Equity Finance

Question 1

What is share capital?

Answer 1

Money raised by the issue of shares

Question 2

What are shares?

Answer 2

Shares are a bundle of rights. An investor becomes a part owner of the company and will often have voting rights. A share represents a unit of ownership

Incentives for investing:
- receipt of income (dividend)
- capital gain (growth in company value)

Question 3

What is the nominal value and premium value of a share?

Answer 3

• Nominal: the minimum subscription price for that share
• Premium: a share which is allotted/issued for more than its nominal value and the excess over that is the premium

Question 4

How are the rights attached to shares determined?

Answer 4

The rights are determined in the Company’s Articles

Question 5

Ordinary shares

Answer 5

• Most common and default position
• Carry right to vote in general meetings, right to dividend if one is declared, right to a portion of surplus assets on a winding-up

Question 6

Preference shares

Answer 6

Gives a shareholder preference as to payment of dividend or to return of capital on a winding up. The payment ranks as higher priority than any equivalent payment to ordinary shareholders

• Preference shares are normally non-voting

Question 7

Cumulative preference shares

Answer 7

It is presumed that preference share is cumulative, unless otherwise stated (non-cumulative)

• If a dividend is not declared for a particular year, the right to the preferred amount is carried forward and will be paid together with other dividends when there are available profits

Question 8

Participating preference shares

Answer 8

May participate together with holders of ordinary shares
1. In surplus profits available for distribution after they have received their own fixed preferred dividend; and/or
2. In surplus assets of the company on a winding up

Question 9

Redeemable shares

Answer 9

Shares which are issued with the intention that the company will, or may wish to, buy them back and cancel them

Question 10

How can class rights be varied?

Answer 10

• Always check the company’s Articles to find the relevant rights attached to the class of share
• The Articles can be amended by special resolution (passed at a general meeting of shareholders of that class)

Question 11

Dividends

Answer 11

A dividend is a distribution and is only payable by a company if it has sufficient, distributable profits. It is a payment which involves the reduction of a company’s assets.

1. Final dividends - recommended by directors and declared by the company by ordinary resolution of the shareholders
2. Interim dividends - articles of a company usually give directors the power to decide to pay interim dividends if the company has sufficient distributable profits. Usually if the company has realised an investment

Question 12

What is the allotment of shares?

Answer 12

A contract between the company and a new/existing shareholder whereby the company agrees to issue new shares in return for the purchaser paying the subscription price

It is the process of creating and issuing new shares to new or existing shareholders. This allows the company to raise capital or to offer shares to specific individuals.

Question 13

What is the transfer of shares?

Answer 13

An existing shareholder sells their shares in the company to a purchaser. The company is not part of this transfer. It is the movement of ownership of existing shares, without creating new shares, by way of sale or gift

Question 14

What is the transmission of shares?

Answer 14

This is an automatic process on the death or bankruptcy of a shareholder where the shares pass automatically to the personal representative or the trustee in bankruptcy

Question 15

What are potential restrictions on the transfer of shares?

Answer 15

Shareholders are free to transfer subject to any restrictions in the Articles

Common restrictions:
1. Directors’ power to refuse to register
2. Pre-emption clauses (rights of first refusal)
- If this was in the Articles, it would mean that shareholders wishing to sell shares must offer them to other existing shareholders before an outsider

Question 16

When does a new shareholder’s membership take effect?

Answer 16

On the registration by the company of the new shareholder as a member
- When they are formally registered in the company’s register of members

Question 17

How are shares transferred?

Answer 17

The transfer of shares is done by the stock transfer form
- this is signed by the transferor and submitted with the share certificate to the new shareholder
- the stock transfer form must be stamped (stamp duty) before the new owner can be registered. Stamp duty payable by buyer at 0.5%

Question 18

When does legal and beneficial ownership of the shares pass to the new shareholder?

Answer 18

• Beneficial title to shares passes on execution of the stock transfer form
• Legal title to shares passes on registration of the member as owner in the register of members by the company

Question 19

What is the process for the allotment of shares?

