CAPITAL AND FINANCING OF A COMPANY

What is Financing?

Financing refers to the methods and types of funding a business uses to sustain and grow its operations. It consists of debt and equity capital, which are used to carry out capital investments, make acquisitions, and generally support the business. This guide will explore how managers and professionals in the industry think about the financing activities of a company.

On a company’s cash flow statement, there is a section that’s referred to as cash flow from financing activities, which summarizes how the business was funded over a particular period.

Activities include:

• Issuing debt to raise money
• Repaying debt
• Issuing equity to raise money
• Repurchasing equity
• Paying dividends

Debt vs Equity

Managers of businesses have two choices when it comes to funding activities: debt or equity. There are pros and cons to each, and the optimal choice is often a combination of each

Capital

• The capital of a business is the money it has available to pay for its day-to-day operations and to fund its future growth.
• The four major types of capital include working capital, debt, equity, and trading capital. Trading capital is used by brokerages and other financial institutions.
• Any debt capital is offset by a debt liability on the balance sheet.
• The capital structure of a company determines what mix of these types of capital it uses to fund its business.
• Economists look at the capital of a family, a business, or an entire economy to evaluate how efficiently it is using its resources.

Loan Capital

Loan capital comprises all the longer term borrowing of a company. It is distinguished from share capital by the fact that, at some point, borrowing must be repaid. Share capital on the other hand is only returned to shareholders when the company is wound up.

A company’s loan capital comprises all amounts which it borrows for the long-term, such as:

(a) Permanent overdrafts at the bank

(b) Unsecured loans, from a bank or other party

(c) Loans secured on assets, from a bank or other party

Debentures

A debenture is the written acknowledgement of a debt by a company, normally containing provisions as to payment of interest and the terms of repayment of principal. A debenture may be secured on some or all of the assets of the company or its subsidiaries.

Types of Debenture

A Single Debenture 

If, for example, a company obtains a secured loan or overdraft facility from its bank, the latter is likely to insist that the company seals the bank’s standard form of debenture creating the charge and giving the bank various safeguards and powers.

Debentures issued as a series and usually registered

Different lenders may provide different amounts on different dates. Although each transaction is a separate loan, the intention is that the lenders should rank equally in their right to repayment and in any security given to them. Each lender therefore receives a debenture in identical form in respect of his loan.

The Issue of Debenture Stock subscribed to by a large number of lenders

Only a public company may use this method to offer its debentures to the public and any such offer is a prospectus; if it seeks a listing on The Stock Exchange then the rules on listing particulars must be followed

Advantages of Debentures as Compared to Shares

• Usually Board of Directors have authority to issue Loan Notes without specific approval of Shareholders. This is not possible in case of share issue Loan Notes does not carry any voting rights.
• Interest Expenses gives tax benefit
• Loan is a cheaper source of finance.
• Loan notes can be issued at discount OR premium without any restriction.

Disadvantages of Loan Notes

• It increases fixed cost of the company as interest must be paid irrespective of profits
• In case of non payment, company may have to face liquidation

Charges

A charge is an encumbrance upon real or personal property granting the holder certain rights over that property. They are often used as security for a debt owed to the charge holder. The most amon form of charge is by way of legal mortgage. used to secure the indebtedness of borrowers in house purchase transactions. In the case of companies, charges over assets are most frequently granted to persons who provide loan capital to the business

Fixed charges

A fixed charge is a form of protection given to secured creditors relating to specific assets of a company. The charge grants the holder the right of enforcement against the identified asset (in the event of default in repayment or some other matter) so that the creditor may realise the asset to meet the debt owed. Fixed charges rank first in order of priority in liquidation.

Floating Charges

A floating charge has been defined as:

• A charge on a class of assets of a company, present and future…
• Which class is, in the ordinary course of the company’s business, changing from time to time and
• Until the holders enforce the charge the company may carry on business and deal with the assets charged

Advantages of Floating Charge

• The corporation has the ability to sell charged assets 
• Floating charge gives greater accessibility of funds to company
• Floating charge is favourable for charge holders because it is a high liquid asset, therefore easily saleable.

Disadvantages of Floating Charge

• Fixed charges are prioritised over floating charges if they are created on the same asset
• Because floating charges are created on a system rather than a specific asset, it can be challenging for charge holders to locate their asset
• In case of dissolution, liquidator can challenge fixed charges created in last 6 months and floating charges created in last 12 months of dissolution if he feels that charge was created to give unfair priority to some charge holders

Priority of Charges

Basic rule

• With equal charges the first in time prevails.
• With unequal charges (e.g a fixed charge and a floating charge) a fixed charge takes priority over a floating charge.

Registration of Charges

• The charge will not be legitimate if each charged holder does not get his charge recorded within 21 days. Loan will be considered unsecured if charge is found to be invalid.
• The registration date establishes the priority of charges.
• The Company and the executives who created the charge will be subject to a fine if it is not registered on time.

