Equity Finance WS

Question 1

How do company’s fund their business? Where do they get money?.

Answer 1

2 ways! Debt finance and equity finance

Question 2

What is equity finance?

Answer 2

When shares of a company are bought by someone - a shareholder. This money/ property received in exchange can be used by the company to fund its business.

Question 3

What is debt finance?

Answer 3

When companies borrow money to fund expansion or just the day-to-day running of the company. Debt finance can of course apply to sole traders and partnerships too in some areas.
Loans and securities.

Question 4

How can shares change hands ?

Answer 4

3 ways: allotment, transfer (or transmission) and buyback

Question 5

What is allotment?

Answer 5

WHEN NEW SHARES ARE CREATED: When a company creates shares and amends the register of members to assign those shares to an existing shareholder OR register a new shareholder and assign those shares to them.
Shares are usually purchased with cash, and sometimes, with property.
Total number of shares changes - it increases.

Question 6

What is share transfer?

Answer 6

When the shareholder sells or gives shares to another shareholder or to a
new shareholder. Total number of shares remain the same. Just the identities of the shareholders that changes.

Question 7

What is buyback?

Answer 7

Where the company buys back some of its own shares from one or more
shareholders. It may help to think of buyback as the reverse of allotment. Instead of new shares being created, the company ‘reabsorbs’ some of it shares so that the total number of shares in the company decreases.
Total number of shares will decrease.

Question 8

What does allotment, share transfer and buyback all have in common?

Answer 8

They are all able to change the percentage shareholding of at least one existing shareholder.

Allotment - generally decreases shareholding percentage of existing shareholders.
Share transfer - transferor’s percentage shareholding decreases, whilst the transferee’s increases.
In buyback - remaining shareholder’s shareholding percentage increases.

Question 9

Calculation of allotment - how to calculate the new percentage of shares for existing shareholders (as this will decrease with allotment)

Answer 9

Their own shares will not change but what it is divided by (the new shares total overall) will change.
For example, before allotment = 1000 shares, 100 for A, 500 for B, etc.
After allotment = 1200 shares overall, 100 for A, 500 for B etc.

Question 10

What is more tightly regulated? Allotment, share transfer or buyback? And why?

Answer 10

Allotment and buyback.
Both of these have the power to change the amount of power and control shareholders have in the company - this will be bad for those shareholders who have invested a lot in the company. It is for this reason that a number of restrictions are
placed by statute on allotment and buyback.

Question 11

What do solicitors do in a situation where allotment is needed?

Answer 11

Solicitors advise on the procedure necessary to lawfully allot shares, and prepare the necessary paperwork.

Question 12

3 questions need to be considered for allotment:

Answer 12

These are:
1. Are there any constitutional restrictions on allotment?

Companies incorporated BEFORE 2009 might have an ASC (authorised share capital) which limits the total shares companies can have.
To remove the ASC, companies will have to do an ordinary resolution.

For other companies without an ASC but still has a limit, check the articles to see if there is a general limit on the number of shares - this can be changed by special resolution.

2. Do the directors have authority to allot shares?

Alloting shares, can be a board or shareholder decision. Depends on what type of company and how many classes of shares.

PRIVATE company + ONE CLASS of shares (before and after allotment):
Key piece of legislation: s 550 of CA 2006.
if company incorporated BEFORE CA - shareholder decision/ permission was needed to allot shares. This can now be changed to activate s 550 via ordinary resolution. Effect? Board decisions (directors) can allot shares.
if company incorporated AFTER CA - s 550 will already be present and to allot shares therefore, only a board decision is necessary.

To restrict directors power - company articles can restrict it. Plus, s 550 can be deactivated via special resoluton - giving the power back to shareholders in the allotment of shares.

PUBLIC/ PRIVATE companies + MORE THAN 1 CLASS of shares (before or after allotment):
Key piece of legislation: s 551 of CA 2006.
Authority to allot in this situation MUST come from shareholders or may be mentioned in the articles. There will be an ordinary resolution - it will also state the max shares to allot and this cannot exceed more than 5 years - may need to be renewed after every expire date.
Articles of association may already state how many shares can be alloted by shareholders - this can however be changed by an ordinary resolution.