Answer 19

1. Is there a cap on the number of shares which can be issued?
2. Do directors need authority to allot the shares?
3. Must pre-emption rights be disapplied on allotment?
4. Must new class rights be created for the shares?
5. Directors pass a board resolution to allot the shares

Question 20

Step 1: is there a cap on the number of shares that can be issued?

Answer 20

CA 2006
- No default cap on the number of shares (unless decided in the Articles)
- If there is a cap (in the Articles) - pass a special resolution to amend Articles and change the cap

CA 1985:
- There is a default cap (unless amended Articles)
- To change the cap: pass an ordinary resolution

Question 21

Step 2: Do directors need authority to allot shares?

Answer 21

Private company with ONE class of shares (s550):
- Automatic authority to allot new shares of the SAME class (unless prohibited by Articles)
- *CA 1985: requires ordinary resolution

All other companies (s551):
- Must be granted authority to allot shares by ordinary resolution

Question 22

Step 3: Must pre-emption rights be disapplied on allotment?

Answer 22

Equity Security:
- Pre-emption applies. This means that it must be offered to existing shareholders pro-rata first
- Pre-emption rights can be disapplied by special resolution

Not Equity Security:
- Shares capped as to both dividend and capital
- Pre-emption does not apply. This means not required to offer to existing shareholders first

Question 23

Step 4: Must new class rights be created for the shares?

Answer 23

New class of shares being created
- Not already in the Articles
- Special resolution required to amend the Articles for the new class

No new class of shares being created
- Class already in use
- No action required

Question 24

Step 5: Directors must pass a Board Resolution to allot the shares

Answer 24

This step is always required

• any requirements for shareholder resolutions must be dealt with in a general meeting before the board meeting is held to allot the shares

Question 25

Administrative requirements on allotment (post-meeting matters / filing requirements)

Answer 25

Copies of resolutions to be sent to Companies House within 15 days: - CA 1985 companies: file any ordinary resolution to remove the cap on authorised share capital - Any s551 ordinary resolution granting directors authority to allot (if passed) - All special resolutions (regarding disapplication of pre-emption rights and/or amending Articles) - Amended Articles sent to Companies House (if a new class of shares is created)

Question 26

What company forms need to be sent to Companies House?

Answer 26

- Return of allotment (Form SH01) and statement of capital, within one month - If persons of significant control have changed, the relevant forms (PSC01, PSC02, PSC04, PSC07)

Question 27

What needs to be done to update the company registers following allotment?

Answer 27

Update the register of members within two months of allotment - Update PSC if necessary

Question 28

What must be done for share certificates?

Answer 28

Share certificates must be prepared and sent to new shareholders within two months of allotment

Question 29

Financial assistance for the acquisition of shares?

Answer 29

Assistance provided by a company to facilitate the purchase of shares or of its holding company, which is often restricted by law, particularly for public companies - Look at the TARGET company (the company whose shares are being brought) Relevant transactions: The rules are applicable for: - acquisition or sale of shares - issue of shares

Question 30

If the target company is a public company

Answer 30

There is a prohibition on giving financial assistance. This applies to: - the target company itself (the public company); and - any subsidiary of the public company, whether private or public

Question 31

If the target company is a private company

Answer 31

The prohibition on giving financial assistance applies to any public company subsidiary of the target company

Question 32

Direct or indirect financial assistance

Answer 32

- Direct: e.g., a loan - Indirect: e.g., security Prohibition on financial assistance applies to both direct and indirect assistance. The rules apply whether the assistance is given before or at the same time as the acquisition or after the acquisition. But the assistance must be given for the purpose of the acquisition

Question 33

What are transactions that may amount to financial assistance?

Answer 33

- Financial assistance by gift - Guarantee, security or indemnity, release or waiver - Loan or similar agreement

Question 34

What are the consequences of breaching the rules on prohibited financial assistance?

Answer 34

Breach is a criminal offence - Company: fine - Officers of the company: fine / up to two years imprisonment The transaction amounting to prohibited financial assistance would be void and wider transaction may be void as well

Question 35

What is the doctrine of maintenance of share capital?

