Capital Accumulation for Beautiful You Ltd - Essay Example

?Memo Suzanne Cooper, Cooper & Company Solicitors RE: Capital Accumulation for Beautiful You Ltd Introduction The ever changing business environments often force entrepreneurs to apply emergent strategies that have the potential to determine the overall sustainability of their firms. Very often managements need to take decisions on the basis of future forecasts rather than making reference to past experiences or current developments. However, with regard to share issuance or borrowing, management will have to comply with certain aspects of the company law. This report will point out the documents need to be prepared and the various mandatory procedures Alethra Brotherton and her partner and Beautiful You Ltd. need to comply with, in order to issue the shares to Expansion Capital plc or, alternatively, borrow the money from the bank and create the security required.  I. Legal Procedures and Documentation Required According to Bos (1969), every business transaction is a legal activity as each business concern is a separate legal entity. In the given case, there are two options available for the Beautiful You Ltd to finance its planned expansion. One is to acquire ?150,000 from Expansion Capital plc in return of one third of the shares of the company. The second option allows the company to receive ?100,000 from the company’s bank on the strength of a fixed charge over the new shop premises. In order to proceed with both these options, the Beautiful You Ltd has to prepare certain documentations and comply with other legal procedures. If the company decides to finance its proposed business expansion plan by acquiring funds from Expansion Capital plc, it needs to issue one third of its shares to Expansion Capital plc. Since the Beautiful You Ltd is a private company, it is not required to state the authorized share capital. However, if the Beautiful You Ltd has registered before 01.10.2009, it would have an authorized share capital provision in its memorandum of association if it has not been removed. In such a situation, the Beautiful You Ltd can issue shares only up to its authorized capital amount which is stated under the capital clause of the memorandum of association. If the company has no sufficient authorized capital available, it must amend the articles before the share issue. A copy of the passed resolution, a form of G123, and the altered memorandum must be registered at Companies House. However, these procedures do not affect the Beautiful You Ltd if it had been formed after 01.10.2009. Although the share allotment is a matter of management, the directors are subjected to some statutory obligations in order to prevent abuses of powers. The directors have the authority to allot shares if the company has only one class of shares; this provision is also subjected to specific restrictions in the company’s articles (sec550, CA 2006). In contrast, a special resolution (sec51, CA 2006) or a provision in the company’s articles must authorize the directors to allot shares if the company has more than one class of shares. While taking a decision regarding share issuance to the Expansion Capital plc, the beautiful You Ltd must consider the pre-emptive rights for existing members, which have been defined as statutory pre-emptive rights in sec561, CA 2006. However, the Beautiful You Ltd can exclude these rights by either a provision in the company’s articles or by passing a special resolution (sec569-sec571). When the Beautiful You Ltd takes such a capital accumulation decision, some of its existing shareholders may waive their rights to them. Under such circumstances, the company has the legal obligation to offer shares to them. After ensuring that all the above matters has been attended, the directors of the Beautiful You Ltd may resolve to allot shares by clearly stating number and class of shares, the price paid, the allottees, whether for cash or other assets. The directors must issue share certificate to the Expansion Capital Ltd once the share allotment process is completed. The share certificate must be under seal once it is required by the articles. The document of ‘completing return of allotments’ is also needed, which is a form of SH01 and it should be sent to Companies House. The company law demands that the allotment has to be clearly represented in the register of members (statutory register) and in register of allotments (voluntary register). Likewise, if the company wishes to raise capital as bank loan, it has to give a fixed charge over the new shop premises. In the case ‘General Auction’, Estate and Monetary Co V Smith [1891] 3 Ch 432, it was held that the companies have an implied power to borrow money in return of their assets as security. In addition, the section 738 of CA 2006 states that “the ‘debenture’ includes the debenture stock, bonds and any other securities of a company, whether or not constituting a charge over the assets of the company” (Judgments of the Supreme Court of Canada).Therefore the Beautiful You Ltd has the legal authority to borrow money from the company’s bank in return for a fixed charge over the new shop premises and a floating charge over the rest of the business assets. However, some sections involved forces the company to create company charges since the charges reflect a form of security for the lender. The section 860 (1) says that any charge created must be registered within 21 days. The prescribed particulars and related instruments must be sent to the registrar before the allowed registration period gets