3. Are there any pre-emption (rights to refuse allotment of shares) rights?
   Does not apply to bonus shares or is cash or an employee share scheme is involved.
   S 561: companies need to offer shares to existing shareholders first before offering them to anyone else - these shares offered should enable existing shareholders to maintain their power/ shareholding percentage. These ordinary shares offered are called ‘equity securities’.

Ordinary shares are the ones that give shareholders the right to vote at general meetings.

When equity securities have been offered to shareholders, there must also be an acceptance deadline stated (cannot be less than 14 days). Do not withdraw offer in this period. No acceptance = directors can offer the shares to new shareholders.
Pre-emption rights can be disapplied or there may already be provisions to disapply them.

Question 13

Are there any pre-emption rights in Model Articles?

Answer 13

No. If companies want them, they will need to add them to their articles.

Question 14

How do companies disapply pre-emption rights? Allotment

Answer 14

Via special resolution.

Question 15

For private companies with 1 class of shares, how do you disapply pre-emption rights? Allotment

Answer 15

Can pass special resolution to disapply existing shareholders pre-emption rights. Any pre-emption rights can be disapplied.

Question 16

For public or private companies with more than 1 class of shares, how do you disapply pre-emption rights?

Answer 16

If the ordinary resolution gives the authority to allot shares generally,
then s 570 allows the company to remove the pre-emption
rights just by passing a special resolution. Disapplication will last as long as the directors’
authority under s 551.
If the authority to allot shares contained in the s 551 ordinary resolution was in relation to
a specific allotment, s 571 also allows companies to disapply pre-emption rights by special resolution.

Under s 571(6) the directors must make a written statement setting out:
* the reasons for making the recommendation;
* the amount the purchaser will pay; and
* the directors’ justification of that amount.

The directors’ written statement must be circulated to the shareholders along with the notice of the general meeting, or, if the resolution is proposed as a written resolution, it must be sent out with the written resolution (s 571(7) CA 2006).

Question 17

What is included in the directors written statement to disapply the pre-emption rights - allotment

Answer 17

Under s 571(6) the directors must make a written statement setting out:
* the reasons for making the recommendation;
* the amount the purchaser will pay; and
* the directors’ justification of that amount.

It is an offence to knowingly or recklessly authorise or permit the inclusion of any matter
that is misleading, false or deceptive in a material particular in the directors’ written statement
(s 572 CA 2006).

Question 18

How is payment received for shares

Answer 18

MA 21 - all shares must be fully paid.
If MA 21 is not incorporated into articles - shares can be issued where they are only partly paid. Shareholder must pay the rest when they are contractually obliged to do so or when the company is wound up.

f the company performs well, the value of its shares will increase, so a share with a nominal
value of £1, for example, may be allotted (or transferred) for £1.75 and we would say that
the share was issued at a premium. The excess consideration of 75p would be recorded
in a separate share premium account on the company’s balance sheet (s 610 CA 2006).
This money will then be treated as share capital and must be maintained (see 4.5 for an
explanation of the principle of maintenance of share capital).

Question 19

When should share certificates be issued?

Answer 19

Prepare share certificates within two months of allotment.

Question 20

Can share transfer affect existing shareholders?

Answer 20

Yes, depending on who receives the shares - it could come up to being equal to another shareholder and their rights.

The CA does not regulate share tranfers much.

But the company articles can be adapted to prevent issues from share transfers from arising. Ultimately, we want to prevent conflict between shareholders.

Solicitors often have to draft quite complex share transfer provisions in the company’s articles, or interpret them should a shareholder want to transfer shares.

Question 21

Can company articles then restrict who the shareholder transfers their shares to?

Answer 21

No. But what could happen is the company could choose to never deal with the new shareholder who receives those shares.
This is achieved by the directors right to refuse to register the transfer of shares into the register of members MA 26. This keeps the transferor as the legal owner (who then has to attend all the meetings etc) and keeps the new shareholder as a beneficial owner - they can’t attend meetings and so aren’t involved with the company directly. However, legal owner still must do beneficial owner’s bidding.

