Equity Finance Notes

• SQE1 Syllabus: Chapters 4 and 5 combined cover:

  • Funding options: debt and equity.

  • Distribution of profits and gains.

• SQE1 Focus: Recalling specific case names or citing statutory/regulatory authorities is usually not required.

• Statutory References: Provided for information, such as understanding references to $s 172 CA 2006$.

• Learning Outcomes (Chapter 4):

  • Understand share capital maintenance.

  • Advise on share allotment procedures.

  • Advise on share transfer and transmission mechanics.

  • Advise on buying back company shares from profit or capital.

4.1 Introduction

• Generally, companies obtain finance in two ways:

  • Equity finance: Shareholders pay for shares.

  • Debt finance: Borrow money for expansion or day-to-day operations.

• Chapter focuses on share creation, allotment, transfer, transmission, and buyback.

• Debt finance covered in Chapter 5.

4.2 Allotting, Transferring, and Buying Back Shares: An Overview

• Three ways shares change hands:

  • Allotment.

  • Transfer (or transmission).

  • Buyback.

• Allotment: Company creates and gives shares to shareholders (existing or new) for payment.

  • Company issues share certificate and updates register of members.

  • Payment usually in cash but can be property.

• Share Transfer: Shareholder sells or gives shares to another party.

• Buyback: Company buys back its own shares, cancelling them, thus decreasing the total number of shares.

• Commonality: All three methods alter the percentage shareholding of at least one shareholder.

Examples

• Allotment of Shares: Emma and Farha each own 100 shares in UOL Limited. UOL Limited allots 100 shares to Geeta for £1,000. Before: 2 shareholders, 200 shares. After: 3 shareholders, 300 shares.

• Share Transfer: Changes the identity of shareholders but not the total number of shares. Before: Two shareholders with 100 shares each. After: Three shareholders with 100, 50, and 50 shares respectively.

• Share Buyback: Decreases the total number of shares. Before: Two shareholders with 100 shares each. After: One shareholder with 100 shares.

• Percentage effects of allotment: Emma with 25.1% shareholding can block special resolutions. Allotting 100 shares to Geeta reduces Emma's share to 22.82%, losing her blocking power.

• Percentage effects of buyback: Buying back Geeta’s shares increases Emma’s shareholding to over 50%, allowing her to pass ordinary resolutions alone.

• Restrictions on Allotment and Buyback: Imposed due to potential loss/gain of power for shareholders.

• Share Transfer Control: Not as strict as allotment/buyback, as the total shares don’t change.

4.3 Allotment of Shares

• Allot vs Issue: Allot = person gains unconditional right to be on register of members. Issue = name entered on register.

• Process: Board decides price and quantity of shares, advised by accountant/banker. Solicitors handle procedure and paperwork.

Allotment Considerations

1. Constitutional Restrictions: Check for upper limits (authorized share capital - ASC).

   • Pre-CA 2006 companies: ASC in memorandum transferred to articles; remove by ordinary resolution.

   • Post-CA 2006 companies: Articles may include an ASC clause; remove by special resolution.

2. Directors' Authority: Board or shareholder decision.

   • Private companies (one share class): Directors have authority (s 550 CA 2006) if incorporated under CA 2006; otherwise, shareholders must pass an ordinary resolution to activate s 550.

   • Public companies/private companies (multiple share classes): Shareholders' ordinary resolution needed (s 551 CA 2006) stating maximum shares and expiry date (max 5 years).

3. Pre-emption Rights: Existing ordinary shareholders get first refusal on new ‘equity securities’ (ordinary shares or rights to convert into ordinary shares) to maintain percentage shareholding (s 561).

   • Shares offered must enable shareholders to preserve their percentage shareholding.

   • Offer must state acceptance period (minimum 14 days, s 562(5)) and cannot be withdrawn.

   • Exceptions: bonus shares (s 564), non-cash consideration (s 565), employee share scheme (s 566).

Pre-Emption Rights in Articles

• CA 2006 (s 567) allows private companies to exclude pre-emption rights in articles.

• Check articles first for alternative provisions.

Disapplication of Pre-Emption Rights

• Private companies can disapply s 561 pre-emption rights for a specific allotment by special resolution.

• Private companies (one share class): Shareholders can disapply pre-emption rights via special resolution (s 569).

• Public companies/private companies (multiple share classes): Authority depends on initial authority to allot shares.

  • General authority (s 551): Remove pre-emption rights by special resolution (s 570).

  • Specific allotment authority (s 551): Disapply pre-emption rights by special resolution (s 571) recommended by directors, along with a written statement justifying it.

  • Directors' written statement must include reasons, amount purchaser will pay, and directors’ justification.

  • Misleading statements in director’s statement are an offense (s 572).

Payment for Shares

• MA 21: All shares must be fully paid.

• If articles don’t include MA 21, shares can be partly paid.

