Unit 5 Company Finance

Question 1

2 ways to obtain finance

Answer 1

Equity finance = prospective shareholders pay money or give property to the company in return for shares

Debt finance = companies borrow money to fund expansion or just the day- to- day running of the company.

Question 2

Equity Finance - Allotment of shares

Answer 2

When a person acquires the unconditional right to be included in the company’s register of members in respect of the shares.

Board decide how many and price.

Pre 2009 upper limit on shares in memorandum of association.
2009 CA06 came into force and transferred it to articles - can be removed by ordinary resolution.

Any company incorporated after 09 won’t have upper limit unless put one in articles itself - can remove limit in articles using special resolution.

Question 3

Equity Finance - Allotment of shares - Private companies with one class of share

Answer 3

One class of shares before and after allotment - only need board decision.

If incorporated before CA06 came into force (09) need ordinary resolution to activate giving directors authority.

Question 4

Equity Finance - Allotment of shares - public companies, or private companies with more than one class of shares

Answer 4

Directors need ordinary resolution of shareholders. Contains date at which authority expires cannot be more than 5 years.

Or may amend articles to include directors authority using special resolution.

Question 5

Equity Finance - Allotment of shares - pre- emption rights

Answer 5

Rights of first refusal over shares which are being allotted.

Must first offer them to existing holders of ordinary shares on same or more favourable terms.
Must offer the number of shares which will enable them to preserve their percentage shareholding in the company.

Period of acceptance cannot be less than 14 days.

Exceptions:
- where consideration is non-cash
- shares held under, allotted or transferred pursuant to an employee share scheme
- bonus shares

Can exclude right in articles for private companies with one class of shares.

Question 6

Equity Finance - Allotment of shares - pre- emption rights - misapplication - Public companies or private companies with more than one class of shares

Answer 6

• Companies which do not have automatic authority to allot under s 550 will need to pass an ordinary resolution under s 551 CA 2006 to give the directors authority to allot shares.
• If the ordinary resolution gave a general authority to allot (rather than authority in relation to a specific allotment) then s 570 allows the company to remove the pre- emption rights just by passing a special resolution.
• If the ordinary resolution was in relation to a specific allotment, s571 allows companies to disapply pre- emption rights by special resolution.
  SR must be recommended by directors. Directors must make written statement setting out reasons for recommendation, amount purchaser will pay and justification for price.

Question 7

Equity finance - payment for shares

Answer 7

Under MA 21, all shares in a company must be fully paid, meaning that the buyer must pay for the shares when they receive them.

If the company’s articles do not include MA 21, then shares can be issued partly paid, but the shareholder must pay the remainder when contractually obliged to do so or if the company is wound up.

Question 8

Equity finance - allotment - admin requirements

Answer 8

• Copies of resolutions filed with CH within 15 days
• All special resolutions
• Ordinary resolution removing authorised share capital in a pre-CA06 company
• Ordinary resolution to active s550 in pre-CA06 company
• Ordinary resolution granting directors authority to allot
• Forms to be sent to CH
• Return of allotment and statement of capital (Form SH01) within 1 month of allotment
• Persons with significant control (possible forms - PSC01 PSC02 PSC04 PSC07)
• Entries in company’s own registers
• Amend register of members within 2 months
• Amend PSC if necessary
• Preparation and allocation of share certificates
• Prepare share certificates within 2 months of allotment

Question 9

Equity finance - transfer of shares

Answer 9

Nothing in CA 06 to prevent shareholders transferring shares or offering to existing shareholders first (pre-emption).

Articles will contain restrictions.
Common for transfer to be approved by board of directors.

Articles cannot restrict a shareholder from selling the shares and cannot stop a particular purchaser from buying them. However do not become shareholder until interest on register of members.
MA26 gives board discretion to refuse to register transfer of shares.

The transferor will be legal owner who receives divides and can attend general meetings. But must vote in accordance with wishes of beneficial owner (new owner) and must pay dividends to them.

Question 10

Equity finance - transfer of shares - process

Answer 10

Transferor sign stock transfer form. Give it to transferee with share certificate.

If the sale price of the shares is over £1,000, the buyer must pay stamp duty. Don’t have to pay of gift.

Transferee sends forms to company.

Company should then:
* send the new shareholder a new share certificate in their name within 2 months (s 776 );
* enter their name on the register of members within 2 months (s 771); and
* notify the Registrar of Companies of the change in ownership of the shares when the company files its annual confirmation statement (CS01).

Question 11

Equity finance - transmission of shares

Answer 11

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.

MA27 trustee in bankruptcy/PRs do not become shareholders but entitled to dividends.

Can choose to be registered as shareholders and then sell shares or sell them directly in capacity as representative.

Question 12

Equity finance - maintenance of share capital

Answer 12

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

Principle that fund cannot be reduced.
So shareholders liability in regard to any capital they have not paid on their shares must not be reduced.

