Equity finance Flashcards
(34 cards)
Difference between capital and legal capital?
Capital:
All of the assets of the company (including debt finance, shares, assets)
Legal capital:
This is the value received from investors who subscribe for the company’s shares. It is also referred to as the share capital.
- -»Private companies also have no minimum legal capital requirements – one share is sufficient (s 7, s 8 CA 2006).
- ->However, s 761/763 CA 2006 states that public companies have a minimum legal requirement of £50,000.
Benefits and risks to shareholders?
Benefits:
- Shareholders share in the profits of the company by way of dividends.
- If the company does well, the shareholders may also receive a capital return where the value of their shares increases. However, shareholders in a private limited company may have difficulty selling their shares.
- Shareholders often have voting rights therefore they have some input into the management of the company.
Risks:
- Company has a separate legal personality, so creditors are paid from the company’s assets. In the event of insolvency, creditors are paid first in the order of priority on winding up. This means that it is unlikely that shareholders will receive the full value of their investment.
Protection for shareholders?
- Limitations on the power of directors to issue new shares:
- Directors require authorisation of the shareholders in order to issue new shares - avoids the directors themselves issuing and subscribing for new shares in order to obtain a controlling majority. - Pre-emption rights:
- Shareholders have rights of first refusal when the company issues new shares in most circumstances - means that the shareholders are able to retain the same proportion of their shareholding in the company if they wish to do so, without dilution. - Class rights:
- Certain classes of shares may have particular rights, enhanced voting rights or greater dividends.
- Limitations on the power of directors to issue new shares?
Firstly it is necessary to check whether there is any cap on the maximum number of shares that a company itself is authorised to issue. This would be unusual for a company incorporated under CA 2006.
Secondly, the directors need to be authorised to issue shares. Section 549 CA 2006 states that the directors have NO power to issue shares except:
1. In accordance with s 550:
Gives directors of a private company which has only a single class of shares authorisation to issue further shares of the same class (as long as articles ok)
2. Shareholders authorise the directors to issue new shares under s 551:
They may grant the directors authorisation to issue new shares by ordinary resolution. This lasts for up to 5 years and for a certain number of shares (as stated in the authorisation) only.
- Pre-emption rights?
Section 561 states that new shares should first be offered to the existing shareholders, who are given a right of first refusal. However, this only applies where the shares to be issued are “equity securities”.
What are ‘equity securities’?
Section 560(1)
(a) ordinary shares in the company, or
(b) rights to subscribe for, or to convert securities into, ordinary shares in the company;
“ordinary shares” means shares other than shares that as respects dividends and capital carry a right to participate only up to a specified amount in a distribution.
This means that pre-emption rights apply where the new shares to be issued are ordinary shares. The definition of “ordinary shares” under s 560 encompasses shares which would not normally be described as ordinary shares eg participating preference shares.
!!!-> Pre-emption rights only do not apply to preference shares that have capped preference rights as to BOTH dividends and capital.
Exceptions and exclusion of the right of pre- emption?
EXCEPTIONS
There are exceptions to the right of pre-emption which apply where the new shares to be issued are:
• bonus shares,
• issued under an employee share scheme, or
• Issued for non-cash consideration (s 564).
EXCLUSION
A company may exclude the right of pre-emption by specific provision in the articles (s 567 – 568).
Can companies disapply pre-emption rights?
May be disapplied in the company’s articles, but this is not common.
But - More commonly, the pre-emption rights may be disapplied by SPECIAL RESOLUTION of the shareholders. Sections 569 – 571.
s 569: Directors of a private limited company with only class of shares where the new shares to be issued are of the same class: shareholders may agree to disapply s 570: directors of the company are acting under a general authority to issue shares. s 571: may pass a special resolution to disapply pre-emption rights in relation to a particular share allotment only.
Pre-emption rights on transfer of shares?
In general there are no rights of pre-emption
for existing shareholders.
HOWEVER - private company may provide for pre-emption rights on transfer of shares in either the articles or a shareholder agreement. This is quite common in small private companies.
BUT IF private company has a corporate shareholder (company A), the transfer of the corporate shareholder (A)’s own shares will not trigger these pre-emption rights provisions for the company, because as respects the company there has been no change in ownership. Re Coroin.
Issuing shares at a discount /premium?
Issue at a discount
Shares may not be issued at a discount (eg issuing £1 shares for 75p each).
HoL held that issuing shares at a discount was beyond the power of the company in Ooregum Gold Mining Co of India v Roper.
Now prohibited by s 552 CA 2006.
Issue at a premium
Shares can be issued at a premium (s 610) (eg issuing £1 shares for £2)
This is allowed but is not required, as confirmed in the case of Hilder v Dexter.
Allotted share capital?
s 558 CA 2006
Shares are deemed to be allotted when a person acquires the unconditional right to be included in the company’s register of members.
