Equity Finance

Question 1

What are shares?

Answer 1

A bundle of rights!

By investing in shares the investor becomes a part owner of the company and will often have voting rights in shareholder meetings.

Incentives for investing:
- receipt of income (dividend)
- capital gain (on selling shares)

Different classes of shares carry different rights and entitlements - all of these will be set out in the articles.

Question 2

Issued shares

Answer 2

Amount of shares in issue - ‘issued share capital’

This is the amount that will show up in the company’s balance sheet in its accounts.

ISC is made up up:
- shares purchased by first members (subscriber shares)
- further shares issued after the company has been incorporated to new or existing shareholders
- new shares can be issued at any time provided that the correct procedures are followed

Question 3

Allotment of shares

Answer 3

Allotment - when a person acquires the unconditional right to be included in the company’s register of members in respect of those shares.

Used interchangeably with issue but technically shares are only issued when the shareholder has actually been registered in the company’s register of members

Question 4

Paid-up share capital

Answer 4

Common not to pay the full amount due on shares. Portion which is paid is known as the ‘paid-up’ share capital.

Question 5

Treasury shares

Answer 5

Shares that have been bought back by the company itself and are held by the company in treasury.

Shares held by company in its own name and the company can subsequently sell those shares out of treasury.

Sale of these shares is called a transfer not an issue.

Question 6

Ordinary shares

Answer 6

Most common form of shares and are the default position: if issued without differentiation they will be ordinary shares.

Carry:
- right to vote
- right to dividend if one is declared
- right to portion of surplus on winding up

Question 7

Preference shares

Answer 7

May give the holder a ‘preference’ as to payment of dividend or to return of capital on a winding up of the company or both.

Means that the payment will rank as higher priority than any equivalent payment to ordinary shareholders - so dividend is paid before paid to ordinary shareholders.

Normally non-voting shares

May be fixed - meaning percentage share of the par value of the shares e.g. 10% of par value. If par value is £1 then that would be 10p each.
could also be value of subscription price

Question 8

Cumulative preference shares

Answer 8

Preference shares are cumulative unless otherwise stated.

This means that if a dividend is not declared for a particular year the right to the preferred amount on the share is carried forward and will be paid together with the other dividends due when there are available profits.

If cumulation is not desired then the shares will be expressed to be non-cumulative

Question 9

Participating preference shares

Answer 9

Means may participate in:

(1) surplus profits available for distribution after own fixed dividends
and/or
(2) in surplus assets of the company on a winding up

Question 10

Deferred shares

Answer 10

Carry no voting rights and no ordinary dividend but entitled to a share of surplus after other dividends have been paid.

Usually only used when need ‘worthless shares’.

Question 11

Redeemable shares

Answer 11

Redeemable shares are shares which are issued with the intention that the company will, or may wish to, at some time in the future buy them back and cancel them.

Question 12

Convertible shares

Answer 12

Such shares will usually carry an option to convert into a different class of share according to stipulated criteria.

Question 13

Variation of class rights

Answer 13

To be effective:

• must be in accordance with the company’s articles
• or if no provisions: by consent in writing of holders of at least 75% of the issued shares of that class or by means of a special resolution passed at a separate general meeting

Shareholders holding at least 15% of relevant shares may (as long as didn’t vote in favour) apply to court within 21 days to have a variation cancelled.
Following application, the variation will not take effect unless and until it is confirmed by the court. Court will not confirm the variation if it feels the variation unfairly prejudices the shareholders of that class.

Question 14

Dividends

Answer 14

Only payable if a company has distributable profits.

Two types:
1. Final dividends: recommended by the directors and declared by the company by an ordinary resolution of the shareholders following financial year end

2. Interim dividends:
   directors normally have power to decide to pay interim dividends if the company has sufficient distributable profits.
   Can be paid without ordinary resolution - commonly paid where the company has realised an investment.