Consequences of principle:
* dividends cannot be paid out of capital, just out of distributable profits; and
* the company must not generally purchase its own shares.

Exceptions:
* 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 13

Equity finance - share buyback

Answer 13

Can pass ordinary resolution authorising the company to buy back their shares.
E.g. can’t find purchaser or can’t get enough support for SR to change the articles permitting the shareholders to transfer the shares as they wish.

Bought back shares are cancelled so company is financially worse off.
However, companies can often justify buyback on the basis that it is better for the company in the long run to buy out a disgruntled shareholder than continue to work with them in an unproductive way, especially if that shareholder is also a director and their resignation was conditional on the company buying back their shares.

Question 14

Equity finance - share buyback - procedure

Answer 14

For shares not on stock market = off market purchase.

Requirements:
1. Articles must not forbid buyback (s 690(1)).
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).
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 10 years starting with the date of the buyback.

Shareholder whose shares are being bought back not eligible to vote.

Question 15

Equity finance - share buyback - buyback out of capital

Answer 15

Private companies are permitted to buy back their own shares out of capital, unless the company’s articles forbid buyback out of capital (s 709 CA 2006).
But must exhaust their distributable profits first.

Public companies are not permitted to buy back shares out of capital.

Same requirements, plus:
1. The company’s directors must make a statement of solvency, no sooner than 1 week before the general meeting.
2. The statement of solvency must have annexed to it an auditors’ report confirming that the auditors are not aware of anything to indicate that the directors’ opinion is unreasonable (s 714 CA 2006).
3. The payment out of capital must be approved by special resolution (s 716). This is in addition to the ordinary resolution that the shareholders must pass under s 694 CA 2006 to approve the buyback contract.
4. A copy of the directors’ statement of solvency and auditors’ report must be available to members.
5. Within 7 days of the special resolution being passed, the company must put a notice in the London Gazette, stating that the shareholders have approved payment out of capital in order that the company can buy back its own shares (s 719 CA 2006).
6. The company must also file a copy of the directors’ statement and auditors’ report at Companies House before or at the same time as it places the notices in the London Gazette and the newspaper (s 719(4)).
7. The directors’ statement and auditors’ report must be kept available for inspection at the company’s registered office from the time the company publishes its first notice until 5 weeks after the passing of the special resolution (s 720).
8. As long as none of the creditors object to the buyback out of capital, the directors hold a board meeting and will pass a board resolution to decide to enter into the contract to buy back the shares. The payment out of capital itself must be made no earlier than 5 weeks after the date of the special resolution to approve the buyback out of capital, and no later than 7 weeks after the date of the special resolution (s 723(1)), so the board has a 2 week window to enter into the contract.

Question 16

Equity finance - dividends

Answer 16

A shareholder can make money from their shares in two ways.

1. the value of the shares will increase as the company makes money
   2 dividends - a company can pay a dividend if it has profits available for the purpose (s 830 CA 2006). A company’s available profits are its accumulated, realised profits less its accumulated, realised losses.

Question 17

Debt finance - 2 types

Answer 17

1. Loans
   Where a business borrows money from a bank or another lender, such as its owner(s) (for a sole trader or partnership) or its directors or shareholders (for a company).
2. Debt securities
   IOUs which are issued by the company to the investor in return for a cash payment, and have to be repaid by the company at an agreed future date.

Question 18

Debt finance - Considerations prior to borrowing

Answer 18

Check constitution allows it.
Model articles for private companies do not place any restrictions on borrowing. If pre 1 Oct 2009 check company’s memorandum.

Directors must have authority to act on behalf of company (MA3)

Check no restrictions in partnership agreement - if is can only change it with unanimous consent.

Question 19

Debt finance - loans

Answer 19

Contract so governed by contract law.

Secured loans involve the business giving security to the lender over some or all of its property so that the bank can recover what is owed.

Pay higher rates for unsecured loans.

Question 20

Debt finance - overdraft facility

Answer 20

= contract between the business and its bank which allows the business to go overdrawn on its current account.

Known as an uncommitted facility = it will usually be payable on demand.

Pay a fee for overdraft facility and charged interest by reference to banks base rate.

Advantages:
- is a flexible source of finance and relatively few formalities are required to arrange it.

Disadvantages:
- repayment may be demanded at any time by the bank.
- relatively expensive way to borrow, as it is usually unsecured and the banks charge high interest rates in return for offering such flexibility to the borrower.

Question 21

Debt finance - term loans

Answer 21

= the business borrows a fixed amount of money, usually from a bank, for a specified period (ie term), at the end of which it must all be repaid.

The borrower must also pay interest at regular intervals.

Short term = up to 1 year
Medium term = 1-5 years
Loan term = 5+ years

Can be secured or unsecured.