Origins of the doctrine of capital maintenance?
Trevor v Whitworth (now also s 658 CA 2006)
States that the company must maintain and not reduce its share capital except in certain very limited circumstances. The share capital therefore is a permanent fund available to creditors - reason is to protect the creditors. Unsecured creditors will seek claim from capital as well as unsecured assets if the company is wound up.
Capital can of course be lost as a result of poor business decisions or market conditions, but this is a legitimate risk which both shareholders and creditors will face.
What does s 658 say?
(1) A limited company must not acquire its own shares, whether by
purchase, subscription or otherwise, except in accordance with the provisions of this Part.
(2) If a company purports to act in contravention of this section—
(a) an offence is committed by (i) the company, and (ii) every officer of the company who is in default, and
(b) the purported acquisition is void.
Section 659 sets out a series of limited exceptions to this rule.
Impact of the doctrine of capital maintenance?
Has an impact on a number of different transactions as it prevents a company from reducing its share capital or returning value to shareholders except in limited circumstances:
• The granting of dividends or distributions
• Reduction of share capital
• Purchase and redemption of own shares
• Financial assistance
Where is the def of ‘dividend’ laid out?
s 829(1) CA 2006, which states that “distribution” means every description of distribution of a company’s assets to its members, whether in cash or otherwise, subject to the exceptions set out in s 829(2).
s 830(1) is for ‘distributable profits’.
s 836 refers to the ‘relevant accounts’ - what are these?
Annual accounts - but in some circumstances, interim accounts may be ok - i.e. annual accounts not justify dividend payment but there’s been a recent large sell of property.
Company just started - initial accounts ok.
3 different types of dividends?
- Dividend - usually involves the distribution of profits by way of cash to shareholders.
- Scrip dividend - is where a company gives the existing shareholders further shares in the company rather than cash.
- Dividend in specie - involves the company giving the shareholders value by way of assets.
Note that when recommending a dividend, the directors must have regard to all of their duties, and particularly the duty to promote the success of the company under s 172.
Final and interim dividends?
Final dividends:
Typically recommended by the board of directors and declared by ordinary resolution by the shareholders at the next general meeting following the annual accounts. The articles however may provide that final dividends may be paid without any shareholder involvement.
Shareholders cannot generally (subject to anything to the contrary in the articles) vote for payment of a higher dividend than that recommended by the board but they are able to require a lower dividend to be paid.
Interim dividends:
Usually (subject to anything to the contrary in the articles) of a lesser amount than a final dividend and are recommended by the directors alone. Interim dividends will be paid for example where a company has had a particularly profitable quarter.
Disguised distributions?
Courts have found this (breaching maintenance of share capital) in some cases.
- Re Halt Garage
Another problematic area where disguised distributions may be found to have occurred is on intra-group transfers: Aveling Barford v Perion Ltd
Unlawful distributions – liability of directors?
Directors who knew or ought to have known that the payment amounted to a breach are liable to personally repay the dividends (and the shareholders receiving it may be liable too)
Bairstow v Queens Moat Houses plc.
Unlawful distributions – liability of shareholders
s 847(1) and (2) CA 2006 provide that where a distribution is made in contravention of the requirements of CA 2006 and, at the time of the distribution, the member knows or has reasonable grounds for believing the distribution to have been unlawful, they are liable to repay it to the company. It's a Wrap (UK) Ltd v Gula.
Dividends – steps that the board must take before issuing a dividend / distribution?
- Directors’ duties: Directors need to consider their duties, particularly s 171 /172. Is making the distribution in accordance with those duties?
- Restrictions on distributions: Consider whether the proposed transaction is either a dividend or a disguised distribution (Aveling Barford Ltd v Perion Ltd)
- Are there any distributable profits?: Check the relevant accounts. If not, the distribution is unlawful.
- Amount of distribution: Check whether the distributable profits cover the whole amount of the distribution. If not, the distribution is unlawful.
Why do companies ever reduce their share capital? (2)
Normal practice:
- If the share capital is greater than the actual net assets, eg where there have been business losses. In this situation the company may wish to reduce its share capital so that it corresponds to the actual net assets, with the hope that it will then be able to resume dividend payments.
- Where the company has surplus cash that it may wish to return to shareholders eg where an asset has been sold. Here the company may wish to reduce its share capital and at the same time return money to shareholders.
The doctrine of maintenance of capital prevents a company from reducing its share capital, and therefore CA 2006 sets out stringent procedures that companies must follow in order to reduce their share capital.
Where is the procedure for reducing share capital laid out?
s 645 - 651. This requires:
• A special resolution of the shareholders, followed by
• An order of the court.
Creditors have a right to object.
Courts may make order declaring permitted with T&Cs (s648(1)) - will consider creditors first (s648(2)).
Reduction of share capital will need to be confirmed at Companies House (s649(5)).
