Capital and the financing of companies

 Members
 A member of a company is a person who has agreed to be a member and whose
name has been entered in the register of members.
 Entry in the register is essential. Mere delivery to the company of a transfer of shares
does not make the transferor a member – until the transfer is entered in the register.
 Subscriber shares
 Subscribers to the memorandum are deemed to have agreed to become members of
the company.
 As soon as the company is formed their names should be entered in the register of
members.
 Other persons may acquire shares and become members:

 Ceasing to be a member
 There are eight ways in which a member ceases to be so.

 The number of members

 Public and private companies must have a minimum of one member.
 There is no maximum number.

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 Capital and the financing of companies

 The nature of shares and capital

 Under the Companies Act 2006 (TSO, 2006) a share is a transferable form of property,
carrying rights and obligations, by which the interest of a member of a company
limited by shares is measured.
 Shares
 A share is the interest of a shareholder in the company measured by a sum of money,
for the purpose of a liability in the first place, and of interest in the second, but also
consisting of a series of mutual covenants entered into by all the shareholders inter
se.

 A share is a form of personal property, carrying rights and obligations. It is, by its
nature, transferable.
 A member who holds one or more shares is a shareholder.
 However, some companies (such as most companies limited by guarantee) do not
have a share capital. So they have members who are not also shareholders.

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 Capital and the financing of companies

 Types of capital
 The term 'capital' is used in several senses in company legislation, to mean issued,
allotted or called up share capital or loan capital.
 Authorised share capital
o Under previous company legislation, companies had to specify a maximum
authorised share capital that it could issue.
o Under the 2006 Act, the concept of authorised share capital was removed.
 Issued and allotted share capital
o Issued and allotted share capital is the type, class, number and amount of the
shares issued and allotted to specific shareholders, including shares taken on
formation by the subscribers to the memorandum.
o A company need not issue all its share capital at once.
o If it retains a part, this is unissued share capital.
o Issued share capital can be increased through the allotment of shares.
o Rights issues and the issue of bonus shares will also increase the amount of a
company's capital.
 Called up share capital
o Called up share capital is the amount which the company has required
shareholders to pay now or in the future on the shares issued.
 Paid up share capital
o Paid up share capital is the amount which shareholders have actually paid on
the shares issued and called up.

 Loan capital
o Loan capital comprises debentures and other long-term loans to a business.
o Loan capital, in contrast with the above, is the term used to describe borrowed
money obtained usually by the issue of debentures. It is nothing to do with
shares.

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 Capital and the financing of companies

 Types of share
 If the constitution of a company states no differences between shares, it is assumed
that they are all ordinary shares with parallel rights and obligations.
 There may, however, be other types, notably preference shares.

 Ordinary shares (equity)

 Under the Companies Act 2006 (TSO, 2006) if no differences between shares are
expressed then all shares are equity shares with the same rights, known as ordinary
shares.
 Class rights
 Class rights are rights which are attached to particular types of shares by the
company's constitution.

 Shares which have different rights from others are grouped together with other
shares carrying identical rights to form a class.
 The most common types of share capital with different rights are preference shares
and ordinary shares.
 There may also be ordinary shares with voting rights and ordinary shares without
voting rights.
 Preference shares
 The most common right of preference shareholders is a prior right to receive a fixed
dividend.
 This right is not a right to compel payment of a dividend, but it is cumulative unless
otherwise stated.
 Usually, preference shareholders cannot participate in a dividend over and above
their fixed dividend and cease to be entitled to arrears of undeclared dividends if the
company goes into liquidation.

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 Capital and the financing of companies

Advantages and disadvantages of preference shares

Advantages Disadvantages
 Greater security of income  Persistent inflation
 Greater security of capital  Loss of arrears on winding up

 Redeemable shares
 Redeemable shares are shares issued on terms that they may be bought back by a
company either at a future specific date or at the shareholder's or company's option.
 Treasury shares
 Treasury shares are created when a private or public limited company legitimately
purchases its own shares out of cash or distributable profit.
 The purchased shares are then held by the company 'in treasury' which means the
company can re-issue them without the usual formalities.
 They can only be sold for cash and the company cannot exercise the voting rights
which attach to them.