Question 15

Allotment versus transfer of shares

Answer 15

Allotment: contract between company and new/existing shareholder under which company agrees to issue new shares in return for the purchaser paying

Transfer: contract to sell (or gift) existing shares in the company between an existing shareholder and purchaser (company is not party to the contract)

Question 16

Considerations on allotment

Answer 16

1. Private company limited by shares is prohibited from offering its shares to the public
2. Prospectus: explanatory circular giving investors details about the company and the investment itself and should contain all the information necessary to enable investors to make an informed assessment of the financial status of the company
3. Financial promotions: any invitation or inducement to engage in the investment activity. Prohibited unless certain requirements set out in FSMA are fulfilled.

Question 17

Transmission of shares

Answer 17

Automatic process in the event of death or bankruptcy.

• automatically pass to PRs
• vest in trustee in bankruptcy

Question 18

Restrictions on transfer

Answer 18

1. Directors power to refuse to register

• Directors may refuse to register the transfer of a share and if they do must be returned with notice of refusal (unless suspect fraud)
• Company must give reasons

2. Pre-emption clauses: not in MA, on transfer usually requires that a shareholder wishing to sell shares must offer them to other existing shareholders before being able to offer them to an outsider.

Question 19

Methods of transfer

Answer 19

Instrument:
Stock transfer form - has to be signed by the transferor and submitted with the share certificate to the new shareholder

Legal and equitable ownership - beneficial title passes on execution of stock transfer form, legal title passes on registration of new owner in the register of owners.

Stamp duty:
Stock transfer form must be stamped before the new owner can be registered as the holder of those shares.
Stamp duty is payable by the buyer at 0.5% of the consideration rounded up to the nearest £5.
Not payable if consideration is £1000 or less. If more than £1000 minimum fee of £5

Question 20

5 Step Procedure for the Allotment of Shares

Answer 20

1. Check whether there is a cap on the amount of shares that can be issued by the company
2. Check whether company directors need authority to allot the shares
3. Consider whether pre-emption rights need to be disapplied
   Are the shares equity securities? Look at dividend and capital pay out on shares - if both are capped the share is not an equity security and pre-emption rights are not relevant
4. Is the company creating a new class of shares? if so teh Articles will need to be amended
5. Board resolution to allot the shares (this will always be required)

Question 21

Step 1: any cap on the number of shares that may be issued?

Answer 21

Check articles for any cap or limit on the number of shares that may be issued.

CA2006 companies: no cap in the MA but there could be a special provision added

CA1985: Will have had a cap (authorised share capital) and will continue to have one unless the cap is removed from their articles.

Removing cap:

CA1985: ordinary resolution
CA2006: special resolution

Question 22

Step 2: directors’ authority to allot

Answer 22

Directors will need authority to allot shares in the company unless:

it is a 2006 private company with only one class of shares in existence and the directors want to allot new shares of the same class (unless prohibited)

Otherwise - need authority from shareholders by ordinary resolution.

Question 23

What is a pre-emption right?

Answer 23

It is a right of first refusal.

New shares should be offered to existing shareholders before any new investor (issuing new shares would dilute proportion of ownership).

A company’s shareholders can disapply these rights by special resolution.

Question 24

To what type of shares to pre-emption rights apply?

Answer 24

They apply to any new equity securities.

These must be offered to existing shareholders of a company in proportion to their existing shareholdings before they can be offered to anyone outside the company.

Will not be an equity security if both:

• right to receive a dividend
• right to receive capital payments on winding up

are capped.
These will not need to be offered pre-emptively but every other case will.

Question 25

Disapplication of pre-emption rights

Answer 25

1. General disapplication - special resolution - generally applies to pre-existing authority (already authorised by OR) 2. Private companies with one class of shares - applies for so long as the company has in issue and allots shares of only one class - special resolution 3. Specific disapplication - disapply rights in relation to a specific allotment of shares (e.g. particular person or specified purpose) - special resolution - more complicated: need to provide shareholders with written statement explaining reasons and amount 4. If a private company can also exclude permanently but this is rare

Question 26

Step 4: new class rights created?