Question 22

In share transfer, what is the process to transfering shares?

Answer 22

1.TRANSFEROR:
The transferor must complete and sign a stock transfer form and give it to the transferee along with the share certificate relating to the shares (ss 770–772 CA 2006).

2.TRANSFEREE:
Must pay stamp duty if price of shares is over £1,000.

The transferee must then send the share certificate and stock transfer form to the company.

3.COMPANY:
* send the new shareholder a new share certificate in their name within two months (s 776 CA 2006);
* enter their name on the register of members within two months (s 771 CA 2006); and
* notify the Registrar of Companies of the change in ownership of the shares when the company files its annual confirmation statement (CS01).

Question 23

When is share transfer automatic?

Answer 23

• 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.

In both instances, the people aren’t automatically made shareholders and must be registered. If Directors reject this, they are still entitled to any dividends from the share and will have beneficial ownership (MA 27).

Question 24

What is share capital?

Answer 24

The company’s share capital is the money provided by shareholders in return for shares.

Question 25

Why should share capital be maintained?

Answer 25

To protect creditors - who will look at this money in case any liability arises. No money from share capital can be touched as such by shareholders.
Money for dividends will only come from distributable profits, not the capital. A company must not buy its own shares, generally.

Question 26

In what exceptions can the share capital be interfered with?

Answer 26

• a company can buy back its own shares as long as the correct procedure is followed
  (s 690);
• a company can purchase its own shares under a court order made under s 994 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 27

Why is buyback not good?

Answer 27

It affects the share capital.

Easy justification directors could make: that buyback is necessary and better for the long term of the business

If a company buys back its own shares, the shares in question are cancelled, and the company has to pay the outgoing shareholder for the shares, meaning that the company
is financially worse off as a result of the buyback. Buyback will result in the reduction of profits available for declaring dividends, or of capital available for creditors in the event
that a company cannot pay its debts. Further, if the company is wound up, there will be less money available for the company’s shareholders once creditors have been paid.

Directors owe a duty here.

Directors must consider their duties under the CA 2006 when the company is buying back shares, and
whether the buyback will be good for the company in the long run under s 172 CA 2006. The board will also need to make their decision with regard to the buyback with due skill, care and attention pursuant to s 174 CA 2006.

Question 28

What are the 2 ways of buyback?

Answer 28

On or off the stock market.

Buyback of shares on the stock market, called a market
purchase, and buyback which is not on the stock market, known as an off-market purchase

Question 29

Who makes off market purchases? So, not on the stock market

Answer 29

Private companies

Question 30

What are the requirements of buyback?

Answer 30

It is because buyback is financially risky that the CA 2006 closely controls the circumstances in which a company may buy back its own shares. The requirements are:

1. Firstly, the company’s articles must not forbid buyback (s 690(1)). Check if company’s articles limit buyback.
2. The shares must be fully paid (s 691(1)).
3. The company must pay for the shares at the time of purchase (s 691(2)).
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 (s 692(2)(a) CA
   2006). What is meant by distributable profits is explained in s 830 CA 2006. They 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.
   Please see 12.9.4 for a full explanation of company balance sheets.
5. The shareholders must pass an ordinary resolution authorising the buyback contract (s 694
   CA 2006).
6. A copy of the buyback contract, or a summary of it, must be available for inspection for
   at least 15 days before the general meeting and at the general meeting itself (or be sent
   with the proposed written resolution when or before it is circulated (s 696(2)).
7. Under s 702 CA 2006, a copy of the buyback contract, or, if the contract is not in writing,
   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 31

What needs to happen in any share stuff?

Answer 31

Minutes of meetings must be taken.

Question 32

When a buyout is being considered and a general meeting is being conducted for this, who cannot vote?

Answer 32

The shareholder whose shares the company intends to purchase/ buyback.

Question 33

Whilst companies should not reach into the share capital and should purchase the share they are buyingback using distributable profits, are there any excemptions to this?

Answer 33

Private companies can use share capital to buyback shares. BUT, they must exhaust any distributable profits (and ofc taking into account any liabilities that need to be paid soon) first.