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 Capital and the financing of companies

 Variation of class rights

 A variation of class rights is an alteration in the position of shareholders with regard
to those rights or duties which they have by virtue of their shares.
 These class rights can only be varied by the company with the consent of all the
shareholders in the class, or with such consent of a majority as is specified (usually) in
the articles.
 The standard procedure for variation of class rights requires that a special resolution
shall be passed by a three-quarters (75%) majority cast either at a separate meeting
of the class, or by written consent.
 If any other requirements are imposed by the company's articles then these must
also be followed.
 It is not a variation of class rights to:
a) Issue shares to new members,
b) To subdivide shares of another class
c) To return capital to preference shareholder
d) To create a new class of preference shareholders.

 Minority appeals to the court for unfair prejudice

o Whenever class rights are varied under a procedure contained in the
constitution, a minority of holders of shares of the class may apply to the court
to have the variation cancelled.

o The court can either approve the variation as made or cancel it as 'unfairly
prejudicial'.
o It cannot, however, modify the terms of the variation.
o To establish that a variation is 'unfairly prejudicial' to the class, the minority
must show that the majority was seeking some advantage to themselves as
members of a different class, instead of considering the interests of the class in
which they were then voting.

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 Capital and the financing of companies

 Statement of capital and initial shareholdings

 A return known as a statement of capital and initial shareholdings is required to be
made to the Registrar when a company is registered, and therefore applies only to
the shares of the subscribers.
 This statement must give the following details in respect of the company's share
capital and be up to date as of the statement date.

 Allotment of shares
 Allotment of shares is the issue and allocation to a person of a certain number of
shares under a contract of allotment.
 Once the shares are allotted and the holder is entered in the register of members,
the holder becomes a member of the company.
 The member is issued with a share certificate.
 Directors exercise the delegated power to allot shares, either by virtue of the articles
or a resolution in general meeting.
 The intending shareholder applies to the company for shares, and the company
accepts the offer.
 The terms 'allotment' and 'issue' have different meanings.

 The allotment of shares of a private company is a simple and immediate matter.

 The name of the allottee is entered in the register of members soon after the
allotment of shares and they become a member.

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 Capital and the financing of companies

 Public company allotment of shares

 There are various methods of selling shares to the public.

 Private company allotment of shares

 The allotment of shares in a private company is more straightforward.
 The rule to remember is that private companies cannot sell shares to the public.
 An application must be made to the directors directly.
 After that, shares are allotted and issued, and a return of allotment made to the
Registrar, as for a public company.
 Directors' powers to allot shares
 Directors of private companies with one class of share have the authority to allot
shares unless restricted by the articles.
 Directors of public companies, or private companies with more than one class of
share, may not allot shares (except to subscribers to the memorandum and to
employees' share schemes) without authority from the members.
 Any director who allots shares without authority commits an offence under the
Companies Act 2006 and may be fined.
 However, the allotment remains valid.
 Pre-emption rights
 Pre-emption rights are the rights of existing ordinary shareholders to be offered new
shares issued by the company pro rata to their existing holding of that class of shares.
 If a company proposes to allot ordinary shares wholly for cash, it has a statutory
obligation to offer those shares first to holders of similar shares in proportion to their
holdings and on the same or more favourable terms as the main allotment.
 This is known as a rights issue.
 A private company may by its articles permanently exclude these rules so that there
is no statutory right of first refusal.

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 Capital and the financing of companies

 Rights issues
o A rights issue is a right given to a shareholder to subscribe for further shares in
the company, usually pro rata to their existing holding in the company's shares.
o A rights issue must be made in writing (hard copy or electronic) in the same
manner as a notice of a general meeting is sent to members.
o It must specify a period of not less than 21 days during which the offer may be
accepted but may not be withdrawn.
o If not accepted or renounced in favour of another person within that period
the offer is deemed to be declined.
o Equity securities which have been offered to members in this way but are not
accepted may then be allotted on the same (or less favourable) terms to non-
members.
o If equity securities are allotted in breach of these rules the members to whom
the offer should have been made may, within the ensuing two years, recover
compensation for their loss from those in default.
o The allotment will generally be valid.
 Bonus issues
o A bonus issue is the capitalisation of the reserves of a company by the issue of
additional shares to existing shareholders, in proportion to their holdings.
o Such shares are normally fully paid-up with no cash called for from the
shareholders.
o A bonus issue is more correctly, but less often, called a 'capitalisation issue'
(also called a 'scrip' issue).
o The articles of a company usually give it power to apply its reserves to paying
up unissued shares wholly or in part, and then to allot these shares as a bonus
issue to members.
 Issuing shares at a premium or at a discount
 In issuing shares, a company must fix a price which is equal to, or more than, the
nominal value of the shares.
 It may not allot shares at a discount to the nominal value.
 The Companies Act 2006 (TSO, 2006) states that every share has a nominal value and
may not be allotted at a discount to that.
 In allotting shares, every company is required to obtain in money or money's worth,
consideration of a value at least equal to the nominal value of the shares plus the
whole of any premium.
 If shares are allotted at a discount to their nominal value, the allottee, if they agree to
the issue, must nonetheless pay the full nominal value with interest at the
appropriate rate.