Answer 26

Does a new class of shares need to be created? If so, will need to alter Articles by way of special resolution.

Question 27

Step 5: board resolution

Answer 27

Directors must pass board resolution to allot the shares. A GM will not be needed in advance of this where: - no limit to issued share capital in constitution; and - does not require directors authorisation because company is a private company with one class of shares and no restriction in the articles or already given directors authority; and - is issuing shares in proportion to shareholding to shareholders, or already disapplied or not equity securities; and - has relevant class rights in the articles already

Question 28

Admin requirements on allotment

Answer 28

Copies of resolutions to be sent to Companies House within 15 days: - OR(1985) or SR (2006) removing cap - any OR giving directors authority to allot - any SR disapplying pre-emption rights or amending articles - any amended articles Company forms to be sent to Companies House: - return of allotment (form SH01) and statement of capital within one month - any updates to persons with significant control Updating company register: - update register of members within two months of the allotment Share certificates: - must be prepared and sent to new shareholders within two months of allotment

Question 29

To what does financial assistance apply?

Answer 29

1. Acquisition or sale of shares - relevant when there is an acquisition of shares - should examine funding arrangements carefully 2. Issue of shares - financial assistance is also relevant on an issue of shares by a company to an investor

Question 29

Which companies are prohibited from giving financial assistance?

Answer 29

1) Establish the identity of the company in which shares are being acquired - share sale: company which is the subject of the acquisition - Issue of shares: company doing issue Called the target. Different rules for a public or a private company.

Question 30

Target is a public company

Answer 30

Prohibition applies to: - target company itself; and - any subsidiary of the target company - whether public or private

Question 31

Target is a private company

Answer 31

Prohibition applies to any public company subsidiary of the target company (not the private company/target itself) - if target is a private company and the parent is a public company, will not be subject

Question 32

What is giving financial assistance?

Answer 32

- Gift - Guarantee, security or indemnity, release or waiver - loan or similar agreement - any other transaction where the net assets of the company are reduced to a material extent by the giving of financial assistance Note: - assistance must be given and - it must be financial Covers: - before or at time of acquisition - after the acquisition Must also: - be given for the purpose of the acquisition (or if after for discharging liability for the acquisition) i.e. to help facilitate the acquisition

Question 33

Purpose exception

Answer 33

Will not be caught by the purpose exception if the purpose is not for the acquisition or if it is only incidental part of a larger purpose. Not normally relied upon. Some exemptions: - money lending in course of business - assistance in respect of employee share schemes

Question 34

Consequences of prohibited financial assistance

Answer 34

Company: fine Officers: fine/imprisonment Assistance would be void and wider transaction may be void as well.

Question 35

Maintenance of share capital

Answer 35

- A company is not usually permitted to return capital to its shareholders and cannot release the sums represented in the equity account and the share premium account - doctrine of maintenance of share capital. Primarily for benefit of creditors. Share capital is seen as a permanent fund available to its creditors.

Question 36

Consequences of the principle of maintenance of share capital

Answer 36

- Dividends may only be paid out of distributable profits, not capital - Companies generally must not purchase their own shares Exceptions: - company may buyback its own shares (or redeem redeemable shares) provided it follows the procedures in 2006 - company may purchase its own shares after a successful shareholder petition for unfair prejudice.

Question 37

Redemption and buyback of shares

Answer 37

Two situations where a company can effectively buy its own shares: - redemption of redeemable shares; - purchase of own shares (buyback) But very strict controls on the purchase or redemption of a company's shares.

Question 38

When does a buyback occur?