Answer 35

A company must not reduce or return its share capital (total number of shares) to its shareholders, except as prescribed by law. This is to protect creditors by ensuring that assets remain available to them. The share capital of a company is seen as a permanent fund available to its creditors, should they need it for future recourse

Question 36

What is the principle of maintenance of share capital?

Answer 36

- Dividends can only be paid out of distributable profits, not capital - Companies generally may not purchase their own shares

Question 37

What are the exceptions to the rule that a company cannot purchase its own shares?

Answer 37

- Company may buyback its own shares, provided it follows procedures in CA 2006 - Company may purchase its own shares where a court order is made following successful petition for unfair prejudice Two situations where a company can buy its own shares 1. Redemption of redeemable shares 2. Purchase of own shares (buyback)

Question 38

What is a buyback of shares and how can a company finance it?

Answer 38

When a company purchases its own shares from an existing shareholder. Company may fund a buyback of its own shares: 1. Distributable profits 2. Proceeds of fresh issue of shares made for the purpose of financing the buyback 3. Capital

Question 39

What are the limitations to a buyback out of capital?

Answer 39

Only private companies may use capital to fund a buyback. Only when there is no distributable profits and no proceeds of fresh issue. - Funding by capital is strictly regulated as capital is the amount invested by shareholders that cannot be distributed back to shareholders as it is there for the protection of creditors (doctrine of maintenance of share capital)

Question 40

Buyback of shares out of profits / proceeds of fresh issue

Answer 40

A company can purchase its shares out of distributable profits or proceeds from fresh issue provided: - It is no restricted in Articles - Shares being purchased are fully paid up - Following the purchase, the company must continue to have issued shares other than redeemable or treasury shares Procedure: - Contract to purchase own shares is required - Terms of the contract must be approved by ordinary resolution - The contract must be available for inspection at company's registered office for period of 15 days before GM and also at GM

Question 41

Who cannot vote at the general meeting for the buyback of shares out of profits?

Answer 41

An ordinary resolution is passed by the shareholders, but the shareholder whose shares are being bought cannot vote

Question 42

What is the procedure for the buyback of shares out of profits / proceeds of issue?

Answer 42

Initial steps: - check no limit in Articles on power to buyback shares - prepare accounts to check sufficient distributable profits - confirm shares are fully paid up Board meeting: - BM approve the draft contract - BM to call the GM and approve form of notice - Contract made available to shareholders GM/WR: - Shareholders pass ordinary resolution to approve the contract - Holders of the shares being bought are NOT eligible to vote Board Meeting: - BR to enter into the contract and BR to appoint the director to sign the contract

Question 43

What are the post meeting matters for buyback procedure?

Answer 43

Post Meeting Matters: - file return, notice of cancellation and statement oof capital within 28 days - keep copy of contract for 10 years - cancel shares, update register of members

Question 44

Conditions for a buyback of shares out of capital

Answer 44

- Only available to private companies - Must not be restricted in Articles - Check the accounts were prepared no more than 3 months before directors' statement - If the company has distributable profits, these must be used before capital - Prepare a directors' statement of solvency and an auditors' report - Special resolution to approve payment out of capital must be passed within a week after directors sign the statement of solvency

Question 45

What additional resolution is needed for the payment out of capital to be approved?

Answer 45

The company must pass a special resolution to approve the payment out of capital, within one week of directors signing the written statement of solvency

Question 46

Directors' statement of solvency and auditors report (buyback out of capital)

Answer 46

- Must be made no earlier than one week before the GM - It confirms the company is solvent and can pay its debts as they fall due and will remain solvent for 12 months after the buyback - If the company becomes insolvent and is wound up within a year, directors are personally liable and may have to contribute to assets and may face criminal sanctions

Question 47

Notification requirements for buyback out of capital

Answer 47

Within 7 days of passing the special resolution approving the payment out of capital, a company must give notice to its creditors. It gives notice by: 1. Publishing a notice in Gazette 2. Publish the same in an appropriate national newspaper 3. Filing copies of directors' statement and auditors' report at Companies House

Question 48

Timing requirements for buyback out of capital

Answer 48

The share purchase can take place: - no earlier than five weeks; and - no later than seven weeks After the date of special resolution (E.g., must wait 5 weeks to allow creditors to make an application) Companies House filing requirements: - within 28 days of the share being bought back and delivered to the company, the company must send a return to Companies House, a notice of cancellation and a statement of capital

Question 49

When is the statement of solvency by directors prepared?