Bilateral = is between two parties, the business and the bank.
Syndicated loan = is between the business and a number of different lenders, who jointly provide the money the business wants to borrow.

Contract called a loan agreement, a credit agreement or a facility agreement.

Advantages:
- it gives greater certainty than an overdraft, which is repayable on demand, and the borrower has greater control because the bank can only request repayment under the terms of the contract.
Disadvantages:
- 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.

Question 22

Debt finance - revolving credit facilities

Answer 22

= the bank agrees to make available a maximum amount of money to the business throughout the agreed period of the revolving credit facility. During the lifetime of the facility, the business can borrow and repay money.

Interest is payable at regular intervals.

Can be secured or unsecured.

Advantages:
- very flexible means of borrowing money and it is possible to reduce the total amount of interest payable by reducing borrowings.
Disadvantages:
- the time and expense in negotiating and agreeing all the legal documentation for the loan and the high fees that are charged.

Question 23

Debt finance - contractual terms

Answer 23

The initial clauses of the facility agreement 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).

Will also set out the agreed repayment schedule for the loan. It may provide for 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’).

No statutory control on interest rate applicable to companies.
Can be fixed or variable.

Default interest clauses when payments missed in a facility agreement must therefore be drafted very carefully due to the contract law on penalty clauses.

Agreement will contain ‘events in default’ where if any terms breached lender may terminate the agreement if it so wishes.

Question 24

Debt finance - contractual terms - covenants

Answer 24

Promises to do or not do something.

Express:
(a) Limitation of dividends. Dividends 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.
(d) No further security over the assets without the lender’s consent.
(e) Provision of information on the business, for example, annual accounts.

Implied:
E.g. implied by trade usage such as the bank’s right to charge compound interest.

The court’s power to imply terms is limited. Only implied if it were necessary to give business efficacy to the contract or if the term is so obvious that it ‘goes without saying’.

Question 25

Debt finance - debentures

Answer 25

Generally used to describe a loan agreement in writing between a borrower and a lender that is registered at Companies House.

Question 26

Debt finance - secured debt

Answer 26

A lender with security may claim the secured assets of the business if the business fails to meet its obligations under the facility agreement.

Unsecured debts are all reduced pro rata if there are insufficient funds to pay all the business’s debts.

Question 27

Debt finance - When sole traders, partnerships and LLPs borrow money

Answer 27

Sole traders and general partnerships cannot grant floating charges only fixed charges.

Must be registered at HM Land Registry if they are over land.

LLPs can also grant floating charges.

Question 28

Debt finance - Company considerations

Answer 28

Directors must make sure company has power to grant security over assets.

A company formed under the CA 2006 has unrestricted objects, unless specifically restricted by the company’s articles of association (s 30(1)).

For a company formed before 1 October 2009, the objects of the company were set out in its old- style memorandum of association, after check articles.

If any restrictions must pass special resolution to amend articles.

Question 29

Debt finance - Lender considerations

Answer 29

Ensure no restrictions and director has authority to act.

Request copies of relevant board resolutions and search companies records at companies house.

If taking charge over land should check land registry to see if pre existing charges registered.

Conduct a winding- up search by telephone at the Companies Court to check that no insolvency proceedings have been commenced against the company.

Question 30

Debt finance - What assets may be secured?

Answer 30

Virtually all assets that a company (or LLP) might own.

Examples:
(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 31

Debt finance - types of security - mortgages

Answer 31

Highest form of security.

A mortgage, not over and, transfers legal ownership to mortgagee/lender.
Gives the lender the right to immediate possession of the property, this is held in reserve and exercised only if the borrowed money is not repaid (ie if the borrower defaults).

Over and is a charge by deed expressed by way of legal mortgage. Rights to take possession of the land and to sell it.

Question 32

Debt finance - types of security - charges

Answer 32

Gives the lender important rights over the asset should the borrower fail to repay the money borrowed.

• Fixed charge
• Must create a separate fixed charge over each asset.
• Lender has control of asset e.g. can’t sell it without consent.
• Have to keep it in good condition.
• Possible to create more than one fixed charge over the same asset. Created first gets first money.
• Floating charge
• Secures a group of constantly changing assets e.g. stock.
• Possible to have more than one floating charge over same assets.
• Company/LLP retains freedom to deal with assets in ordinary course of business until the charge ‘crystallises’.
• Will normally crystallise (basically turn into a fixed charge) if:
  a) the chargor goes into receivership;
  (b) the chargor goes into liquidation;
  (c) the chargor ceases to trade; or
  (d) any other event occurs which is specified in the charge document.
• Book debts
  Money owed to company/LLP by debtors. Can be charged as an asset.

