Topic 2 – Corporate Financing – Shares & Debentures

Question 1

1. Intro

Answer 1

Corporate Financing - ways companies raise and maintain capital (equity vs. debt).

1. Equity finance through issuing shares
2. Debt Finance through debentures & other loan agreements.

Also essay includes charges (fixed & floating) and the impact on creditors.

Question 2

2. Shares

Answer 2

Shares = equity in a company. shareholder becomes a part owner of company, entitled to dividends and certain rights (voting, depending on share class)

Limited companies must have at least one shareholder; for many small businesses its only shareholders are its directors. However, it is possible to purchase shares in other companies and enjoy a portion of any profits. When buying equity shares in a company you can purchase these from two distinct categories: ordinary shares and preference shares.

TYPES:
1. PREFERENCE SHARES
No voting rights except in special circumstances.
Have priority over ordinary shares, often with a fixed dividend rate.
In liquidation, the preference shareholders rank ahead of ordinary shareholders but behind creditors.

Preference shares come with no voting rights but they do provide an advantage over ordinary shareholders when it comes to receiving dividends. Preference shareholders are first in line for dividend payments, both when the business is operating, and also in the event of the company entering liquidation in the future. Dividend payments for preference shareholders are often at an agreed level and are made at defined points throughout the year. Due to this preference shares are often seen as a less risky investment, although payment amounts may be lower in light of this. Should the company experience a period of growth with profits to match, preference shareholders will not see the benefit in this when it comes to receiving their dividend payment. However, this works both ways, and many individuals investing in this way appreciate the element of certainty that comes with it.
Despite this, companies may choose not to make a dividend payment in certain instances. Even if you hold preferred stock, you will still not be able to receive a dividend payment if the company decides not to issue them. What happens in this situation depends on the type of preference share which is held.

subtypes:
a. convertible preference shares (into ordinary shares under certain conditions)
b. participating preference shares (may share in surplus profits)
c. redeemable preference shares (company can buy back on agreed terms)

d. Cumulative preference shares – the amount of missed dividend rolls onto the next dividend date, if dividend payments are vetoed, then both amounts rolled over to next date etc..

e. Non-cumulative preference shares – if the company make a decision to NOT pay a dividend, this amount will NOT be paid in the future, shareholders will lose this dividend for good.

2. ORDINARY/EQUITY SHARES
   aka common stock.
   carry voting rights at general meetings, e.g AGM. Gives holders the right to vote at meetings as well as take dividends from the company’s profits. Voting rights mean you have a say on issues such as salaries and the future direction of the business.
   Dividends are variable and declared at the discretion of the board.
   highest risk (last in line on liquidation) but potentially the highest reward when profits are substantial.

Although you do have the right to dividends when they are paid, companies are not obliged to distribute them should a decision be made to the contrary. This may be because profits are lower than expected, or because it has been decided that these profits are to be reinvested straight back into the business to fuel further growth instead.

3. SWEAT EQUITY SHARES – issues to employees/directors at a discount for know-how or similar contributions.
4. BONUS SHARES – issued free to existing shareholders by capitalising profits, not deemed as income.

Question 3

2. Issuing & Maintaining Share Capital

Dividend Policy

Transfer/Transmission of Shares

Allotment of Shares

Answer 3

Initial Public offering (IPO) VS Private Placement
Rights issue - existing shareholders were offered new shares to maintain proportionate ownership.

Securities premium account constraints - must be used only for certain statutory purposes.

forfeiture of shares if calls are unpaid and the company’s articles allow it.

dividend policy = must be paid out of profits only, approved by shareholders, residual dividend policy VS stable dividend policy.
can be reinvested into business or distributed to shareholders, resolution passed at AGM.

Transfer = shares are moveable, shareholders have the right to transfer to anyone without consent.
private company with share capital may restrict right to transfer; public companies are less strict.