Answer 49

No earlier than three months before, the directors prepare the statement of solvency

Question 50

What is dealt with at the first Board Meeting (buyback out of capital)?

Answer 50

- BR to approve the directors' statement of solvency and auditor's report - BR to approve draft contract - BR to call the GM - Contract is made available to the shareholders 15 days before the GM and at the GM - Directors statement of solvency and auditor's report are signed no earlier than one week before the GM/WR

Question 51

How can this be done by written resolution?

Answer 51

Circulate the written resolution with the contract, DDS and AR - Special resolution to approve payment of capital - OR to approve the contract

Question 52

What is voted on during the general meeting?

Answer 52

- Shareholders pass ordinary resolution to approve the terms of the contract - Shareholders pass special resolution to approve the payment out of capital - Holders of shares being bought back cannot vote - Contract, DSS, AR all available at the meeting

Question 53

What steps are taken following the GM / WR

Answer 53

- Within 7 days: notice in Gazette, newspaper and file DDS and AR at Companies House - Within 15 days: file SR at Companies House - For five weeks after date of SR: creditors and shareholders have the right to object

Question 54

What happens at the second BM (after GM)

Answer 54

- BR to enter into the contract - BR to appoint a director to sign the contract - Payment out of capital takes place 5-7 weeks after SR passed

Question 55

Post Meeting Matters

Answer 55

- 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

Question 56

Redemption of redeemable shares

Answer 56

Redeemable shares are those issued as redeemable shares, to be redeem on occurrence of certain circumstances A contract is NOT required to redeem these shares (as the terms of redemption have already been set out in the Articles)

Question 57

Structure of points to consider when advising a client company on issuing new shares

Answer 57

1. What type of shares does the company have in issue? 2. What type of shares is the company intending to issue? - These questions determine what procedure the company must follow 3. What is the procedure that the company must follow to allot the shares? 4. Any funding considerations in terms of assistance to the purchaser? - consider financial assistance (prohibitions?)

Question 58

What are pre-emption rights?

Answer 58

New shares should first be offered to existing shareholders, who are given a right of first refusal. This is because when new shares are issued, this will prejudice existing shareholders, as their rights (voting and rights to dividends and capital) are diluted by the new shares - Only applies to equity securities - Not equity securities = capped as to both dividends and right to capital - Special resolution is required to disapply pre-emption rights - Company can also disapply them in the Articles

Question 59

Explanation of doctrine of capital maintenance

Answer 59

The doctrine of capital maintenance states that the company must maintain and not reduce its share capital, except in very limited circumstances. Share capital is a permanent fund available to creditors, and is to protect creditors. - Share capital of a company gives creditors an indication of the company's credit-worthiness

Question 60

What transactions does the doctrine of capital maintenance have an impact on?

Answer 60

- The granting of dividends or distribution - Reduction of share capital - Purchase and redemption of company's own shares - Financial assistance

Question 61

Steps a board must take before issuing a dividend

Answer 61

1. Directors duties: directors need to consider their duties, and whether a distribution is in accordance with these duties 2. Restrictions on distributions: check it is a dividend not a disguised distribution 3. Are there any distributable profits: check relevant accounts 4. Amount of distribution: check whether the distributable profits cover the whole amount of the distribution. If not, the distribution is unlawful

Question 62

Structure for financial assistance issue

Answer 62

1. What type of company is the target (company in whom the shares are being purchased)? - public or private 2. What type of assistance is to be given - financial, direct, indirect - is it for the purpose of the acquisition? 3. Are there any exceptions? 4. What are the consequences of a breach? - transaction is void and company and any officer is liable