#10129 - Equity Debt Finance - Business Law and Practice

Equity		Debt
P.190Equity Finance= allotment of new shares for which Co. receives money (property) in return, which is used in the Co.’s business.		P.190Debt Finance = borrowing money (3 main types = overdraft, term loan and revolving credit facility)
Tightly controlled by CA 2006		Contract law (not much legislation). Lightly controlled = flexible
	WHAT IT MEANS FOR THE INVESTORP.227
	Equity		Debt
Risk P.227	Buying Shares is more risky than lending to a Co Dividends might not be issued Payment of dividends is discretionary If insolvent, investor loses the capital value on the shares Might be hard to sell shares		Interest payments are a contractual liability which the Co must pay and thus Interests are paid before dividends are paid to investors Loan can be secured over property or personal guarantees from the directors Security = lender gets paid 1^st& investors 2^nd
Involvement in Co. P.227	Member has the right to attend and vote at a GM + influence the Ds’ decisions S’holders have liability ltd to their $ of shares		Lender is merely a creditor with not say in how the company is to be run
Income P.228	Members have no guaranteed income Dividends are discretionary and only payable out of distributable profits		Agreed interest must be paid to the lender If not, lender can demand repayment and enforce their security
Repayment of Capital	Generally, not repaid unless Co. is wound-up Recoup capital by selling shares to 3^rd P		An agreed repayment date will be set
Restrictions on Sale	Transfer of shares is governed by Articles MA26(5) gives Ds absolute freedom to refuse any member they don’t want		Lender may syndicate or sell his debenture to whomever he wishes
Capital Value of Investment	Value fluctuates depending on Co.’s or/and Market conditions etc…		Value usually remains constant
	WHAT IT MEANS FOR THE COMPANYP.228
	Equity		Debt
Payment of Income	Dividends might not be issued Payment of dividends is discretionary and only out of distributable profits		Interest payments are a contractual liability which the company must pay If no profits, company must use capital
Tax Treatment of Income	Payment of dividends is not a deductible expense and is payable after Co. has paid Corp. Tax		Payment of a debenture interest is a deductible expense and deductible before Corp. Tax is assessed.
Involvement of investor	Member whose name is entered on the register has certain rights and can yield some influence over Ds’ decisions		Has no say in how the company is run
Repayment of Capital	Generally, not repaid unless Co is wound-up Recoup capital by selling shares to 3^rd P		An agreed repayment date will be set Company must set aside money to ensure they can meet their obligations under debt
Costs	Cost of equity is difficult to establish There are likely returns to members (dividends; capital; share buybacks) More members will decrease return on shares for each member Dividends are not tax deductible unlike debt interests Low i rate = debt is better		Cost of debt is easy to establish (interest) Interest rate is charged by the lender Vary from lender to lender, economic climate, length of loan, how much borrowed, credit status of the company Tax system favours debt finance because interests unlike dividends are tax deductible High i rate = equity is better
Who Provides It?	Whoever buys the shares		Banks, venture capitalists, Ds or members
Why Take It?	Difficult to get loans in current climate Interest on loans is high If already highly geared (have a lot of debts), you may not be able to get any more loans Do Articles restrict ability to borrow?		When interest rates are low, this is cheaper than equity Less regulated than equity finance Do existing loan agreements apply a negative pledge? P.243(for negative pledge)

Type of Debt Finance

There are two main types of debt finance: Loans (bank overdraft, a term loan and a revolving credit facility) and Debt Securities to investors in return for a cash payment (IOUs). IOUs have to be redeemed (i.e. repaid) by the Co. at an agreed future.