Question 34

How do shareholders make money from their shares?

Answer 34

1. Dividends or 2. Investing and selling (assuming that over time the share price will increase).

Question 35

What are the 2 types of debt finance

Answer 35

Loans and securities.

Question 36

What types of loans are available

Answer 36

The main ones include a bank overdraft, a term loan and a revolving credit facility - all are governed by contract law.

Question 37

Whilst equity finance is largely regulated by the CA 2006, debt finance is largely controlled by what?

Answer 37

Contract law

Question 38

Before borrowing money for your company or partnership, what is the first thing you should do?

Answer 38

Check if there are any limitations to borrowing money. And check if director has authority to act on behalf of company - authority comes from MA 3.

Check company’s articles - if there are restrictions and it needs to be changed, can be done via special resolution.

Check partnership agreement, if there are restrictions and it needs to be changed, can be done via unanimous consent.

Question 39

What will businesses give when they enter into a loan?

Answer 39

Security over some or all of its property so that the bank can recover what it is owed more easily if the business defaults on the loan.

Businesses pay higher rates of interest for unsecured loans, because the lender will require some financial advantage to compensate it for not taking security.

Question 40

What is the overdraft facility?

Answer 40

Exactly like the normal overdraft people have for their accounts, except that its for a business. Temporary every day use loan.
The maximum overdraft amount is something that will be negotiated in the contracts between business and lender.
Interest will be charged generally, by reference of lender’s base rate - implied in contracts, unless suggested otherwise.
Disadvantage: repayment can be demanded at any time by bank. Unsecured way of borrowing so banks may charge high interest. Can reduce interest by borrowing a smaller amount. Can reborrow.

Question 41

Term loans

Answer 41

Fixed amount loans. Fixed period of time where it needs to be paid back at the end. Interest is likely to be charged and need to be paid in intervals.
A period of more than 5 years is seen as a long term.
Taking the money in installments might reduce the interest.
Generally, it is a secured loan.
Can be a bilateral (between 2 parties: business and bank) or syndicated loan (between multiple people - 1 business + mulitple lenders).

Disadvantages are the
time and expense in negotiating and agreeing all the legal documentation for such a loan
and the fact that, once repaid, the money cannot then be re-borrowed by the business.
Complex contract terms - requires lots of negotiating between solicitors for the bank and the business.

Question 42

Revolving credit facilities

Answer 42

Bank gives a maximum amount that can be borrowed. This money can be borrowed and returned within the lifetime of the credit facility. Interest payable at regular intervals.
Generally, secured. Can be bilateral or syndicated. Can reborrow.
Complex contract terms - requires lots of negotiating between solicitors for the bank and the business.

Disadvantages of a revolving credit facility for the business are
the time and expense in negotiating and agreeing all the legal documentation for the loan
and the high fees that are charged.

Question 43

What term refers to both loans and revolving credit facilities?

Answer 43

Facility agreements - they are both committed facilities.

Question 44

What clauses are found in a facility agreement contract? So, for loans and revolving credit facilities.

Answer 44

1. Payment of money to borrower clause
2. Repayment and pre-payment clause
3. Interest rates
4. Covenants
5. Implied covenants
6. Events of default

Question 45

1. Payment of money to borrower clause (Facility agreements clauses (1/6)

Answer 45

Will set out:

(a) the amount of the loan;

(b) the currency (eg £, $ or €);

(c) the type of loan (if it is to be a term loan or revolving credit facility); and

(d) the availability period(s) during which the loan can be taken (for a revolving credit facility,
this is almost the entire length of the facility)

Question 46

2. Repayment and pre-payment clause (Facility agreements clauses 2/6)

Answer 46

Will set out;

The agreed repayment schedule.
This looks like, the repayment:

(a) of the whole loan in one go at the end of the term (a ‘bullet’ payment); or

(b) in equal instalments over the term of the loan (‘amortisation’); or

(c) in unequal instalments, with the final instalment being the largest (‘balloon repayment’).

