 14

Is it possible for a company’s articles to have different pre-emption rights to the statutory provisions?

Answer 14

Yes, private companies can exclude pre-emption rights in articles, generally or for particular allotments – companies can override the statutory provisions above

• Provisions in articles can be removed via special resolution
• MAs have no pre-emption rights

Question 15

If the company’s articles follow the statutory provisions in relation to pre-emption rights, can these be disapplied?

Answer 15

1) Private companies with one class of shares can disapply the s561 rights by special resolution

2) For public companies and private ones with more than one class of shares can disapply pre-emption rights depends on their authority to allot shares

2a) If the shareholders passed an ordinary resolution and gave a general authority to allot, rather than for a specific allotment, the company can then pass a special resolution to remove pre-emption rights

• Disapplication lasts as long as the directors’ authority to allot under s551

2b) If the shareholders passed an ordinary resolution for a specific allotment, the directors must make a written statement before any disapplication by special resolution

2ba) The written statement states:

• the reasons for making the recommendation;
• the amount the purchaser will pay; and
• the directors’ justification of that amount

2bb) Must be circulated along with notice of GM or sent out with written resolution

Question 16

Give a summary of pre-emption rights

Answer 16

Pre-emption rights which differ from those set out in the CA 2006 are sometimes contained in the company’s articles, so these should be checked first, and removed by special resolution if necessary.

If the pre-emption rights under s 561 apply, because the company’s articles have not changed the position, they can be disapplied by special resolution.

Where the company is disapplying pre-emption rights under s 571 CA 2006, the directors must make a written statement justifying the disapplication of pre-emption rights

Question 17

What are the rules around payment of shares on allotment?

Answer 17

MA 21 – all shares must be fully paid, so buyer must pay when they receive them

If MAs not used, shares can be issued partly paid, which must be fully paid when contractually obliged or if company wound up

Question 18

What administrative requirements and steps does a company need to take in respect of allotment of shares?

Answer 18

1) Company needs to prepare minutes of every board meeting and GM

2) Copies of resolutions to be sent to Companies House within 15 days

• All special resolutions
• Any ordinary resolution removing the authorised share capital in a pre- CA 2006 company
• Any ordinary resolution to activate s 550 in a pre- CA 2006 company
• Any s 551 ordinary resolution granting directors authority to allot

3) Company forms to be sent to Companies House

• Return of allotment and statement of capital (Form SH01) within one month of the allotment
• Possibly form(s) PSC01, PSC02, PSC04 and PSC07, for new persons with significant control/ a change of which percentage band a person is in/ a person ceasing to be a person with significant control

4) Entries in company’s own registers

• Amend register of members within two months
• Amend PSC register if necessary

5) Preparation and allocation of share certificates

• Prepare share certificates within two months of allotment

Question 19

Can a company restrict the transfer of shares?

Answer 19

Transfer of shares occurs when transferor sells or gives shares to another existing/new shareholder (transferee)

Nothing in CA 2006 to prevent transferring of shares and no pre-emption rights in this context

However, MA 26 allows the board to refuse to register the transfer of shares

• This would mean the transferee was the beneficial owner of the shares, but the transferor remains the legal owner

Question 20

How are shares transferred?

Answer 20

1) Transferor completes and signs a stock transfer form + gives it to transferee along with share certificate

• Sale price over £1000 - buyer pays stamp duty at 0.5% (rounded to nearest £5)
• Gift – no stamp duty to pay

2) Transferee sends share certificate and stock transfer form to company

3) Company:

• Sends the new shareholder a new share certificate in their name within 2 months
• Enters their name on the register of members within 2 months
• Notifies the Registrar of Companies of the change in ownership of the shares when the company files its annual confirmation statement

Question 21

What is ‘transmission’ in the context of transferring shares?

Answer 21

Automatic process whereby:

• If a shareholder dies, their shares automatically pass to their personal representatives (PRs); or
• if a shareholder is made bankrupt, their shares automatically vest in their trustee in bankruptcy.

Under MA 27, the trustee in bankruptcy and the PRs do not become shareholders of the company, but they are entitled to any dividends declared on the shares

• They can choose to be registered as shareholders and sell them
• They can sell them directly as representatives

Question 22

What is the principle of maintenance of share capital?

Answer 22

The share capital is the money provided by shareholders in return for shares

This principle means this fund cannot be reduced, as creditors look to this fund to satisfy debts owed to them. Consequences include:

• dividends cannot be paid out of capital, just out of distributable profits; and
• the company must not generally purchase its own shares

Question 23

What are the exceptions to the principle of maintenance of share capital?

