Complete notes covering Workshop 10/11 of the University of Law's Business Law & Practice Module.
- Company Finance: Debt versus Equity
- Shares Overview
- Allotment of Shares
- Debt Finance; Security, Registration of a Charge,Loan Options and Contractual Terms
A company can raise finance in two main ways:
Equity Finance (i.e. issuing shares to new members)
Debt Finance (i.e. borrowing)
The boxes shaded indicate which of the options is more advantageous in a particular category.
From the Lender/Investor’s/Shareholder’s Point of View
Reason Equity (Shares) Debt (Loans)
Return on The company normally has discretion over Interest payments must be paid when they
Investment dividend payments. become due.
The investor is not guaranteed payment. The lender may be able to petition to wind up the
company if it is unable to pay its debts when they
fall due.
Alternatively, may be able to enforce security.
Capital value May increase or decrease depending on the Will remain constant.
of the company’s fortunes.
investment
Repayment of Will not be repaid unless the company is Capital will need to be repaid or else borrower
capital wound up, though shareholder can sell his will default on the loan and the lender can
shares to a third-party investor. enforce security.
Can recoup capital by selling shares to 3rd
party – hard to find for small companies.
Restrictions Can be sold through may be restricted by Nothing to stop a lender transferring the loan
on sale the articles agreement to a third party.
Model Article 26(5) gives directors discretion
to refuse to register a new shareholder
Control over Investor will be able to attend GM’s and is Save for the imposition of covenants in the loan
the Company likely to get voting rights so will be able to agreement, the lender will be unable to influence
influence company decisions – depends on company decisions.
size of holding. Lender can require company to give undertakings.
Risk Riskier than providing a loan. Cannot take Can spread the risk:
security, and if the company becomes o Syndicated loans
insolvent creditors will be paid before o Security
shareholders. May get nothing back. o Can seek guarantees from directors.
Buying shares is riskier.
Priority on A company in financial difficulty will not issue
Winding Up a dividend as no distributable profit exists Lender is much more likely to get repaid if the
Payment of dividends is usually discretionary company goes insolvent.
(but depends on type of share) Interest payments
If company is insolvent, capital value of
shares is 0
1
, BLP WS10/11
From the Company’s Point of View
Reason Equity (Shares) Debt (Loans)
Control over Shareholder granted voting rights and can Interest payments must be paid when they
the Company hold significant power in the company. become due.
The company can avoid this by issuing Onus put on the loan agreement, so company is
preference shares with no voting rights, but limited by those terms.
there can be expensive as normally a Can make company use wide-ranging
guarantee to pay representations and undertakings as conditions
The company normally has control over precedents for loan grant.
dividend payments; it can choose not to pay If the company has insufficient funds it may have
them if the company is struggling to sell assets to meet the payments.
financially. Failure to pay interest on time is likely to be an
event of default.
Repayment of Generally, not repayable unless the Repayable in full at a future date
capital. company is wound up. If company doesn’t pay, then it will be in default.
Tax Dividend payments are NOT tax-deductible Interest is normally a trading expense which can
expenses for the company, as they are be deducted to reduce the company’s tax liability
merely distributions of net profits
Cost Dilution of existing shareholdings. May raise Dependent on economic circumstances e.g. if
control issues. interest rates are low can be relatively cheap.
Cost of granting new shares is harder to
quantity then debt. Dividends will be a cost
to existing shareholders.
Restrictions on Company may need to obtain several board Company’s articles may impose restrictions on
company’s and shareholder resolutions. finance through borrowing.
ability to raise FSMA prohibition on offering shares in Where company has entered other loan
funds private companies to public (s.755(1)). agreements these may impose further restrictions
Market for shares in private company is very on further borrowing.
limited.
Gearing Increased shareholder investment will If the company has a lot of debt in comparison to
improve a company’s proportion of debts shareholder funds it may only be able to obtain
to shareholder funds finance through equity finance
Degree of Issuing of new shares is subject to No statutory procedure to follow, though
regulation and procedural restrictions in the Companies Act company’s articles may specify a procedure.
procedure 2006. Loans are far less regulated.
Opposing shareholders may use their power
to prevent proposed investments as they
do not want voting right diluted.
Risk For ordinary shares directors have Loan agreement may cntain certain financial
discretion as to whether to pay a dividend performance targets (covenants) which may be
and can be flexible. breached.
An event of default may accelerate the loan and
security might be enforced with fire consequences.
Shares Overview
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