Sunday, July 25, 2010

Issue of Debentures

A debenture is a type of loan stock issued by a company where a company will indicate the amount borrowed and the amount of interest that will be paid on the debentures. There are different types of debentures

Secured Debentures
This is where the company which is issuing the debentures will provide assets as security. Secured debentures can be broadly derived in to two as

Floating Charge
This is where the company will keep all the assets as security when issuing the debentures

Fixed Charge
This is where a specific asset will be kept as security when issuing the debentures

Unsecured Debentures
This is where a company will issue debentures without providing assets as security. The investors will be taking a higher risk in buying unsecured debentures. Based on the method of paying interest, debentures can be divided into two

Floating Rate of Debentures
Floating rate debentures will be issued where the rate of interest to be paid will be linked to generally LIBOR (London Inter Bank Offered Rate) which is the rate of interest at which the commercial banks will borrow from one another

Fixed Rate of Debentures
If debentures are issued at fixed rate debentures, then the company will specified the rate of interest that will be paid at the time of issuing the debentures

Alternative Investment Market (AIM)

This was started in 1995 to replace unlisted securities market. The AIM was introduced so that even the companies which do not meet the conditions laid down by the main market can have their shares traded in the AIM. The following conditions relate to the AIM.

• There are no eligibility criteria. (Past track records is not needed)

• Any type of security can be traded as long as there are no restrictions on the ability to transfer the ownership

• There are no stock exchange requirements for purchasing of shares by the general public or the number of shareholders.

• There are few obligations to issue shareholders circulars, therefore public announcements will be sufficient

• Every company which has its shares traded on the AIM must have a nominated adviser selected from the official list. This adviser will instruct the company on how it’s shares are to be traded in the AIM. In addition a stock broker should also be selected where this stock broker must be a member firm of the stock exchange

• Documents provided for admission to the AIM will be the responsibility of the directors. Therefore it will not be reviewed by the exchange

• The shares traded in the AIM will be treated as unquoted shares for tax purposes

London International Stock Exchange

London International Stock exchange is considered as one of the main stock exchanges in the world. The others being the Tokyo Stock Exchange and the New York Stock Exchange. If a company is to obtain a listing in the London International Stock Exchange which is called the main market the following conditions should be met.

• There should be at least three years past track records if a listing to be provided. This will ensure that start up companies (new companies) cannot have its shares traded in the main market.

• The shares offered to the general public should amount to at least 25% of the issued share capital

• There must be sufficient trading in the shares

• The market capitalization (value per share into number of shares in issue) should exceed £ 6 million

• There must be an agreement with a market makers (an organization which act as a stock broker but it can buy and sell shares under its own name) to market the shares

• The board of directors should pass a resolution indicating that they will abide by the rules and regulations of the stock exchange

Advantages of a Stock Exchange Listing

This is where the company will have it’s shares traded in the stock exchange which will provide the following benefits to the company

The company will have access to avoid a pool of financing because the company can issue new shares; have a rights issue, issue debentures and commercial payment to attract financing in to the company.

The company will have improved marketability for this shares

The company has the ability to transfer the capital to other users

Enhancement of the company’s image

Ability to grow by acquisition

Methods of Issuing Shares

Offer For sale
This is where the company which is issuing the shares will offer the shares to an issuing house. Generally a merchant bank will cat as an issuing house. The shares bought over by the issuing house will be re issued to the general public. Under this method the company which is issuing the shares can make use of the financial strength and the image of the issuing house to make.

Prospectus Issue
This is where the company will directly issue the shares to the general public by preparing a document called a prospectus which will be used to invite general public to participate in the share issue. Therefore the prospectus will carry information about the company, its past, its present and the future expectations. This will be an expensive method of issuing shares. This is because the company which is issuing the shares should bear the cost of preparing the prospectus, advertise, the share issue, pay underwriting cost. If the share issue is to be underwritten and incur any legal fees necessary to make the share issue possible such as changing the articles and memorandum of association. In a prospectus issue the company can make use of an issuing house for the administration of the share issue.

Placing
This is where the company which is carrying out the share issue will select large institutional investors and offer the shares by conducting “road shows”. A road show is where the company will conduct a presentation to educate the selected investors about the share issue. This will be a low cost method of issuing the shares. Some of the institutional investors who will be interested in the share issue will include pension funds, unit trusts, venture capital organizations, building societies.

Offer for Sale by Tender
This is where the company which is issuing the shares will call upon the investors to bid the price at which they are willing to buy the shares. Therefore each individual investor will indicate the quantity of shares they expect to buy and price they are willing to pay. The company should decide upon a price at which all the shares can be issued and collect the highest possible revenue. This price will be called the strike price.

Stock Exchange Introduction
This is where a company which already has shares in issue, wants to obtain a listing (quotation) in a recognized stock exchange. In a stock exchange introduction the company will not issue new shares but will obtain a facility to have the existing shares traded in the stock exchange. This can be used by the existing shareholders as an ‘exit rate’ where the shareholders can convert their paper wealth (share certificate) in to cash.

Some Definitions

Nominal Value (Par Value / Face Value)
This is the value at which the shares will be recorded in the share capital account. The company will pay dividends based on the nominal value of the shares


Market Value
This is the value at which the shares will be treated in a recognize stock exchange

Bonus Issue (Free Issue / Scrip Issue / Capitalization Issue)
This is where the company will issue shares free of charge to existing shareholders based on their current shareholding. Companies will carry out a bonus issue when they have large amounts of undistributed profits or if the company does not want cash out flow by having a cash dividend payment instead of a cash dividend the company can carry out a bonus issue.

Rights Issue
This is where the company will issue shares to the existing shareholders for a fee. The rights issue will also be carried out based on the current shareholding. The rights received from the company will be negotiable instrument because the rights can be separated from the shares and traded. If the rights are to be converted in to shares then the specified amounts should be paid to the company.