Answer 23

• A company can buy back its own shares as long as the correct procedure is followed;
• A company can purchase its own shares under a court order made under s994 CA 2006 to buy out an unfairly prejudiced minority shareholder; and
• A company can return capital to shareholders, after payment of the company’s debts, in a winding up

Question 24

What is the consequence of buying back shares and what must directors consider generally before doing so?

Answer 24

Buyback results in less profits available for declaring dividends or capital available for creditors if the company cannot pay its debts

Directors must consider their duty to promote the success of the company before buying shares back

Question 25

What are the main requirements before a private company can buy back shares?

Answer 25

1) The company’s articles must not forbid buyback 2) The shares must be fully paid 3) The company must pay for the shares at the time of purchase 4) The shares must usually be paid for out of distributable profits or the proceeds of a fresh issue of shares made for the purpose of financing the purchase. * Distributable profits are the company’s accumulated, realised profits less its accumulated, realised losses. They are shown on the bottom half of the company’s balance sheet, under profit/loss reserve. 5) The shareholders must pass an **ordinary resolution** authorising the buyback contract 6) A copy of the buyback contract, or a summary of it, must be available for inspection for **at least 15 days before the GM and at the GM itself** (or be sent with the proposed written resolution when or before it is circulated 7) A copy of the buyback contract, or a written memorandum setting out its terms, must be made available for inspection at the company’s registered office or SAIL as soon the contract has been concluded, for a period of **ten years starting with the date of the buyback**

Question 26

What other administrative requirements are relevant after a buyback of shares is authorised?

Answer 26

1) Company must also keep the minutes/WRs for ten years 2) If OR is passed, one or two directors are authorised to execute the buyback contract 3) After completion * File return of purchase of own shares and notice of cancellation of shares within 28 days of completion * Keep copy of contract at registered office for ten years * Cancel the shares, update register of members and PSC register (if required)

Question 27

What restrictions are there on shareholders when voting for a buyback of shares?

Answer 27

The shareholder whose votes are being bought back cannot vote at a GM if their votes make a difference between the resolution passing or not, when it comes to the decision to buy back shares For a WR, the shareholder whose shares are being bought cannot vote

Question 28

What are the main practical considerations a company must consider before deciding to buy back shares?

Answer 28

Check what cash they have, to pay for the shares and whether they need it for another purpose soon, like to pay a liability

Question 29

Are companies able to buy back shares out of capital?

Answer 29

If a **private company** does not have enough distributable profits, they **are permitted to buy back their own shares** out of capital, **unless the articles forbid it** **Public companies are not permitted** to do this

Question 30

There are some additional requirements for a buyback of shares out of capital, in addition to those for buybacks out of distributable profits. Outline the requirements **until** the buyback is approved

Answer 30

1) Directors make a statement of solvency, no more than one week before GM to say the company will remain solvent during the year following the buyback 2) An auditors’ report must be annexed to the statement of solvency * This confirms that the auditors are not aware of anything to indicate that the directors’ opinion is unreasonable * Copy of both must be available to members - Sent with WR or available to inspect at GM 3) Payment out of capital must be approved by **special resolution**, in addition to **ordinary resolution approving buyback contract** * Same rules about interested shareholder apply to GM + WR

Question 31

Outline the requirements for buyback out of capital, **after** this has been approved by the shareholders

Answer 31

1) Within 7 days of special resolution, company puts notice in London Gazette, stating that shareholders have approved payment out of capital to buy back its own shares * Must specify amount of capital to be used, date of SR and where the statement + auditor’s report are available for inspection * Must state that any creditors may, within 5 weeks of SR apply for an order to prevent the buyback out of capital 2) Company must also give notice to each creditor or give notice in an appropriate national newspaper 3) Company must file a copy of the directors’ statement and auditors’ report at Companies House before or at same time as it places the notices in the LG and newspaper * They must be kept available for inspection at the registered office from first notice until 5 weeks after passing of SR 4) If no creditors object, directors hold a BM and pass a board resolution to enter the contract to buy back the shares * Payment out of capital must be made no earlier than 5 weeks after SR and no later than 7 weeks after SR (2-week window)

Question 32

Summarise the forms that need to be sent to Companies House after a buyback of shares out of capital

Answer 32

Forms for return of purchase of own shares and notice of cancellation of shares, statement of solvency, auditor’s report and the special resolution (authorising buyback out of capital)

Question 33

What are dividends paid out of and who authorises the payment of them?

Answer 33

1) Shareholder can make money from their shares in two ways: * Value of shares increase as company becomes more profitable * They can receive dividends 2) Companies pay dividends if it has **profits available for that purpose** * Company's available profits are its accumulated, realised profits less its accumulated, realised losses * Shown in bottom half of balance sheet, under profit/loss reserve 3) MA 30 – **directors decide** whether to recommend a dividend be paid and for how much. Shareholders must then pass an **ordinary resolution for this to be approved**