Type	Advantages	Disadvantages
Term LoansP.222 Specific sum for a specific period Repayment date is set (“term”) Used to purchase a capital asset Can be bilateral or syndicated May be secured or unsecured	Allows financial planning Certainty of term as not repayable on demand as with overdrafts Cash can be tied up by the borrower without worry Borrower has more control	Once capital has been repaid, it can’t be re-borrowed by the Co. Time and expense of agreeing contract + all the legal documentation
Revolving Credit FacilityP.222 A working capital facility but much larger than an overdraft Good for seasonal Co.s whose income fluctuates thru the year. Maximum aggregate amount can be borrowed over a set period Usually subject to a ‘clean down’ provision to stop borrower misusing the facility	Flexibility of overdraft Certainty of term as not repayable on demand as with overdrafts Borrower can draw down and then repay funds to reduce interest payments May be secured or unsecured bilateral or syndicated	Often subject to more restrictions than overdrafts (such as notice periods to draw or repay, max or min amounts, frequencies) A commitment fee is normally payable Need to ‘clean down’
OverdraftP.221 Aids cash flow on day to day basis Shows as a current liability on the balance sheet Given on lender’s standard terms with a maximum limit	Very flexible Few formalities required Easy instant access to funds Easily supply daily needs	“Uncommitted” (a Co.’s attempt to withdraw money in excess of its funds is regarded as an offer, which the bank accepts by providing the money) Payable on demand Expensive form of borrowing Usually unsecured (bad for bank) Fee and interest payable by Co.
Debt Securities P.226 Issued to investors by a Co. to raise money. Investors give cash to Co. & Co. promises repayment + interests. Essentially an IOU (a signed document acknowledging a debt) E.g. commercial paper, bonds or EMTN programme	Commercial Papers are an alternative to short term borrowing from a bank – 12 months Bonds are long term debt alternative + 12 months. In London Stock Exchange EMTN is medium/long term debt alternative.
DebenturesP.227 The Common Law defines them as “A document that creates a debt or acknowledges one”	A company must send a copy of their accounts to every debenture holder (s.423(1))

Due diligence on companies’ finance and business plan
Money laundering checks
Documents:
1. Articles: can the D borrow, guarantee, buy or sell property as relevant? (MA-3 / TA-70).
2. Can Co. grant security over its assets? (MA no restriction but check articles TA=Check articles)(remove restriction by S’holder SR s 21 CA 2006)
3. Certificate of incorporation of the company
4. Other mortgages charged against eh Co.’s property (Check Companies House)
5. Check Co.’s land title (Land Registry)
6. Prior charge documentation (for negative pledges) – Form MG01/MG01 (Form 395/403a)
7. Minutes showing board resolutions approving the terms of the loan or guarantee
Are all the Ds are who they say they are (register of Ds and AP01s)
Check the property is theirs to deal with (title deeds, LR, specialist searches, etc.)
Survey and value the assets to see that you’re getting your money’s worth
Insolvency search(Companies Court)

P.240-241

Update the charges register (s.860(1)) but not for guarantees, pledges, liens, over shares (s.860(7))
This is the company’s responsibility to register (s.860(1)), but it is usually the lender who does it because they are the ones that will suffer if it is not done (s.860(2)) and because there is no compulsory registration (s.859A)
- Form MR01(s.859D) outlining the particulars of the charge and defined terms to CH (s.859A(2))
- Certified Copy of the instrument creating the charge (s.859A(3))
- Registration fee of 13 (or 10 if done e-registration with Form MR01)

All three to Companies House within in 21 days of creation of the charge (s.859A(2)/(4))

Receive back: original charging document which is stamped and certificate of registration (s.859I(3)) which under (s.859I(6)) is conclusive evidence of registration of the charge.
Form MR01 will also go on the company file and be open to inspection by the public (s.869(7)) which is useful for any future lenders
Also, details of any charge (with the charging document) is kept in the company’s own register of charges (s.876)

Failure to Register:

Renders the charge void against a liquidator/administrator/other creditors (s.859H(3))
Therefore, a later registered charge will take priority
Security remains valid against the company and becomes repayable immediately (s.859H(4))
The company and every officer in default is liable to a fine (s.860(5))

Late or Inaccurate Registration:

There’s a 21 day period (s.859A(2)/(4)) if missed, then same consequences as above
Limited power to extend the 21 day period:

If it was accidental or due to inadvertence or if not prejudicial to the other side (s.859F). The court also has the power to rectify inaccurate details like wrong form, names, type of charge being registered...

#10129 - Equity Debt Finance - Business Law and Practice

About Oxbridge

More Business Law And Practice Samples