Equity Finance

Question 1

Capital

Answer 1

All of the assets of the company (including debt finance, shares, assets)

Question 2

Legal capital

Answer 2

This is the value received from investors who subscribe for the company’s shares. It is also referred to as the share capital.

Question 3

Maximum legal capital provision?

Answer 3

There is no maximum legal capital provision under CA 2006. Companies may have as much share capital as they wish.

Question 4

Minimum legal capital provision?

Answer 4

Private companies also have no minimum legal capital requirements – one share is sufficient (s 7, s 8 CA 2006).

Question 5

Benefits to shareholders

Answer 5

• Shareholders share in the profits of the company by way of dividends.
• If the company does well, the shareholders may also receive a capital return where the value of their shares increases. However, shareholders in a private limited company may have difficulty selling their shares.
• Shareholders often have voting rights therefore they have some input into the management of the company.

Question 6

Risks borne by shareholders

Answer 6

• Company has a separate legal personality, so creditors are paid from the company’s assets. Shareholders are only liable up to the amount invested – they will not be (unless exceptionally the corporate veil is pierced) personally liable for outstanding debts of a company. However, in the event of insolvency, creditors are paid first in the order of priority on winding up. This means that it is unlikely that shareholders will receive the full value of their investment.

Question 7

There are a number of mechanisms that protect shareholders.

Answer 7

1. Limitations on the power of directors to issue new shares

Directors require authorisation of the shareholders in order to issue new shares in most circumstances. This is important as it avoids the directors themselves issuing and subscribing for new shares in order to obtain a controlling majority.

2. Pre-emption rights

Shareholders have rights of first refusal when the company issues new shares in most circumstances. This means that the shareholders are able to retain the same proportion of their shareholding in the company if they wish to do so, without dilution.

3. Class rights

Certain classes of shares may have particular rights, as you saw earlier in the module. Examples of such rights include rights of pre-emption (which we consider later in this topic), enhanced voting rights or greater dividends.

Question 8

1. Limitations on the power of directors to issue shares

Answer 8

In order for a company to issue new shares, firstly it is necessary to check whether there is any cap on the maximum number of shares that a company itself is authorised to issue. This would be unusual for a company incorporated under CA 2006 but it is necessary to check the company’s articles since it is possible to insert a restriction on a company’s ability to issue share capital above a certain amount in the articles.

Secondly, the directors need to be authorised to issue shares. Section 549 CA 2006 states that the directors have NO power to issue shares except:

1. In accordance with s 550:

Section 550 gives the directors of a private company which has only a single class of shares authorisation to issue further shares of the same class, provided there is nothing to the contrary in the articles.

2. Shareholders authorise the directors to issue new shares under s 551:

The shareholders may grant the directors authorisation to issue new shares by ordinary resolution. This lasts for up to 5 years and for a certain number of shares (as stated in the authorisation) only.

Question 9

2. Pre-emption rights

Answer 9

Section 561 states that new shares should first be offered to the existing shareholders, who are given a right of first refusal. However, this only applies where the shares to be issued are “equity securities”.

Section 560(1) defines “equity securities” as:

(a) ordinary shares in the company, or
(b) rights to subscribe for, or to convert securities into, ordinary shares in the company;

“ordinary shares” means 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 means that pre-emption rights apply where the new shares to be issued are ordinary shares. The definition of “ordinary shares” under s 560 encompasses shares which would not normally be described as ordinary shares eg participating preference shares.

Pre-emption rights only do not apply to preference shares that have capped preference rights as to both dividends and capital.

Question 10

Exceptions of the rights of pre-emption

Answer 10

There are exceptions to the right of pre-emption which apply where the new shares to be issued are:

• bonus shares,
• issued under an employee share scheme, or
• Issued for non-cash consideration (s 564).

Question 11

Exclusion of the right of pre-emption

Answer 11

• A company may exclude the right of pre-emption by specific provision in the articles (s 567 – 568).

Question 12

Disapplication of pre-emption rights

Answer 12

Often, a company may wish to issue new shares without having to offer these shares first to the existing shareholders who have pre-emption rights. Pre-emption rights may be disapplied in the company’s articles, but this is not common.