Stock Split
This is where the company will cancel the existing shares and convert the shares in to shares with a lower nominal value. A stock split will be carried out if the company has identified that it’s shares are too expensive or the company wants to make the shares available at which time a stock split would be carried out.

Share Consolidation
This will be the opposite of stock split therefore in a share consolidation. The company will add up shares will a lower nominal value and issue shares with a higher nominal value.

Disadvantages of Issuing Preference Shares

The company will have to pay dividend if the company has made a profit

If the shares were issued as redeemable preference shares then the share capital should be repaid after a specific time period at which time there will be cash out flow.

The preference shareholders should be paid a return more than other forms of debit capitals so that they are compensated for taking a higher risk

Advantages of Issuing Preference Shares

• There will not be a loss of control within the company because the preference shareholders do not have the voting right

• It can be raised for a specific time period at the end of which it can be repaid. Thereafter the company need not pay the preference dividend

• The risk of financing will be less when compared to updating a loan because the preference dividend will be paid only if distributable profits are available.

• The company can collect financing through issue of preference shares because the company can pay an attractive dividend to attract funds in to the company

Types of Preference Shares

Cumulative Preference Shares
This is where preference shares will be issued within the condition that the unpaid cumulative preference dividend will be carried forward until it is paid.

Non Cumulative Preference Shares
This is where unpaid preference dividend will not be carried forward in the future therefore if the company did not pay a dividend during a particular year then that dividend will be lost to the shareholders forever.

Redeemable Preference Shares
This is where the company will issue preference shares with the condition that the share capital collected will be repaid after a specific time period.


Irredeemable Preference Shares
The company does not expect to repay the irredeemable preference share capital collected. Therefore the company will be paying specified dividend through out the time period over which it is in issue.

Participating Preference Shares
This is where preference shares will be issued with a condition stating that the preference shareholder will be paid the specified dividend plus an additional dividend if the ordinary shareholders are paid a dividend more than a specified amount.

Convertible Preference Shares
This is where the company will issue preference shares with the condition of it being converted in to ordinary shares after a specified time period. Therefore the company does not have to repay the share capital collected.

Preference Shares

This is a type of shares issued where the shareholders will have a preference over the ordinary shareholders in respect of the following

The preference dividend should be paid before the ordinary dividend if the distributable profits are available

At the time of the liquidation the preference share capital should be paid back before the ordinary share capital

Rights of Ordinary Shareholders

The right to vote
All ordinary shares issued except for non voting ordinary shares will have the right to vote

The right to receive a dividend if the directors have proposed a dividend

A right to receive a copy of the annual report

The right to transfer the ownership of shares

The right to receive a portion of the remaining assets at the time of liquidation

The right to demand the directors to issue shares to the existing shareholders before issuing any shares to outsiders. This will be called the pre-emption right

Disadvantages of Issuing Ordinary Shares

• There will be a higher cost because the company which is issuing the shares will have to prepare a document call a ‘prospectus’ inviting general public to purchase shares of the company. The company will have to advertise which will lead to a cost to the company. The company may enter into an underwriting agreement where the company which provides the underwriting agreement will agree to purchase any shares not taken up (subscribed) by the investors.

Generally the underwriters would charge 2.25% of the value of the shares issued by the company. This amount should be paid irrespective of whether the shares are subscribed by the investors or not. In addition the company may have to obtain legal advice for which there can be a cost.

• Loss of Control due to issue of shares the company may find its original shareholders loosing the control within the company.

• It will be time consuming to issue shares because the company will have to prepare the necessary documents, advertise and carry out the share issue if it is to be successful.

• Due to the ordinary shareholders taking a higher risk they should be compensated with a higher return which will lead a higher cost to the company. This will lead to high cost of capital.

Advantages of Issuing Ordinary Shares to a Company

The ordinary dividend will be paid only if distributable profits are available and if the directors decide to pay a dividend therefore there will not be a fixed commitment to pay a dividend to the ordinary shareholders.

The amount of ordinary share capital collected will not be repaid until liquidation of the company. Even at liquidation it will be repaid only if assets remain after settlement of other liabilities.

No security will be needed when issuing ordinary shares when compared to loans where assets should be kept as security

The company has the ability to attract large amounts of money as capital

The ordinary shares can be issued because there is a ready market for it.

Types of Ordinary Shares

Voting Ordinary Shares
These ordinary shareholders will have the right to vote. Therefore the voting ordinary shareholders will control the company. The major decisions such as appointment of the board of directors will be carried out by the ordinary shareholders to have the power.

Non Voting Ordinary Shares
Companies may issue non voting ordinary shares so that the control within the company will not be loss and these shareholders will take the same level of risk but they will not have the right to vote.

Differed Ordinary Shares
This is the special type of ordinary share issue by the company where the company will have a condition under which the differed ordinary shares will be paid a dividend only if the other ordinary shareholders are paid a dividend more than a specified amount.
Eg: A company to issue differed ordinary shares where the shareholders will be paid the dividend only if the ordinary shareholders are paid a dividend more than a specified dividend such as 50 p per share.

Ordinary Share Capital

Ordinary shares are the most common type of shares that are issued by a company. The ordinary share holders will be owners of the company. Ordinary shareholders will take the highest risk by investing in shares of a company. This is because of the following two reasons

• The return to the ordinary shareholders which is the ordinary share dividend will be paid only if distributable profits are available after providing all the other providers of finance and if the directors proposed to pay a dividend.

• At the time of liquidation the ordinary share capital will be repaid only often providing a return of the investments made by other providers of financing

Since the ordinary shareholders take the highest risk by investing, they will also require the highest return to compensate the highest risk taken by the ordinary shareholders.