• Shares issued at a premium: Excess consideration recorded in share premium account (s 610 CA 2006) and treated as share capital.

Allotment - Administration

• Send resolutions to Companies House within 15 days.

• Send Return of Allotment and statement of capital (Form SH01) to Companies House within one month of the allotment.

• Amend the register of members within two months.

• Prepare share certificates within two months of allotment.

4.4 Transfer of Shares

• Shareholder sells or gives shares to another party, changing percentage shareholdings but not total shares.

• No CA 2006 prevention of transfer or obligation to offer to existing shareholders first.

• Articles often contain restrictions on who shares can be transferred to.

• Articles cannot restrict a shareholder from selling shares or stop a purchaser from buying them. However, shares need to be approved by the board.

Model Article 26

• Gives board the discretion to refuse share transfer registration, meaning board approval is needed for every transfer.

• Without registration, the transferee is the beneficial owner, but the transferor remains the legal owner and receives dividends.

How Shares are Transferred

• Transferor completes and signs stock transfer form, giving it with share certificate to transferee (ss 770–772 CA 2006).

• If sale price over £1,000, buyer pays stamp duty (0.5% rounded up to nearest £5).

• Transferee sends form and certificate to company, which then:

  • Sends new certificate to shareholder within two months (s 776 CA 2006).

  • Enters name on register of members within two months (s 771 CA 2006).

  • Notifies Registrar of Companies via annual confirmation statement (CS01).

4.4.2 Transmission of shares

• Automatic process:

  • Shareholder death: Shares pass to personal representatives (PRs).

  • Shareholder bankruptcy: Shares vest in trustee in bankruptcy.

• Under MA 27, Bankruptcy trustee/PRs do not become shareholders, but are entitled to dividends.

4.5 Maintenance of Share Capital

• Share capital is foundation of company and cannot be reduced, protecting creditors.

• Consequences:

  • Dividends only from distributable profits.

  • Company generally cannot purchase its own shares.

• Exceptions:

  • Buyback with correct procedure (s 690).

  • Court order under s 994 CA 2006 to buy out unfairly prejudiced minority shareholder.

4.6 Share Buyback

• Shareholders want to cut ties or restrictions on share transfer.

• Shares are canceled, reducing profits available for dividends or capital for creditors.

• Directors must consider CA 2006 duties (s 172, s 174) and long-term benefit.

• Distinction between market purchase vs. off-market purchase (s 693).

Buyback Requirements

1. Articles must not forbid buyback (s 690(1)).

2. Shares must be fully paid (s 691(1)).

3. Company must pay for shares at time of purchase (s 691(2)).

4. Payment from distributable profits or proceeds of fresh issue of shares (s 692(2)(a) CA 2006).

   • Distributable profits are accumulated, realised profits less losses (s 830 CA 2006).

5. Shareholders must pass ordinary resolution authorizing buyback contract (s 694 CA 2006).

6. Buyback contract available for inspection 15 days before general meeting or sent with written resolution (s 696(2)).

7. Copy of buyback contract available for inspection at registered office for ten years (s 702 CA 2006).

Voting at the General Meeting for Buyback

• An exception is where an ordinary resolution to approve a buyback under s 694 CA 2006 is proposed.

• When the resolution is proposed as a written resolution, a shareholder who holds shares which are being bought back is not an eligible member for the purposes of the written resolution, so cannot vote, and at a general meeting the resolution will not be effective if that shareholder’s votes made the difference between the resolution passing or not (s 695 CA 2006).

Practical Considerations When Buying shares back

• Check cash availability and liabilities to pay, assessing directors’ duties as explained at 4.6.

Buyback Out of Capital

• Private companies can buy back shares out of capital if articles permit (s 709 CA 2006).

• Public companies cannot buy back out of capital.

• Distributable profits must be exhausted first.

• Must meet the same condition as a buyback out of distributable profits.

Payment for Buyback out of Capital

1. Directors’ solvency statement (one week before general meeting) confirming solvency for the following year.

2. Auditors’ report confirms reasonableness of directors' statement (s 714 CA 2006).

3. Special resolution approving payment out of capital (s 716). Disapplied to those shares being bought back. (s 717(2) CA 2006).

4. Directors’ statement and auditors’ report available to members.

5. Notice in London Gazette within seven days stating shareholder approval and creditor application possibility (s 721).

6. File copy of directors’ statement and auditors’ report at Companies House (s 719(4)).

7. Directors’ statement and auditors’ report available at registered office (s 720).

8. Board resolution decides to enter contract.

   • Payment out of capital itself no earlier than five weeks after the special resolution to approve the buyback out of capital, and no later than seven weeks after the date of the special resolution (s 723(1))

4.7 Dividends

• Shareholders make money via share value increase or dividends (s 830 CA 2006).

• Divided is payed only if the company has profits availble.

• Under MA 30, Directors recommend dividend amount, shareholders approve via ordinary resolution.