More commonly, the pre-emption rights may be disapplied by a special resolution of the shareholders. Sections 569 – 571 deal with this as follows:

• Directors of a private limited company with only one class of shares where the new shares to be issued are of the same class: shareholders may agree to disapply pre-emption rights by special resolution under s 569.
• Pre-emption rights may also be disapplied by special resolution under s 570 where the directors of the company are acting under a general authority to issue shares. In this situation, pre-emption rights are disapplied for all shares issued in accordance with this general authority.
• Under s 571, shareholders may pass a special resolution to disapply pre-emption rights in relation to a particular share allotment only.

Question 13

Pre-emption rights on transfer of shares

Answer 13

Where shareholders transfer their shares, in general there are no rights of pre-emption for existing shareholders.

However, a private company may provide for pre-emption rights on transfer of shares in either the articles or a shareholder agreement. This is quite common in small private companies, where it is important to keep control of the company to a small circle of individuals.

However, if a private company has a corporate shareholder (company A), the transfer of the corporate shareholder (A)’s own shares will not trigger these pre-emption rights provisions for the company, because as respects the company there has been no change in ownership (Re Coroin).

Question 14

Issuing shares at a discount

Answer 14

Shares may not be issued at a discount (eg issuing £1 shares for 75p each).

The House of Lords held that issuing shares at a discount was beyond the power of the company in Ooregum Gold Mining Co of India v Roper [1892]

This is now prohibited by s 552 CA 2006.

Question 15

Issuing shares at a premium

Answer 15

Shares can be issued at a premium (s 610) (eg issuing £1 shares for £2)

This is allowed but is not required, as confirmed in the case ofHilder v Dexter

Question 16

Allotted share capital s 558 CA 2006

Answer 16

Shares are deemed to be allotted when a person acquires the unconditional right to be included in the company’s register of members.

Public companies are required to have a minimum allotted share capital of £50,000 (s 761/763). There is no minimum share capital requirement for private companies.

Question 17

Issued share capital

Answer 17

“Issued share capital” refers to all the shares that have been issued by the company ie all the shares included in the company’s Register of Members.

Question 18

Checklist of things that need to be considered when issuing new shares in a private limited company.

Answer 18

• Check cap on number of shares in articles?
• MA - so unlikely such a cap exists, but we should check this first.
• S. 550 – if there is one class of share in issue, directors have the authority to issue more. Do check articles to check this, however.
• S. 550 will not apply in this situation, given we are intending to issue 8% fixed cumulative participating voting preference shares.
• Therefore to issue such shares we will need:
  a) For the director to permission to issue these shares through an ordinary resolution at a GM (simple majority)
  b) This specific share type will have to be created - i.e. articles will have to be amended by special resolution (not less than 75%) of the shareholders at a GM.
• For background, to call a GM:
  a board meeting of directors will have to be called.
• quorum is two directors. s 318(2)
• simple majority vote to call GM
• 14 days’ clear notice before GM s307(1)
• short notice prodecure: 90% shareholders with voting rights may agree to call GM immediately (s307(4-6)).

GM
- quorum of two shareholders (s318(2))

1. to create the new class of shares (i.e. amend the company’s articles) a special resolution will have to be passed.
   - to pass the special resolution to amend the articles they need not less that 75% of the votes.
2. to pass the director resolution (i.e. giving the director the power to issue shares) an ordinary resolution will have to be passed.
   - ordinary resolution needs 50%

• the vote may be done by a show of hands (MA 42) unless a poll vote is requested (MA 44).
  3. Check for pre-emption rights, if they need to be disapplied

Ordinary shares means shares other than shares that as respect to dividends and capital carry a right only up to a specified amount in a distribution.

The shares are equity securites because their participation is not capped. This means they come with pre-emtption rights. The pre-emtption rights can be disapplied by:

Special resolution s571
shareholders may pass a special resolution to disapply pre-emption rights in relation to a particular share allotment only.

Further info required to check whether any financial assistance going on

• When the shareholder resolutions have been passed, the board should resolve to allot the shares. There are registration requirements:

Shares are offered to Li-May. She signs for them, and pays for them. On receipt…

• Issue share certificates to the new shareholders
• Complete the SH01 form and file that at Companies House within one month of the allotment.
• Also file at Companies House any ordinary resolution passed in respect of the directors’ authority to allot shares, as well as any special resolution passed to alter or waive any pre-emption rights (shareholder resolutions are required to be filed at Companies House within 15 days of the date they were passed).
• Amend the company’s statutory register of members.