Answer 38

Takes place when a company purchases its own shares from an existing shareholder

Question 39

Buyback funding

Answer 39

1. Distributable profits 2. Proceeds of a fresh issue of shares made for the purposes of financing the buyback 3. Capital Capital is strictly regulated: - only for private companies - must comply with restrictions - must first use profits or proceeds of a fresh issue of shares

Question 39

Buyback of shares out of profits/fresh issue

Answer 39

May purchase if: - purchase of own shares if not restricted or prohibited in the company's articles - shares being purchased are fully paid up - following purchase the company still has issued shares Procedure: - contract to purchase shares - terms are approved by ordinary resolution Contract must be available for inspection for 15 days before GM or attached if written resolution is used

Question 40

Procedure for buyback out of profits/fresh issue

Answer 40

Initial steps: - check no limit in articles to buyback - prepare accounts to check there are sufficient distributable profits - confirm shares are fully paid Board Meeting: - BR to approve draft contract - BR to call a GM and approve form of notice/propose a WR - Contract to be made available to shareholders - If GM: 15 days prior - If WR: circulate contract with WR GM/WR: - shareholders pass OR to approve contract - holders of shares being bought are not eligible to vote Board meeting: - BR to enter into the contract - BR to appoint a director to sign the contract Post meeting matters: - file return, notice of cancellation and statement of capital within 28 days - keep copy of contract for 10 years - cancel shares, update register of members (and PSC is necessary)

Question 41

Buyback of shares out of capital

Answer 41

- check not restricted - check accounts were prepared no more than three months ago - check if the company has any distributable profits available (if yes these must be used first) - prepare directors' statement of solvency and an auditors report - a special resolution to approve payment out of capital must be passed within a week after the directors sign the written statement of solvency

Question 42

Directors' statement of solvency

Answer 42

- made no earlier than one week before the GM - confirms company is solvent and able to pay its debts as they fall due and it will remain solvent for a period of 12 months after buyback - must have reasonable grounds for making this statement otherwise may have backlash (criminal and personal assets) if company does go insolvent

Question 43

Auditors report

Answer 43

- confirms auditors are not aware of anything to indicate that the directors' opinion is not reasonable

Question 44

Buyback out of capital: notification requirements

Answer 44

Must give notice to creditors within 7 days of passing special resolution approving payment by: 1. Publishing notice in gazette stating: - company has approved a payment out of capital for purpose of purchasing own shares - where the directors and auditors statements are available for inspection - any creditor of the company may within 5 weeks following date of resolution apply to the court to prevent payment 2. Publish same notice in appropriate nation paper or give notice in writing to each of its creditors 3. Filing copies of directors statements and auditors report at Companies House

Question 45

Timing of buyback out of capital

Answer 45

No earlier than five weeks and no later than seven weeks after the date of the special resolution. Within 28 days of buyback date, must send return to Companies House and a notice of cancellation together with a statement of capital.

Question 46

Procedure for buyback of shares out of capital

Answer 46

Initial steps: - check no limit in articles - no earlier than three months before directors statement, prepare accounts - confirm shares are fully paid Board Meetings: - BR to approve directors statement of solvency and auditors report - BR to approve the draft contract - BR to call a GM and approve form of notice for GM/propose a WR - contract to be made available to shareholders: GM - 15 days, WR - attach - directors statement of solvency and auditors report signed no earlier than once week before the GM or passing of the WR WR/GM: - SR approval of payment out of capital - OR to approve contract (holders of shares being bought cannot vote) Following GM/WR: - within 7 days place notice in gazette and national newspaper and file directors statement and auditors report at Companies House - For five weeks after date of SR creditors can object - DSS adn AR must be available for inspection at registered office Board Meeting: - BR to enter into contract - BR to appoint a director to sign contract - Payment out of capital must take place between 5-7 weeks after SR passed Post meeting matters: - file return, notice of cancellation and statement of capital within 28 days - keep copy of contract for 10 years - cancel shares, update register of members (and PSC register if applicable)

Question 47

Redemption of shares

Answer 47

The terms on which redeemable shares may be redeemed are determined at the time that the shares are issued and are set out in the company’s articles.