Question 47

3. Interest rates (Facility agreements clauses 3/6)

Answer 47

Agreed between parties.
It may be fixed for the period of the loan, or it could be variable, that
is, a ‘floating’ rate, where the interest rate is altered at specified intervals, for example three or six months, by reference to a formula which is intended to maintain the lender’s profit on the loan.

If payments are missed, lender may want to impose a default interest - but this has to be drafted very carefully in the contract.

Question 48

4. Covenants (Facility agreements clauses 4/6)

Answer 48

Contract will include many promises/ covenants made by business to the lender. Covenant = contractual promise.
Aim: ensures that there are agreed limits and that business will be able to make repayments in time. Ensures that business stays solvent.

Certain specific covenants that are common:

(a) Limitation of dividends. Companies must ensure that dividends and other distributions to
shareholders do not exceed a specified percentage of the net profits.

(b) Minimum capital requirements
. The business must ensure that current assets exceed
current liabilities by a specified amount of money or a specified percentage.

(c) No disposal of assets, or change of business. The business must not dispose of assets
without the lender’s consent, or change the scope or nature of the business.

(d) No further security over the assets. The business must not create any further security over the whole, or any part, of the undertaking without the lender’s consent (a ‘negative pledge’ clause, see 5.17.8).
(e) Provision of information on the business, for example, annual accounts.

Question 49

What is equity finance?

Answer 49

When shares of a company are bought by someone - a shareholder. This money/ property received in exchange can be used by the company to fund its business.

Question 50

5. Implied Covenants (Facility agreements clauses 5/6)

Answer 50

Court’s power to imply terms are limited.
Trade usage such as a bank’s right to charge compound interest is an implied term.

A contractual term would be implied only if it were necessary to give business efficacy to the contract or if the term is so obvious that it ‘goes without saying’. In any event, the court could not imply a term that was inconsistent with an express term
of the contract. This should not be a problem with facility agreements drawn up by legal advisers.

Question 51

6. Events of default (Facility agreements clauses 6/6)

Answer 51

If the business breaches any of these
terms, the lender may terminate the agreement if it so wishes. Such events include failure to pay any sum due, commencement of an insolvency procedure or breach of other obligations under the facility agreement.

Question 52

What is a debenture? Should sole traders have it?

Answer 52

It is the registration of a loan agreement between a borrower (the company) and a lender (the bank) at the Companies House so of course this will not be something sole traders need to do. Only for companies and LLPs.

It gives the lender security over the borrower’s assets.

Question 53

Who benefits from having a security granted over the loan?

Answer 53

Lender - when things go wrong.
Borrower can also benefit as this means more can be borrowed and at a lower rate.

Question 54

Is ‘security’ the only way a security will be referred to?

Answer 54

No. It can also be referred to as a mortgage or a charge etc.

Question 55

What about sole traders and general partnerships? What can they use to grant security?

Answer 55

Sole traders and general partnerships cannot grant floating charges, only fixed
charges. These must be registered at HM Land Registry if they are over land.

Question 56

Initial steps for a company borrowing money?

Answer 56

(1) ensure that company has the power to borrow

(2) ensure that the company has the power to grant security over assets. Company formed under CA 2006 is unrestricted - check MA to ensure that this is the case. If company formed before 1 Oct 2009, check MEMORANDUM to see if there are any restrictions, if it has not been updated regarding the CA 2006.

Question 57

What should lenders do before giving money?

Answer 57

Ensure that the company has no restrictions on granting security. And that the directors have authority to act.

Lender should serach the company’s records at Companies House to see if any
charges have been registered already against the company’s property, and ensure that there is sufficient value in that property to provide adequate security for the proposed loan.

Check with the Registrar of Companies:
From the register, the lender will be able to discover:
(a) the date of creation of any existing charge;
(b) the amount secured;
(c) which property is the subject of the charge; and
(d) who holds that charge (ie who can enforce the charge).

Question 58

What assets can be secured?

Answer 58

Virtually, all assets.

(a) land, whether freehold or leasehold, and fixtures and fittings;
(b) tangible property, such as machinery, computers and stock;
(c) intangible property, such as money in a bank account, debts owed, any shares they own
in other companies and intellectual property rights.

