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#10132 - Buy Back Of Shares Considerations - Business Law and Practice

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Why?

  • Look also at the Maintenance of Capital notes (BB is an exception)

  • Return member’s investment where no 3rd P can be found to purchase the shares (which means the member is )

  • Return money to member rather than by dividend

  • By decreasing the number of shares in issue, it increases the earnings per share and company is more attractive to investors and existing shareholders (so investors and members are )

  • It facilitates the removal of a D / problematic member

  • Ds should always keep in mind their Duties (particularly s.172) when consideration it
Commercial Problems

  • Shares Bought Back are immediately cancelled under s.706(b)(i), so the Ds are essentially giving away money for no consideration (which makes the consideration of their duties all the more important (i.e. s.172))
Shareholder Concerns

  1. The ‘lost’ money spent on the buy-back cannot be used to make more profits for the existing shareholder ()

  2. Company’s funds become depleted, meaning that it is stepping closer to insolvency and, because members are at the bottom of the list, they won’t get their investment back ()
Creditor Concerns

  1. Company’s funds become depleted, meaning that it is stepping closer to insolvency ()

  2. The reduction in the original pool of capital will mean that creditors will receive a smaller proportion ()
Effect Consider the effect on the change in voting control

Dividends

  • Only distributed if there are profits available (s.830) at the sole discretion and amount that the Ds think fit by members passing an OR (MA30(1) / TA102)

  • Formula: ‘all realised profits to date’ LESS ‘all realised losses to date = distributable profit or loss

  • A breach of s.830:

  • Ds who authorised the dividend are jointly and severally liable for the full amount

  • Member should refund the full amount if knew/reasonable grounds it was unauthorised

Redeemable Shares

  • Can only issue them if you already have ordinary shares (s.684(4))

  • The articles must expressly permit it for public companies

  • For private, there must be an express restriction in it

  • Private companies may redeem redeemable shares from:

    • Distributable profits; and

    • Capital (if Articles permit); and

    • Reduction of Capital

      • Provided that Ds make a statement of solvency and members pass an SR

Justifying Concerns of Concerned Person

A Question asking you to consider a D’s or S’holder Concerns and whether they are justified

Step 1:

Find the Current Ratio

Is a direct comparison of current assets with current liabilities. I measure the assets which can be turned into cash relatively readily in order to meet liabilities which must be paid within 12 months. The result is expressed as a ratio:

__Current assets__ : 1

Current liabilities

So if the current assets are 40,000 and the current liabilities are 20,000, the current ratio will be :

40,000 = 2:1

20,000

  • A ratio of 1:1 would mean that the business has exactly 1 of current assets with which to meet every 1 of current liabilities. Most business would expect to have a higher ratio, say 1.5:1.

Step 2:

Find the Acid Test

The Current ratio takes into account all of the current assets. Closing stock may not be quickly saleable. The Acid Test is the ratio between current liabilities and current assets excluding stock (or work in progress in a non-trading business). The Acid Test Ratio omits stock from current assets because of the difficulty in converting stock into cash quickly.

Current Assets – Closing Stock : 1

Current Liabilities

Prepayments form the current assets figure are also excluded as these represent amounts already paid by the business, their very nature means that they cannot usually be converted back into cash.

Current Assets
Stock (Work in progress/prepayments) 65,000
Debtors +50,000
Cash +5,000
= 120,000
Current Liabilities
Creditors 40,000
Accruals +10,000
= <50,000>
Net Current Assets 70,000

The Acid Test is: 120,000 – 65,000 = 1.1:1

50,000

An acid test of 1:1 means that the business has 1 of readily liquid assets for every 1 of current liabilities. The lower the ratio, the greater the risk of the business being unable to meet its debts as they fall due. However, even a high ratio needs to be considered critically. The business may not be pursuing its debtors rigorously, or may not have written off sufficient bad debts.

  • We want a 1:1 minimum, meaning you can meet liabilities

  • This test removes assets that may not materialise

Step 3:

Difficulty in Paying Debts?

  • Look at the balance sheet to compare Cash to Short Term Trade Creditors and ask whether it has difficulty in paying its debts. Look mainly at the configuration of the Balance Sheet

  • Question:

    • Bad debts

    • Perishable stock

    • Work in progress amount could be over-inflated

    • Debtors figure could be over-inflated

Step 4:

Impact of the BB on the Net Assets

  • Profit/Loss Reserve = reduced

  • Cash = reduced

  • This would damage the ratios further, meaning that liquidity could be a bigger problem

Step 5:

Are Concerns Justified?

  • Always apply to the facts (Not getting a potentially Hostile/conflictive 3rd party might be good)

  • Ds Must have regard to s.172(1)(act in Best interest of the Co.))(Look at Director’s Duties Notes)

  • It might be good for the Co. that the leaving Partner is leaving as he is not happy/ is irresponsible and thus the Co. may be more stable as Ds will have more freedom to make decisions/flow

  • We might be getting a good deal, they asked for 1 million and we actually sold them for 500k

  • Remember that Balance Sheet is only a snapshot of one day

  • What are the future prospects?

  • E.g. concerns are justified because with the low-level of liquidity following a decrease in cash to X, there would be pressure placed if all the money went on a buy-back

Step 6:

Improve Liquidity

  • Can an asset be sold?

  • Issue fresh shares?

Justifying Concerns of S’holder, Worked out

Task 1 Issue Two (b): ¿Are Francine’s concerns justified regarding the issue of shares?

Step 1:

Find the Current Ratio

2,372,000 = 0,87:1

2,723,000

  • We wanted a 1.5:1 minimum

This mainly means that Hampton Graphics Ltd has exactly 0,87p of current assets with which to meet every 1 of liabilities. This means that the company’s liquidity is low and will not be able to meet its liabilities relatively readily if the become due within the next 12 monts.

Step 2:

Find the Acid Test

2,122,000 = 0,77:1

2,723,000

  • We wanted a 1:1 minimum, meaning you can meet liabilities

This test removes assets that may not materialise. The lower the ratio, the greater the risk of the business being unable to meet its debts as they fall due. However, even a high ratio needs to be considered critically. The business may not be pursuing its debtors rigorously, or may not have written off sufficient bad debts.

Step 3:

Difficulty in Paying Debts?

  • By look at the balance sheet and comparing the Cash (1,350,000) to Short Term Trade Creditors (2,473,000) shows that it will be difficult to meet short term debts. This is further confirmation of the Acid Test and the Current Ratio Test as above. There is not enough cash available to repay short term debts.

Step 4:

Impact of the Buy-back on the Net Assets

  • The Profit and Loss Reserve will be drastically reduced.

  • A...
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