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 Capital and the financing of companies

 Any subsequent holder of such a share who knew of the underpayment must make
good the shortfall.

 Private companies
o Private companies may issue shares for inadequate consideration provided the
directors are behaving reasonably and honestly.
o A private company may allot shares for inadequate consideration by
acceptance of goods or services at an overvalue.
o This loophole has been allowed to exist because in some cases it is very much a
matter of opinion whether an asset is or is not of a stated value.
o The courts therefore have refused to overrule directors in their valuation of an
asset acquired for shares if it appears reasonable and honest.
o However, a blatant and unjustified overvaluation will be declared invalid.

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 Capital and the financing of companies

 Public companies

o When a public company allots shares for a non-cash consideration the

company must usually obtain a report on its value from an independent valuer.
o The valuation report must be made to the company within the six months
before the allotment.
o On receiving the report the company must send a copy to the proposed
allottee and later to the Registrar.
o The independent valuation rule does not apply to an allotment of shares made
in the course of a takeover bid.

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 Capital and the financing of companies

 Allotment of shares at a premium

 Share premium is the excess received, either in cash or other consideration, over the
nominal value of the shares issued.
 An established company may be able to obtain consideration for new shares in excess
of their nominal value.
 The excess, called 'share premium', must be credited to a share premium account.
 If a company obtains non-cash consideration for its shares which exceeds the
nominal value of the shares, the excess should also be credited to the share premium
account.
 A company cannot distribute any part of its share premium account as dividend.

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 Capital and the financing of companies

 Borrowing
 All companies registered under the Companies Act 2006 (TSO, 2006) have an implied
power to borrow for purposes incidental to their trade or business.
 In delegating the company's power to borrow to the directors, it is usual, and
essential in the case of a company whose shares are quoted on the stock exchange,
to impose a maximum limit on the borrowing arranged by directors.
 Some lenders may require directors and/or members to agree to repay a loan out of
their personal wealth should the company default on the debt.
 This is known as requesting a personal guarantee, which is a promise by a person (the
directors or shareholders) to assume a debt obligation in the event of non-payment
by the borrower (the company).
 Personal guarantees are a means of protecting the lender by preventing the
shareholders/members from hiding behind the protection of limited liability.
 It is commonly used where the lender is very powerful (such as a bank) and where
the borrower (such as a new or small company) has no other source of funds
available to it.
 Loan capital
 Loan capital comprises all the longer-term borrowing of a company.
 It is distinguished from share capital by the fact that, at some point, borrowing must
be repaid.
 Share capital, on the other hand, is only returned to shareholders if the company is
wound up.
 A company's loan capital comprises all amounts which it borrows for the long term,
such as permanent overdrafts at the bank, unsecured loans from a bank or other
party and loans secured on assets, from a bank or other party.
 Companies often issue long-term loans as capital in the form of debentures.
 Debentures
o A debenture is the written acknowledgement of a debt by a company,
normally containing provisions as to payment of interest and the terms of
repayment of principal.
o A debenture may be secured on some or all of the assets of the company or its
subsidiaries.
o A debenture may create a charge over the company's assets as security for the
loan.
o However, a document relating to an unsecured loan is also a debenture in
company law.

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 Capital and the financing of companies

 Types of debenture
 A debenture is usually a formal legal document. Broadly, there are three main types.

 Debenture stock must be created using a debenture trust deed, though single and
series debentures may also use a debenture trust deed.