expired. As per the concept of Zinbarg (1975), Beautiful You Ltd and the company bank must jointly form a loan agreement that would regulate the terms of the loan. The bank requires the company’s several financial statements such as balance sheets, profit and loss statements, cash flow statements, accounts receivables and payables aging, and personal financial statements (Document to gather before applying for a business loan). In addition, the Beautiful You Ltd has to submit its business plan that includes all important facts about proposed business expansion. The next document required is a loan request that clearly states the amount of money requested, the type of loan, and how the loan amount would be used (ibid). II. Mode of Loan Repayment The case study indicates that both Expansion Capital plc and the company bank demanded different type of financial returns, and hence the Beautiful You Ltd must also be careful about providing the financial returns according to the prescribed mode. In the case of Expansion Capital plc, the company has offered to pay ?150,000 to the Beautiful You Ltd in return of one third of the shares in the Beautiful You Ltd. Assume that if the Beautiful You Ltd possesses a total of 900,000 shares, the Expansion Capital plc would get the ownership of 300, 000 shares in the Beautiful You Ltd. Under such a situation, the Expansion Capital plc becomes the owner of 33.3% business in the Beautiful You Ltd and obtains all the rights of a company shareholder defined under Companies (shareholders rights) Regulations 2009. Hence, based on the opinion of Foerster and Sapp (2006), the Beautiful You Ltd must provide financial returns to Expansion Capital plc in the form of dividends. The company law provides a specific framework for the declaration and distribution of dividends. Section 93 of the Companies Act states that a company may pay dividend on the paid up value of shares if there is a provision in its articles. Provisions of articles of Association give certain directions from Rule 84 to 94 regarding dividend payment. It is stated that the dividend payout ratio never exceed the amount recommended by the board of directors. According to Baker and Wurgler (2004), some companies tend to provide dividends at the end of the fiscal year whereas some other companies distribute interim dividends to its shareholders. The Beautiful You Ltd has the legal obligation to give notice of dividends to its shareholders. Directors have the legal right to transfer a reasonable amount to general reserve in order to meet contingencies. When the Beautiful You Ltd declares a dividend, the company becomes legally obliged to its shareholders including Expansion Capital plc from the date of its declaration. A company can declare dividends only out of its profits. In any situation, a company cannot pay dividends out of its capital [sec. 205 (i)]. The company law also insists that the dividend must be paid only in cash [sec. 205 (ii)] except in certain circumstances which are clearly defined in the articles. The Beautiful You Ltd must pay the dividend to those who are entitled to receive it within 42 days of its declaration. In the case of the company’s bank, it has agreed to lend the Beautiful You Ltd ?100,000 to finance its new venture on the condition that the bank must get a fixed charge over the new shop premises and a floating charge over the rest of the business assets. According to this contract, the company is obliged to pay a fixed charge over its new shop premises regardless the change in quantity and value of assets. As a result, the growth rate of the new business has no impact on this provision. The payment of this fixed charge can be made in the form of cash or checks and the contract terms determine the period of payment. On the other hand, Sealy (1986) states that the floating charge refers to a security that owes an underlying asset or group of assets which is clearly subject to change in value and quantity. Hence, the value and quantity changes in the rest of the business assets determine the floating charge payable to the bank. While determining the floating charge payable to the bank, the Beautiful You Ltd must present its asset flow statements before the Expansion Capital plc in order to prove the arithmetical reliability of the floating charge. III. A Critical Comparison of Two Options In order to choose the most competitive option or finance provider, it is necessary to examine the different aspects of both the proposed contract terms. Both the capital offers are discussed below in detail. Expansion Capital plc The Expansion Capital plc is ready to finance both the expansion plans of the Beautiful You Ltd in return of its one third of shares. The Expansion Capital plc is willing to allow ?150,000 for the expansional activities of the Beautiful You Ltd. The advantages and disadvantages of the Expansion Capital’s offer are examined below Advantages The Expansion Capital plc has completely approved the business expansion plan of the Beautiful You Ltd and agreed to pay ?150,000 in order to finance both the planned ventures. The Expansion Capital plc has agreed to pay money in return of one third of shares in Beautiful You Ltd and this condition compels the Beautiful You Ltd to distribute dividends on the allowed shares. This contract seems to be beneficial for the Beautiful You Ltd as it assists the company to pay in accordance with its profit volumes. In other words, the Beautiful You Ltd needs not to pay a fixed charge. This financial assistance offered by the Expansion Capital plc is of long