Question 33

Debt finance - types of security - other

Answer 33

• personal guarantees: sometimes directors or partners in an LLP will give a personal guarantee for a loan, in case the lender is unable to recover the loan in full from the company/ LLP.
• a pledge, which arises where an asset is physically delivered by the debtor to the creditor to serve as security until the debtor has paid their debt. The creditor has the right to sell the asset to settle the debt owed, provided they give sufficient notice (which may be agreed in advance by the parties).
• a lien, which gives a creditor the right to physical possession of the debtor’s goods or assets until the debt is paid.
• Retention of title: on a sale of goods, the buyer does not get full title to the goods until they pay the full price to the seller. If the buyer defaults then the goods are repossessed by the seller.

Question 34

Debt finance - lender enforcement and powers

Answer 34

Set out in agreement. Usually power to sell assets.

If the lender is a qualifying floating charge holder (QFCH), the lender will be empowered to appoint an administrator without petitioning the court.

Question 35

Debt finance - Procedural matters for companies issuing debentures

Answer 35

May be problems over the ability of the directors to vote and count in the quorum on the resolution to borrow and grant security, particularly if the directors have been asked to guarantee the loan personally.

The articles may prevent any director who has a personal interest (possibly all directors) from being involved in the decision to borrow.

It may therefore be necessary to call a general meeting or to circulate written resolutions, either to suspend any prohibition in the articles by ordinary resolution, to allow the directors to count in the quorum or vote, or to change the articles by special resolution.

Question 36

Debt finance - registering charges

Answer 36

New regime 6 April 2013, now voluntary to register new charges. But high incentive to register as if not registered in time period charge can become void.

The company or a person ‘interested in the charge’ may decide to register it.

• Within 21 days file statement of particulars/form MR01 at companies house.
• Given certificate of registration
• Form MR01 and certificate put on companies file and kept open to inspection (failure to do this criminal offence)
• If over land registered at LR

Failure to register at companies house renders charge void.

If 21 day period missed, charge void.
Limited power for court to extend period if due to accident and would not prejudice the position of other creditors or shareholders of the company.

Charge has priority from the date of actual registration if not registered in 21 days, if in 21 days priority is date of creation.

Question 37

Debt finance - registering charges - redemption of loan

Answer 37

When loan repaid you may but are not obliged to omplete, sign and send Form MR04 to the Registrar of Companies at Companies House.

If borrowers property released from charge or asset sold must complete, sign and send Form MR04 to the Registrar of Companies at Companies House.

Question 38

Debt finance - priority of charges

Answer 38

Order fixed by law (if all registered properly):
(a) A fixed charge or mortgage will take priority over a floating charge over the same asset, even if the floating charge was created before the fixed charge or mortgage.
(b) If there is more than one registered fixed charge or mortgage over the same asset, they have priority in order of their date of creation, not their date of registration.
(c) If there is more than one registered floating charge over the same asset, they have priority in order of their date of creation, not their date of registration.

Subordination/ agreement is deed of priority = creditors to enter into an agreement between themselves to alter the order of priority of their charges.

• Negative pledge = clause in floating charge documents to prohibits the company from creating later charges with priority to the floating charge (ie fixed or mortgage) without the floating charge holder’s permission.
• If lender has actual knowledge their later charge is subordinate.
• Disclose to companies house on form MR01.
• Make sure covenant that there are no earlier charges which are subject to negative pledge clause otherwise agreement terminated.

Question 39

Final accounts

Answer 39

Final account = profit and loss account and the balance sheet.

The profit and loss account tells us how profitable a business is, through a simple calculation:
Income – Expenses = Profit

The trading account shows gross profit by subtracting the cost of sales (the cost of buying trading stock) from the income received from sales.

The balance sheet shows the worth or value of the business by listing its assets and liabilities on the last day of the accounting period.
Assets – Liabilities = Net worth of the business

Question 40

Final accounts - assets and liabilities

Answer 40

Fixed asset = enable it to run effectively e.g. business premises and machinery.

Current assets = short- term assets. E.g. stock, debts and cash.

Current liabilities = repayable in 12 months or less from the date of the balance sheet.

Long-term liabilities = repayable more than 12 months from the date of the balance sheet.

Net assets = fixed and current assets - short- term and long- term liabilities.

Net current assets = current assets - current liabilities.

Question 41

Final accounts - Adjustments

Answer 41

Types of adjustment (must be included when preparing final accounts):
- Outstanding expenses
- Prepayments
- Work in progress (WIP)
- Closing stock
- Bad and doubtful debts
Bad believes will never be paid. Doubtful those who may not pay. Entered in the expenses section of the profit and loss account and are also subtracted from the debtors figure on the balance sheet.
- Deprecation and revaluation
Shown in the profit and loss account as an expense item which reduces net profit.
- Disposing of assets

Question 42

Debt finance vs equity finance

Answer 42

• Interest on loan tax deductible
• Easy to forecast expenses because loan payments don’t fluctuate
• keep control over business
• still have to pay it even if profits low