Question 59

Types of security: Part 1: Mortgages

Answer 59

Legal ownership is transferred from mortgager to mortgagee (i.e. the lender). Title will be transferred back to the borrower once mortgage has been paid off.

Question 60

Types of security: Part 2: Charges

Answer 60

Legal ownership stays with the borrower - no right for lender to have immediate possession.

Question 61

Why check a business’ accounts?

Answer 61

to ascertain whether the business is
profitable and whether it can pay its debts.

Question 62

Does a company being profitable necessarily mean that it can pay its debts?

Answer 62

No. Because the company may be spending this money on other things.

Question 63

What can we look to, to see if a company can pay its debts?

Answer 63

The balance sheet.

Question 64

What are current assets?

Answer 64

Liquid assets - they can be quickly converted into money. This is what will be used to meet its immediate debts. Owning a factory is good but it cannot be sold immediately to make money to pay off a debt - this is not a current asset.

Question 65

What assets are the most liquid (aka you can make money from the quickest)?

Answer 65

Cash
Debts

Business Stock - less so as you will need to take time to sell them for a good price.

Question 66

How do partners in a partnership share profits?

Answer 66

It will be equal shares if there is no agreement between them as per the PA 1890 - if there is an agreement, this should be in their partnership agreement.

Question 67

In a partnership, a partner can earn a salary, how?

Answer 67

By putting in extra hours and doing more work for example

Question 68

Are partners entitled to interest on the capital they have contributed towards the partnership?

Answer 68

Yes. This is the reason for separating the current and the capital accounts.

Question 69

How does taxation work in partnerships?

Answer 69

Partners submit their own tax returns - claiming their own personal allowances.

Question 70

Difference between the accounts of companies, sole traders and partnerships:

Answer 70

Companies have shares… this is not something that will come up on the accounts for sole traders or partnerships: this will be headed as ‘capital and reserves’ on the companies accounts.

Also, because companies are separate legal entities - paying salaries comes under expenses. In partnerships, their profit is divided between the members and this is their salary.

Tax stuff does not come up on sole trader and partnerships accounts as they are unincorporated.

Question 71

Shares on the balance sheet - how will they be shown?

Answer 71

Companies may have more than one type of shares, for example, ordinary and preference
shares. They will be shown separately on the balance sheet

Question 72

If a shareholder sells their shares, will this be shown in the company’s accounts?

Answer 72

Shareholders can usually (depending on the company’s articles) sell their shares to third parties, but this will not be shown in the final accounts: it is a
personal transaction between the shareholder and a third party.

In this situation, company has neither made or lost money.

Question 73

What is a companys profits used for?

Answer 73

Paying dividends.
Retention of profits.
Taxation.

Question 74

Why is tax not shown in the accounts of sole traders and partnerships?

Answer 74

Because they are unincorporated and it is the sole trader or partners themselves that are liable to income tax or CGT.

Question 75

When do companies pay corporation tax?

Answer 75

9 months after the end of the accounting period.

Question 76

Are dividends placed in the profit and loss account?

Answer 76

No.

Question 77

Where is the retained profits placed on the accounts?

Answer 77

They are called profit and loss reserve.
Retained profits do not go into the capital.

Question 78

What does the reserves part of a balance sheet show for companies?

Answer 78

What the company ‘owes’ to its shareholders.

Question 79

Where must companies file their annual accounts?

Answer 79

With the Registrar of Companies and also give a copy of this to shareholders each financial year. The final accounts of public companies must be put before the members in a general meeting.

Question 80

What does the directors report show?

Answer 80

The Directors’ Report contains factual information about the company and a review of the company’s business, as well as confirmation that the auditors (where relevant) have been
given all relevant information.

Question 81

What does an auditors report show?

Answer 81

This report is prepared by the company’s auditors, and in it, the auditors are required to state
whether, in their opinion, the accounts give a true and fair view of the financial state of the
business

Question 82

What must parent/ the holding company do when it comes to accounts?

Answer 82

Parent companies must produce consolidated accounts which show the financial position of all of the companies in the group and therefore the group as a whole.