One of the methods of raising finance detailed by Robert Lovell in his article ‘AccountingWEB guide to alternative finance 2012’ was equity finance which entails the selling of a stake in the ownership of the company in return for cash or other form of assets.
Business angels and venture capitalists were mentioned but there is one source of funding that might also be possible under this heading - the rights issue.
Up until the credit crunch rights issues were a relatively rare method of raising finance because banks were ready and willing to lend at affordable interest rates. Now matters have changed and raising money via this method has become a more attractive proposition. A major disadvantage to equity financing can be the difficulty of actually finding buyers for the shares and if a buyer is found they invariably want a large stake of the business for their risk (as the BBC programme ‘Dragons Den’ made all too clear!). With a rights issue the buyers are already there and know the business; assuming, of course, that the company has more than one shareholder and that those shareholders are able and willing to raise the finance available.
If a company does decide to go down the rights issue route, what are the practicalities?
1. Check the company’s articles to confirm that there is no authorised share capital stated therein that might restrict the maximum number of shares allowed to be issued.
The Companies Act 2006 no longer requires a company to have an authorised share capital so a company can have as many shares as the directors require but companies incorporated prior to 1 October 2009 will need to pass a resolution to take advantage of this new provision.
If this proves to be a problem the company needs to:
- adopt the ‘new’ model articles which do not mention any restriction (special resolution)
- amend the original memorandum/articles to either remove the restriction or authorise the directors to allot shares in excess of the stated authorised maximum (special resolution)
- if the company was incorporated post 1 October 2009 and the articles state a maximum number of shares - pass an ordinary resolution (this can be written) to remove the restriction
2. Check the articles to see whether the directors actually have authority to issue the shares. Under s 550 Companies Act 2006 directors of a company that has just one class of share can allot more shares without having to obtain specific authority from the shareholders unless the company’s articles require it. ‘New’ companies automatically come under this provision but all other companies must pass an ordinary resolution (this can be written) to permit the requirement. Once the resolution has been passed, the authorisation lasts indefinitely, unless an expiry date is stated.
If the company has more than one class of share the directors will still need to ensure that they have authority but the rules are slightly different (s551 Companies Act 2006). Authority granted pre 1 October 2009 remains in place until the period for which it was granted expires, when it will need to be renewed. The authority (by ordinary resolution) must state the maximum number of shares to be allotted and the date on which it will expire, which cannot be more than five years in the future.
3. Approve resolutions as required
4. Issue letters to all shareholders:
i. Provisional letter of allotment offering the new shares usually in proportion to the number of shares already held, stating a closing date for acceptance. This document gives shareholders the right to buy the additional shares, but not the obligation. Many private limited companies place a restriction on the number of shares each shareholder can hold as stated in the articles or passed by ordinary resolution.
ii. Letters of renunciation - if it is intended that the shareholders be permitted to sell their entitlement or renounce the rights completely.
[NOTE: under s 123 TCGA 92 the disposal of a provisional letter of allotment is treated as a capital distribution for tax purposes in the hands of the shareholder]
5. When the closing date for acceptance has passed and the monies received, the directors need to meet to confirm the names and number of shares taken up
6. Issue relevant share certificates
7. Submit form SH01 (return of allotment of shares) to Companies House within 15 days of allotment
8. Update the register of members to reflect the increased holding per shareholder
And finally...
As has been said many times before, paperwork to support decisions made is important. It is the nature of private limited companies that share reorganisations including rights issues, are not always understood by the persons involved. It is worth looking at the case of ‘The Executors Of Mrs Mary Dugan-Chapman & anor v Revenue & Customs Commissioners (2008) SpC666’, (the detail on which can be found in an article by Mark McLaughlin but in summary, the judge ruled that the company’s shareholders had not understood the concept of rights issues in comparison with a share subscription and as the ‘Duomatic’ principle was also ruled not to apply, valuable business property relief was denied.
Reminder: the ‘Duomatic’ principle (from re Duomatic Limited [1969] 2 Ch 365) states that although the articles of a company may require a particular course of action to be taken, so long as all members are aware of the relevant facts and either give their approval to that course or so conduct themselves afterwards as to make it inequitable for them to deny that they have given their approval, then the procedure is deemed to have taken place.
Jennifer Adams FCIS TEP ATT is a freelance writer and author specialising in tax and company secretarial issues, and can be contacted at Abacus Business Solutions.
