Unit 2: Business Law 2: Equity Finance #1

What is equity finance and how does it differ from debt finance?

Equity finance raises capital by issuing shares, giving ownership rights. No obligation to repay principal.

What are the main advantages and disadvantages of equity finance?

Advantages: Permanent capital, no repayment pressure. Disadvantages: Dilutes existing ownership, control, and requires stricter regulation.

Define share capital and the different categories.

Funds raised by issuing shares. Categories: Issued (allotted), paid-up (received), and called-up/unpaid capital.

What are the main classes of shares?

Ordinary shares (default), preference shares, redeemable shares, and deferred or alphabet shares.

What is the difference between allotment and issue of shares?

Allotment is the agreement to issue. Issue is completed upon registration in company books.

What are pre-emption rights?

Existing ordinary shareholders' statutory right to buy new shares pro-rata before outsiders to prevent dilution.

What rights do shareholders have regarding dividends?

No automatic right. Paid from distributable profits; directors recommend, shareholders approve by ordinary resolution.

What is the difference between transfer and transmission of shares?

Transfer is voluntary (sale/gift). Transmission is automatic by operation of law (death/bankruptcy).

Distinguish between nominal value and market value of shares.

Nominal value is fixed in company documents. Market value fluctuates based on performance.

Which provisions of the Companies Act 2006 are important for equity finance and share capital?

Part 17 CA 2006 is the main part dealing with share capital.

Important sections include:

ss.540-545 CA 2006 → Definition of shares and share capital.

s.542 CA 2006 → Shares must have a fixed nominal value.

ss.549-551 CA 2006 → Directors' authority to allot shares.

s.561 CA 2006 → Statutory pre-emption rights.

s.569 CA 2006 → Disapplication of pre-emption rights.

s.580 CA 2006 → Prohibition on issuing shares at a discount for cash.

s.610 CA 2006 → Share premium account rules.

ss.629-640 CA 2006 → Classes of shares and variation of class rights.

ss.830-831 CA 2006 → Distributable profits and payment of dividends.

What are the rules regarding directors' authority to allot shares under the Companies Act 2006?

Private companies with one class of shares (s.550):

Directors automatically have authority to allot shares unless the articles restrict this.

Other companies (s.551):

Directors require shareholder authorisation.

Authorisation can come from an ordinary resolution or the articles.

The authorisation must specify:

Maximum number of shares

Duration of authority (maximum 5 years)

What are the rules regarding payment for shares and issuing shares at a premium or discount?

A12:

Shares cannot be issued at a discount for cash under s.580 CA 2006.

Shares may be issued above nominal value (at a premium).

The extra amount is placed into a share premium account under s.610 CA 2006.

Share premium is treated as capital and has restricted uses.

Shares may be paid for:

In cash

By non-cash consideration (such as assets)

Non-cash payments must be properly valued.

Public companies have stricter valuation requirements under s.593 CA 2006.

What is the policy behind pre-emption rights?

To protect existing shareholders from dilution of ownership and voting power by giving first refusal.

What is the capital maintenance principle and why is it important?

Companies must maintain capital to protect creditors, restricting discounts and non-profit distributions.

Why does company law allow different classes of shares and protect class rights?

Provides financing flexibility while protecting minority class holders from detrimental changes to rights.

What was held in Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821? and what is the legal principle?

facts: Directors of Miller issued new shares to Howard Smith.

The purpose was mainly to reduce Ampol's majority shareholding and prevent Ampol taking over the company.

Privy Council held:

The directors had used their power to allot shares for an improper purpose.

The purpose of issuing shares should mainly be to raise capital.

Directors cannot issue shares mainly to manipulate company control.

Legal principle:

A director's power to allot shares must be exercised for a proper purpose.

What directors' duties apply when allotting shares?

Directors must allot shares for proper purposes (s.171) and in the company's best interests.

How is share capital calculated in the Jumbo Gym Ltd example?

At incorporation:

Kai and Patrick each received one £1 ordinary share.

Issued share capital:

= 2 shares × £1

= £2

After issuing more shares:

2,000 shares × £1

= £2,000 issued share capital

Because all shares were fully paid:

Paid-up share capital:

= £2,000

How did issuing new shares affect Kai and Patrick's control in Jumbo Gym Ltd?

Founders' share falls from 50% to 25% each, losing sole control and risking deadlock.

What does the Saleema shares example demonstrate about nominal and market value?

Nominal value stays fixed (£10,000). Market value rises with performance (£50,000), showing capital growth.

What does the Wagtale Limited example demonstrate about dividends?

Dividends require distributable profits. Directors must assess solvency, future cash needs, and exercise discretion.

What is the procedure for allotting new shares?

The company must:

1. Ensure directors have authority to allot shares.

2. Check whether shareholder approval is required.

3. Follow pre-emption rights unless they are disapplied.

4. Issue shares at the correct price.

5. Record the new shareholders in company records.

What is the procedure for transferring shares?

1. Shareholder completes a stock transfer form.

2. Transfer form and share certificate are sent to the company.

3. Directors consider whether to register the transfer.

4. Company updates the register of members.

When does legal ownership pass for transferring shares?

When registration occurs.

What is the procedure for varying class rights?

Class rights can usually only be changed with:

Consent of at least 75% of the affected class by nominal value, or

A special resolution of that class

unless the articles provide another procedure.

What is the purpose of the procedure for varying class rights?

To protect shareholders from unfair changes to their rights.