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 Capital and the financing of companies

 Register of debentureholders
 Company law does not specifically require a register of debentureholders be
maintained.
 When there is a register of debentureholders, the following regulations apply.

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 Capital and the financing of companies

 Advantages and disadvantages of debentures (for the company)

 Difference between shareholder and debentureholders

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 Capital and the financing of companies

 Charges
 A charge is an encumbrance upon real or personal property granting the holder
certain rights over that property.
 They are often used as security for a debt owed to the chargeholder.
 The most common form of charge is by way of legal mortgage, used to secure the
indebtedness of borrowers in house purchase transactions.
 In the case of companies, charges over assets are most frequently granted to persons
who provide loan capital to the business.
 A charge secured over a company's assets gives to the creditor (called the 'chargee') a
prior claim (over other creditors) to payment of their debt out of those assets.
 Charges are of two kinds, fixed and floating.
 Fixed charges
 A fixed charge is a form of protection given to secured creditors relating to specific
assets of a company.
 The charge grants the holder the right of enforcement against the identified asset (in
the event of default in repayment or some other matter) so that the creditor may
realise the asset to meet the debt owed.
 Fixed charges rank first in order of priority in liquidation.
 By its nature a fixed charge is best suited to assets which the company is likely to
retain for a long period.
 A mortgage is an example of a fixed charge. If the company disposes of the charged
asset it will either repay the secured debt out of the proceeds of sale so that the
charge is discharged at the time of sale, or pass the asset over to the purchaser still
subject to the charge.
 Floating charges
 Floating charges do not attach to the relevant assets until the charge crystallises.
 A floating charge is not restricted to assets such as receivables or inventory.
 A floating charge over 'the undertaking and assets' of a company (the most common
type) applies to future as well as to current assets.

 A floating charge is often created by express words.

 However, no special form of words is essential.
 If a company gives to a chargee rights over its assets while retaining freedom to deal
with them in the ordinary course of business until the charge crystallises, that will be
a charge which 'floats'.

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 Capital and the financing of companies

 Crystallisation of a floating charge

 Crystallisation of a floating charge occurs when it is converted into a fixed charge:
that is, a fixed charge on the assets owned by the company at the time of
crystallisation.
 Floating charges crystallise or harden (convert into a fixed charge) on the happening
of certain relevant events.

 Priority of charges
 If more than one charge exists over the same class of property then legal rules must
be applied to see which takes priority in the event the company goes into liquidation.
 Different charges over the same property may be given to different creditors.
 It will be necessary in such cases to determine which party's claim has priority.

 If a floating charge is existing and a fixed charge over the same property is created
later the fixed charge has priority.
 This is unless the fixed chargeholder knew of the floating charge.
 The fixed charge ranks first since it attached to the property at the time of creation
but the floating charge attaches at the time of crystallisation.
 Once a floating charge has crystallised it becomes a fixed charge and a fixed charge
created subsequently ranks after it.
 A floating chargeholder may seek to protect themselves against losing their priority
by including in the terms of their floating charge a prohibition against the company
creating a fixed charge over the same property (sometimes called a 'negative pledge
clause').

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 Capital and the financing of companies

 Registration of charges
 Certain types of charge created by a company should be registered within 21 days
with the Registrar by either the company or a person interested in it (eg the
debenture trustee).
 Charges securing a debenture issue and floating charges are specifically registrable.
 Other charges that are registrable include charges on:

 The company is responsible for registering the charge but the charge may also be
registered as a result of an application by another person interested in the charge.
 The Registrar should be sent the instrument by which the charge is created or
evidenced.
 The Registrar also has to be sent prescribed particulars of the charge.

 The Registrar files the particulars in the company's 'charges' register and notes the
date of delivery.
 They also issue a certificate which is conclusive evidence that the charge had been
duly registered.
 The 21-day period for registration runs from the creation of the charge, or the
acquisition of property charged, and not from the making of the loan for which the
charge is security.
 Creation of a charge is usually effected by execution of a document.
 A mistake or omission in registered particulars can only be rectified by the court
ordering an extension of the period for registration, and with the subsequent
rectification of the register.
 The court will only make the order if the error or omission was accidental or if it is
just and equitable to do so.
 The duty to deliver particulars falls upon the company creating the charge; if no one
delivers particulars within 21 days, the company and its officers are liable to a fine.
 A charge can only be registered late if it does not prejudice the creditors or
shareholders of the company.
 Therefore a correctly registered fixed charge has priority over a fixed charge created
earlier but registered after it, if that charge is registered late.