Transmission = when shares pass by operation of law, from one person to another e.g death, inheritance

Allotment = rules to be observed. no prospectus shall be filed with registrar. no allotment of shares made to public unless minimum subscriptio amount stated in prospectus is raosed & recieved by company.
applications for shares should be made in prescribed form. money should be paid and received by company in cash.

Question 4

3. Debentures

Answer 4

debenture = written loan agreement between borrower & lender. it gives lender security over the borrower’s assets. form of debt finance distinct from equity: debenture holders dont own part of company.

features:
can be secured mostly or unsecured
may carry fixed interest and be repayable at certain time.

COMPANY
ADV: -Access to capital without diluting shareholder control.
DISADV - fixed interest payments, risk of insolvency if cannot meet obligations.

DEBNTURE HOLDER:
ADV: priority claim on secured assets
DISADV.: no upside in companys profits/returns beyond agreed interest.

ENFORCEMENT - lender has the right to appoint adminstrator to take control of companys assets = enforce secutity to recover debt (by selling secured assets).
faster and more cost-effective alternative to liquidation.

Question 5

4. Charges & Priority of Creditors

Answer 5

Charge – security interest given over a company’s assets to secure repayment of debt.

1. FIXED charge – attaches to specific assets (land,plant,machinery). company cant sell or deal with these assets without the lenders consent.
2. FLOATING chrage - attaches to class of changing/moveable assets (stock, receivables, computers, furniture, equipment). company is free to use/dispose of these assets until the charge “crystallises” (upon default or insolvency).

CONSEQUENCES FOR CREDIOTS:
priority:
fixed charge creditors get paid out first on realisation of charged assets. floating creditors rank behind them but ahead of unsecured creditors.

Preferential creditors (employees) can outrank floating charge holders.

prescribed part: legislation requires portion of floating charge assers to be set aside for unsecured creditors in insolvency (to ensure they receive something). - under insolvency act 1986

Charges are usually registered at Companies House within 14 days usually. failure to register can render the security void against liquidators and other creditors.

debenture/charge holders may block or influence insolvency procedures if they have a qualifying floating charge.
Lenders often require a negative pledge clause (company promise not to create charges ranking above the lenders charge.)

Question 6

5. Synthesis & Critical Observations

Answer 6

1. Balancing Equity and Debt
   ○ Companies weigh share issuance (dilution of control, no mandatory repayment) vs. debenture/loan finance (leverage benefits but risk of default).
   ○ In practice, an optimal capital structure often involves both elements.
   
   2. Protection of Creditors
      ○ Priority rules and security (charges) protect lenders; however, unsecured creditors can be at a disadvantage if most assets are under fixed/floating charges.
   3. Regulatory & Statutory Controls
      ○ Company law (e.g., Companies Act provisions) and insolvency law (e.g., on registration of charges, wrongful trading rules) aim to prevent abuses.
      There is tension between encouraging investment (through limited liability, priority for secured creditors) and safeguarding other stakeholders.

Charges and debentures promote financial stability by protecting lenders. However, critics argue that:
* Floating charges can allow large lenders to sweep up all assets, leaving little for unsecured creditors.
* Complex arrangements (e.g., multiple debentures, deeds of priority) may lack transparency.
* The law assumes sophistication on both sides, which may not always be the case.
Reforms such as the “prescribed part” attempt to strike a balance by ensuring unsecured creditors receive something in insolvency.

Question 7

6. Conclusion

Answer 7

Summary of Key Points
○ Shares represent ownership and typically come in various classes (ordinary vs. preference) with differing rights and risks.
○ Debentures are debt instruments that allow companies to raise capital without diluting equity but impose repayment obligations and grant security to lenders.
○ Charges (fixed or floating) heavily influence how assets are dealt with in insolvency, determining creditor hierarchy.

2. Final Reflection
   ○ Corporate financing decisions significantly impact both the company’s growth potential and stakeholders’ risk profiles.

Talk about:
legal rights (voting,dividends, liquidation ranking)
for charges, talk about priority rules and enforcement issues.