Chapter 8: Companies - Raising Finance

Question 1

What is equity finance?

Answer 1

A method of raising capital whereby a company sells ownership shares in the company to third parties interested in investing in the company.

The third parties give the company money, and in exchange the company allots shares of ownership to the third parties who thereby become members of the company.

Question 2

Who are a company’s subscribers?

Answer 2

Before a company is formed, people will sign a memorandum of association in which they agree to purchase a certain number of the company’s shares at a certain price once the company is formed.

Question 3

What is the nominal or par value of shares?

Answer 3

Shares have a stated minimum value - the least amount that the shareholders may pay for the shares.

Question 4

How can companies allot additional shares?

Answer 4

For companies incorporated after 2009, directors automatically have the power to allot additional shares provided:
i. the company has only 1 class of shares, and
ii. there is no restriction removing this power in the articles.

Otherwise, in order to issue additional shares, the directors must seek permission from the existing shareholders through an ordinary resolution.

Question 5

What is the general procedure for issuing shares?

Answer 5

1. The directors will determine the price + no. of shares to allot, and will resolve to allot the shares after receiving an application from a person who wants to buy the shares.
2. Generally, shares are issued in exchange for cash, but the directors may accept property for shares as well.
3. Under the model articles, the full value of the shares must be paid to the company on allotmnet.
4. If the shares have a nominal or par value, the money received on account of that value will be added to the company’s share capital.

Question 6

What happens if shares are sold for an amount above their nominal value?

Answer 6

Any amount received beyond the nominal value is known as a premium.

The excess amount paid over and above the nominal value must be recorded separately in a share premium account.

This still constitutes share capital.

Question 7

When are preemption rights relevant? What is the pre-emption right?

Answer 7

When the company proposes to issue additional shares in exchange for cash, unless its articles provide otherwise, those shares must first be offered to the existing shareholders so that they have the opportunity to maintain their proportional share of ownership + voting strength in the company.

Question 8

When the pre-emption right applies, what is the statutory procedure involved?

Answer 8

The company must offer the shares to the current shareholders (based on their proportional ownership) on the terms for which the shares would be offered in the open market.

The existing shareholders must be given at least 14 days to accept.

If any shareholder doesn’t accept, the shares allocated to the shareholder may be sold in the market.

Question 9

When does the preemption right not apply?

Answer 9

1. If shares are to be issued for consideration other than cash (e.g., in exchange for a piece of land),
2. When preference shares are being allotted

Question 10

How may the preemption right be disapplied?

Answer 10

The preemption right may be disapplied by a special shareholder resolution

Question 11

What effect may a company’s articles have on the preemption right?

Answer 11

A company’s articles may alter the statutory preemption right.

A private company’s articles may disapply the statutory preemption right altogether.

However, the Model Articles don’t alter the statutory right.

Question 12

What does the transfer of shares involve?

Answer 12

The transfer of shares involves the sale or gift of existing shares by a shareholder to another person.

Question 13

Why is a transfer of shares different to the issue of shares?

Answer 13

As no new shares are created + the selling shareholder receives the consideration paid for the shares rather than the company.

Question 14

What governs a shareholder’s ability to sell their shares?

Answer 14

The ability of an existing shareholder to sell their shares is governed by the articles of the company.

The model articles for private companies grant the directors an absolute power to refuse to allow a transfer of shares.

Question 15

What is the procedure for transferring shares?

Answer 15

1. Existing shareholder gives share certificate and completed stock transfer form (STF) to transferee,
2. If necessary, transferee pays stamp duty,
3. Transferee sends share certificate + stamped STF to company,
4. Board check articles + consider if they have power to refuse registration,
5. Board resolve to register new member/refuse registration,
6. If resolve to register, board also resolve to issue new share certificate,
7. The registrar of members is updated (no filing at Companies House is necessary)

Question 16

What is debt finance?

Answer 16

Occurs when the company borrows money to raise capital.

The company enters into a creditor-debtor relationship, whereby the company has borrowed funds from an ‘outside creditor’ and promises to repay the creditor.

The debt holder has no ownership interest in the company.

Question 17

Who has the power to borrow money?

Answer 17

The directors have the power to decide to borrow money on behalf of the company unless there are restrictions on borrowing in the company’s articles.

The model articles have no such restriction.

Question 18

What is a loan?

Answer 18

A loan is a contract between the company + a lender.

The lender can be a bank or an individual, and in many small companies, a director or shareholder may lend money to the company.

The contract will set out:
i. how much money is or can be borrowed,
ii. when it must be repaid,
iii. interest rates, and
iv. other terms of the loan.

Question 19

What is the effect of a loan being secured?

Answer 19

If the loan is secured, then the lender has more chance of recovering the sum borrowed if the company defaults.

As a result, the rate of interest charged may be lower on a secured loan.

Question 20

What is a mortgage?

Answer 20

A loan taken over high value assets (e.g., land, buildings, or machinery).

Apart from land, the legal ownership of the asset is transferred to the lender, and if the company defaults, then the lender will exercise the right to immediate possession of the asset.

With land the right to possess and sell the asset if the lender defaults are governed by statute.

Question 21

What is a fixed charge?

Answer 21

A fixed charge is taken over assets which the company will own for a substantial period (e.g., machinery and shares).

If a company breaches the loan terms, or goes into receivership or liquidation, the charge holder has the right to sell the asset and recover the outstanding sum owed.

To protect the charge holder, the company is prohibited from disposing of, leasing, or granting a further charge on the charged assets without the lender’s consent.

Question 22

What is a floating charge taken over?

Answer 22

Taken over a group of assets that change regularly.

The clearest example is inventory.

Question 23

What is a floating charge?

Answer 23

The charge hovers over the named asset (e.g., inventory) but doesn’t attach to any particular item until there is a default.

At that time, the charge crystallises and attaches to the individual items that comprise the asset that is subject to a floating lien.

Question 24

When must charges created by a company be registered? What must be sent with this?

Answer 24

A charge created by a company must be registered at Companies House within 21 days of creation. A certified copy of the charge and a fee must also be sent.

Question 25

When would a charge need to be registered other than at Companies House?

Answer 25

Some charges must be registered on other specialised registers, e.g., a fixed charge over land would also be registered at Land Registry.

Question 26

What happens if there is a failure to register the charge at Companies House?

Answer 26

A failure to register the charge at Companies House renders the charge void against a liquidator or administrator of the company + against the company's other creditors. For this reason, the lender will often register the charge, rather than relying on the company's directors to do so.

Question 27

What is the priority of secured debts?

Answer 27

Fixed charges over the same asset take priority in date order of their creation, so long as they were validly registered at Companies House. Floating charges over the same assets take priority in date order of their creation, provided they were validly registered at Companies House. A fixed charge will take priority over a floating charge over the same asset, even if the floating charge was created before the fixed charge.

Question 28

What is a debt security?

Answer 28

A document which evidences a loan made to a company + which may be traded. The holder of the debt security is entitled to interest and repayment of the loan as provided in the security. Conceptually, it is a tradable 'IOU' issued by the company in return for cash. The IOUs must be repaid by the company at an agreed future date.

Question 29

How will shareholders who invest in a company by way of shares be taxed?

Answer 29

Taxed to income tax on any dividends they receive from the company.