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 Capital and the financing of companies

 Debentureholders' remedies
 Rights of unsecured debentureholders

 Rights of secured debentureholders

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 Capital and the financing of companies

 Capital maintenance
 Capital maintenance is a fundamental principle of company law: that limited
companies should not be allowed to make payments out of capital to the detriment
of company creditors.
 Therefore the Companies Act contains many examples of control upon capital
payments.
 These include provisions restricting dividend payments, and capital reduction
schemes.
 The rules which dictate how a company is to manage and maintain its capital exist to
maintain the delicate balance between the members' enjoyment of limited liability
and the creditors' requirements that the company shall remain able to pay its debts.
 Reduction of share capital
 Reduction of capital can be achieved by: extinguishing/reducing liability on partly
paid shares; cancelling paid-up share capital; or paying off part of paid-up share
capital. Court confirmation is required for public companies.
 The court considers the interests of creditors and different classes of shareholder.
 There must be power in the articles and a special resolution.

 Solvency statement
 A solvency statement is a declaration by the directors, provided 15 days in advance of
the meeting where the special resolution is to be voted on.
 It states there is no ground to suspect the company is currently unable or will be
unlikely to be able to pay its debts for the next 12 months.
 All possible liabilities must be taken into account and the statement should be in the
prescribed form, naming all the directors.
 It is an offence for directors to deliver to the Registrar a solvency statement without
having reasonable grounds for the opinions expressed in it.
 The benefits to a private company of using a solvency statement, rather than going to
court, to reduce its share capital include the faster speed of the procedure and the
lower cost of filing documents, rather than involving expensive legal representation
in court.

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 Capital and the financing of companies

 Why reduce share capital?

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 Capital and the financing of companies

 Distributing dividends
 A dividend is an amount payable to shareholders from profits or other distributable
reserves.
 Various rules have been created to ensure that dividends are only paid out of
available profits.
 Under the Companies Act 2006 (TSO, 2006) a company may only pay dividends out of
profits available for the purpose.
 The power to declare a dividend is given by the articles which often include the
following rules.

 Listed companies generally pay two dividends a year; an interim dividend based on
interim profit figures, and a final dividend based on the annual accounts and
approved at the AGM.
 A dividend becomes a debt when it is declared and due for payment.
 A shareholder is not entitled to a dividend unless it is declared in accordance with the
procedure prescribed by the articles and the declared date for payment has arrived.
 This is so even if the member holds preference shares carrying a priority entitlement
to receive a specified amount of dividend on a specified date in the year.
 The directors may decide to withhold profits and cannot be compelled to recommend
a dividend.
 If the articles refer to 'payment' of dividends this means payment in cash.
 Scrip dividends are dividends paid by the issue of additional shares.
 Any provision of the articles for the declaration and payment of dividends is subject
to the overriding rule that no dividend may be paid except out of profits distributable
by law.

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 Capital and the financing of companies

 Distributable profit
 Profits available for distribution are accumulated realised profits (which have not
been distributed or capitalised) less accumulated realised losses (which have not
been previously written off in a reduction or reorganisation of capital).
 A profit or loss is deemed to be realised if it is treated as realised in accordance with
generally accepted accounting principles. Hence, financial reporting and accounting
standards in issue, plus generally accepted accounting principles (GAAP), should be
taken into account when determining realised profits and losses.
 Depreciation must be treated as a realised loss, and debited against profit, in
determining the amount of distributable profit remaining.
 However, a revalued asset will have deprecation charged on its historical cost and the
increase in the value in the asset.
 The Companies Act allows the depreciation provision on the valuation increase to be
treated also as a realised profit.
 Effectively there is a cancelling out, and at the end only depreciation that relates to
historical cost will affect dividends.

 Dividends of public companies

 A public company may only make a distribution if its net assets are, at the time, not
less than the aggregate of its called-up share capital and undistributable reserves.
 The dividend which it may pay is limited to such amount as will leave its net assets at
not less than that aggregate amount.

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 Capital and the financing of companies

 Infringement of dividend rules

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