Register of Charges

All businesses are required to keep a register of charges that is available for public inspection. This register is kept at the registered head office and includes the following information:

• Charge Details
• Charge Holder Details
• Loan Amount
• Loan Date

Every charge holder must inspect this register before creating new charge. Any error in this register will result in personal liabilities of directors.

MEMBERS / SHAREHOLDERS

Share capital of company is divided in following heads:

1. Authorized Share Capital represents the Maximum Number of shares a company can issue but this limit has been removed by Company Act 2006.
2. Unissued share capital: This is the capital’s unused authorized share capital.
3. Issued share capital: This is the amount of actual shares that the corporation has issued.
4. Paid up: It represents the actual amount paid from Issued share Capital. In public company at least 1/4th must be paid.
5. Unpaid: Shares which have been issued but have not yet been paid for by the shareholder.
6. Called up: The amount that the company has demanded but has not yet been paid.
7. Un called: Amount that is still due and for which the corporation has not yet made a claim.

TYPES OF SHARES

Ordinary Shares

The following features apply to these shares:

• Have the ability to vote on the business’s overall decisions
• Be required to be issued on the date of registration
• Have an unfixed or mandated return
• Have the last say in distribution in the event that the company dissolves
• and Normally not redeemable

Preference Shares

 These shares have following characteristics:

• Return is fixed
• Cannot take part in overall decisions of the Company. However they take part in decisions specific to their class
• They have preference over ordinary shareholders in distribution
• The priority will go to the shareholder in the event of a declared preference divide. Their rights will be forfeited if the company enters liquidation without declaring a dividend.

Preference shares are further divided in following classes:

• Redeemable: Buy back date is fixed
• Irredeemable: Buy back date is on company’s discretion
• Cumulative: If a dividend is not paid in a given year, it is carried forward.
• Non-cumulative: If a payout is not paid, dividend rights expire.
• Participating: These preference shares receive their set return in addition to involvement in leftover earnings upon distribution to common stockholders
• Non-participating: The dividend on these preference shares is fixed.

Class Rights

 Including dividend rights, par value of shares, and dissolution rights, can only be varied after special resolution. Minority shareholders can challenge variations within 21 days with at least 15% voting rights. Issue of new shares is not considered a variation in rights.

Treasury Shares

These are temporary shares purchased by a company from distributable profit, not cancelled. They support market value, with a maximum of 10% of share capital. Companies must notify the Registrar within 28 days.

Par value / Face value / Nominal value

These amounts are set in the company’s AOA and are subject to change by special resolutions. Since the corporation is unable to issue shares at a discount to par, this value is often kept low. It is used for following purposes:

• In financial accounts, the capital of shares is displayed at Par Value
• The dividend is stated in connection with par value.
• Should the corporation dissolve, its shares are redeemed at Par Value

Market Value

Market value of shares is influenced by political, economic, demand, supply, company performance, future prospects, market interest rate, and other investment opportunities.

Allotment of Shares

Directors need shareholder consent for shares issuance in public companies, with up to five-year prior power, and private companies have limited power unless otherwise specified.

Pre-emption Rights

Pre-emption rights allow existing shareholders to receive new shares proportional to their existing holding of a specific class of shares, ensuring that companies offer these shares first to similar holders on similar terms.

Bonus Issues

A bonus issue is a company’s capitalization by issuing additional shares to existing shareholders proportional to their holdings, typically fully paid-up without any cash demand.

Rules for Issuing Shares

The company is not allowed to issue shares at a discount, or less than par value.

If shares are issued at a discount, the shareholders who bought such shares will be responsible for paying the outstanding balance plus interest. But this idea is not applicable to:

• Bonus issue
• Under writing
• Unpaid share capital

Shares can be issued at premium i.e. above par value. Premium is recorded in share premium reserve and it can be used:

• to issue bonus shares
• to finance the cost of issuing share
• to finance the buyback of shares at premium

Capital Maintenance

Capital maintenance: Capital mice is a fundamental principle of company law. that limited companies should not be allowed to make payments out of capital to the detriment of company creditors. Thus the Companies Act contains many examples of control upon capital payments include provisions restricting dividend payments, and capital reduction schemes

Reduction of Share Capital

A limited company can cancel unissued shares without permission.

If a limited company with a share capital wishes to reduce its issued share capital it may do if:

• It has power to do so in its articles
• It passes a special resolution
• It obtains confirmation of the reduction from the court 

In order to reduce share capital procedure is:

Private Companies

Private companies can reduce share capital in AOA by passing a special resolution, providing directors with a statement of solvency within 15 days, and applying to the company’s registrar for reduction. False statements can result in personal liability.

Public Company

A public company can reduce share capital in AOA through special resolution, court approval, and application to the registrar.

DIVIDEND

A company can declare dividends in cash or shares, with approval from shareholders but not exceeding the recommended amount. Interim dividends do not require approval from shareholders. Dividends must be paid from distributable profits, including realized profits, and must not fall below the sum of Share Capital and un-distributable reserves. Directors, shareholders, and auditors may be liable for excess dividends, and shares are known as Scrip Dividends or Bonus Issues.

Written by: Maham Maqbool, Bright student of ACCA