term nature and hence the Beautiful You Ltd would get sufficient time to buy out its all shares. By adopting this option, the Beautiful You Ltd can get rid of the legal formalities associated with a bank loan. Disadvantages Giving one third of the shares to Expansion Capital Ltd may seriously impinge on the operational efficiency of the company. Since the Beautiful You Ltd possesses a well market stature, the earnings per share of the company would be very high. Therefore, the Beautiful You Ltd would be forced to pay a huge amount to the Expansion Capital plc until the company buys out all its shares from the Expansion Capital plc. If the Beautiful You Ltd cannot timely repay the borrowed money, the Expansion Capital plc would use its voting rights over the collateral shares. In the view of Gitlow (2005, pp.19-21), the transferring of such a large portion of shares to another institution would adversely affect the share value of the Expansion Capital plc. In order to proceed with this option, the company has to comply with a series of legal formalities which have been described above. The Company’s Bank The Company’s bank is ready to finance the new shop of the Beautiful You Ltd by investing ?100,000. This offer also contains certain advantages and disadvantages. Advantages The bank loan is also of long term nature; hence the company gets sufficient time to raise funds for the repayment of the loan. The bank charges floating charge over the company assets except the new shop premises; therefore, the Beautiful You Ltd is not required to pay much in times of contingencies. The maturity period of the bank loan can be easily extended as compared to other financial institutions Disadvantages The bank charges a fixed charge over the new shop premises and hence the company will have to pay a fixed amount irrespective of its revenues. The calculation of floating charge would be a complex process since the changes in asset values cannot be easily measured. Since the bank is not willing to finance both the expansional projects of the Beautiful You Ltd, the company needs to restructure its formulated future business policies. From the case study, it is obvious that Alethra and Jo are reluctant to give a large portion of company shares to other institutions. In addition, they also believe that increase in market share is more important than short-term profitability. In the opinion of Banescu (2008), every management must focus on long term profitability of the business. The company owner has already trimmed down their salaries for the next three years while still working full time in the company. Therefore, I strongly recommend that the Beautiful You Ltd must seek financial assistance from the company’s bank. The case study indicates that the Expansion Capital plc allows only ?150,000 for both the proposed ventures while the bank provides ?100,000 for financing the new shop project only. Even though, the interests and capital payments on the bank loan would exceed the increased profits from the expanded activities, this option adds to the long-term sustainability of the Beautiful You Ltd. If the company pawns its one third of the shares to the Expansion Capital plc and fails to properly buy out the shares within the stipulated period of five years, the Expansion Capital plc may apply its legal authority over the company. In contrast, the company can take advantages of its whole share earnings if it receives the bank loan option. Moreover, the share issuance to Expansion Capital plc involves some complex legal procedures which can be easily avoided if the company chooses bank loan as its best option. Conclusion Evidently, in order to proceed with any of the available options, it is necessary for the firm to undergo ranges of legal formalities. In the case of bank loan, loan agreement is the main document required; whereas a collateral agreement acts as a crucial document if the Beautiful You Ltd has to receive financial assistance from the Expansion Capital plc. The financial returns would be given to the Expansion Capital plc in the form of dividends while to bank, it would be paid as fixed and floating charges. In total, it is advisable for the Beautiful You Ltd to approach the company’s bank for meeting its capital needs for the expansion. References Baker, M & Wurgler, JA June 2004, “Catering theory of dividends”, The Journal of Finance, Vol.59, No.3, pp. 1125-1165. Banescu, C 2008, Managing for long term success and profitability, ChrisBanescu.com, viewed 10 June 2011http://chrisbanescu.com/blog/2008/08/managing-for-long-term-success-and-profitability/ Bos, AH 1969, “Development principles of organizations”, Management International Review, Vol. 9, No.1, pp.17-30. Companies Act 2006, legislation.gov.uk, The National Archives, viewed 10 June 2011 Document to gather before applying for a business loan, viewed 10 June 2011 http://smallbusiness.dnb.com/business-finance/business-loans/3542-1.html Foerster, SR & Sapp, SG 2006, “The changing role of dividends: A firm level study from the nineteenth to the twenty-first century”, The Canadian Journal of Economics, Vol.39, No.4, pp.1316-1344. Gitlow, AL 2005, Corruption in corporate America: Who is responsible? Who will protect the public interest? University Press of America, USA. Judgments of the Supreme Court of Canada, viewed 10 June 2011 Sealy, LS March 1986, “Company law. Floating charge. Priorities”, The Cambridge Law Journal, Vol.45, No.1, pp.25-27. Zinbarg, ED 1975, “The private placement loan agreement”, Financial Analysts Journal, Vol.31, No.4, pp.33-35+52 Read More