#16730 - Raising Capital

In the context of limited liability, we have seen there are ex post controls to protect the interests of creditors like personal liability for certain wrongdoing directors. Minimum capital requirements are an example of an ex ante control, as it ensures the company has some minimum level of capital out of which it can satisfy its debts. In this context, capital simply means assets contributed to the company by shareholders, typically when they pay their subscription and / or share premium.

Legal capital is typically less than total NAV as company may also turn to debt financing at the outset, and will have (hopefully) generated profits when trading. NAV is the shareholders’ equity – if (NAV-Legal Capital) > 0, the surplus can be distributed as dividends, but no dividends may be paid if (NAV-Legal Capital) < 0.

Alternative to legal capital: minimum capital rules – this is a requirement in the UK for public companies per the Second European Company Law Directive 1977. This means a certain amount of money must be paid in when the company incorporates.

UK company law gives companies great freedom to set their own level of legal capital but their choice can have consequences. Legal capital affects the level of dividend payments that can be declared, eligibility to recapitalise (share buy-backs by company) and reduction in legal capital must be done in a way that protects creditors.

Legal capital – amount that the company receives from those who subscribe to shares. But note the difference between nominal and par value – par value incorporates a share premium. S542(1), (2) – all shares allotted must have a fixed nominal value or else the allotment is void. This means a company may issue eg 20,000 1 shares or 50,000 10p shares. What the shareholder actually pays for the shares can be any amount as long as it is not less than the nominal value – S580. To give themselves maximum flexibility, companies often opt to keep the nominal value as low as possible.

When a company issues more shares after successfully trading for some time, it will be right for them to set a price above par to prevent the later investors from gaining a disproportionate share of the company.

Company Law Review contemplated abolishing par value for private companies but eventually resiled from the proposal. Second Directive – thought to require retention of par value (Art 8).

S580(1) – if share is allotted for less than nominal value, the shareholder is liable to pay the company the shortfall. This is meant to be for the good of creditors but may actually be harmful – a company on the verge of insolvency may be desperate to issue new shares but will be unable to do so if their nominal value is too high. However, there are ways around this like issuing a new class of shares.

Perhaps this rule is more about protecting existing shareholders from dilution through having new shares issued too cheaply. However, this only arises where shares are issues for less than market price, which is not strictly related to nominal value, so it is not so helpful to them either. Oddly, there is no duty to issue shares at a premium where the market price is above nominal value – Hilder v Dexter [1902]. However, directors have a duty to act for the success of the company and should ordinarily obtain the best price which they can – Lowry v Consolidate African Selection Trust Ltd [1940].

The amount received by company as nominal value is part of legal capital. The premium is part of legal capital too – S610. This is because it makes no sense for a shareholder to subscribe to shares and for the monies to be immediately paid out as dividends to the other shareholders.

However, money obtain from nominal value and from premium are not treated in exactly the same way. S610 – two exceptions and two reliefs:

Exception 1: company may apply the share premium account in paying up bonus shares [bonus shares can also be paid for using distributable profits] – this is unobjectionable to the company creditors as it simply moves money from the share premium account to the share capital account – S610(1)
Exception 2: share premium account may be applied to write off expenses / commissions paid to generate the premiums – S610(2); share capital can be used to pay commission too – S553
Relief 1: S610 applies to premiums of cash ‘or otherwise’, so a share premium account must be set up in an M&A context where company A buys shares in company B in exchange for an allotment of company A shares. This means that company B’s previously distributable profits end up being part of A’s share premium account. SS612, 613 therefore offers merger relief.
Relief 2: corporate restructuring – S611 – issues at a premium by a wholly-owned subsidiary – company issuing the shares may value its assets by book value not market value. This means they can understate the value of their assets, reducing the share premium amount, as long as the figure derived is more than the nominal value of the shares.
S614: Secretary of State for Business, Information and Services has power to make other forms of relief but has not done so.

Second Directive – minimum capital requirement for public companies – S761: 50K. This is small change to a public company, and the 50K does not have to be handed over to the company at the time of the issuance of the shares – enough that of the nominal value of the shares paid up at time of issue – S586. However, this does put a little pressure onto companies to not set an overly-high premium as premium will not count towards the minimum. There is no minimum capital rule for private companies, making England an attractive place to incorporate for EU businesses – Becht et al (2008).

S761 – where a company is incorporated as a public company, the minimum capital rule is not a pre-requisite to formation but to starting trading. S762 – public companies need a trading certificate from the Registrar of Companies House. Directors may be personally liable to third parties for losses occasioned by failure to do this and also may face criminal sanctions – S767.

If private company converts to public company – requirement that the company’s allotted share capital be at least the authorised minimum is a condition for re-registration – S90.

What happens if share capital falls below the minimum capital? If a public company wants to reduce capital to below 50K, it will have to re-register as a private company – S650(2). S764 – SS BIS has power to increase the minimum capital and get existing companies to increase their minimum capital too.

There is a fixed requirement of either 0 or 50K but actually the level should depend on the riskiness of the business to be effective; low levels do not offer adequate protection to creditors but high levels discourage new entrants to the market. However, a gradated process would be hard to enforce / calculate. Exceptions exist for industries like banking where minimum capital is taken seriously. Otherwise, most developed countries set minimum capital at a low level if at all.
If minimum capital is not enough to protect the interests of creditors fully, then is it nevertheless a sort of cushion? Not really – minimum capital may soon be paid out legitimately eg as salary, or even initially paid in kind and therefore not be readily available to satisfy debts.
S656 – if NAV falls below 50% called-up share capital then a public company must organise an EGM, but this is not very useful in practice

Asking companies to disclose how much money they have received as share capital is a good way of facilitating self-help, but this is only important when the company starts trading – later on, annual accounts etc are more useful. However, pre-existing shareholders will be interested to know at what rate shares have been allotted to newcomers to see if they are being diluted.

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#16730 - Raising Capital - Company Law

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