Have different costs, specific to each company and how risky it is perceived to be, although based on economic factors
Loan capital
Comprises all longer term borrowings for the purpose of the business. E.g.:
Permanent bank overdraft
Unsecured loans from a bank or third party
Loans secured on assets either from a bank or third party
Debentures
Long-term loans issued by a company to raise significant amounts of capital
Types of debentures
Single debentures
Multiple debentures
Debentures issued as a series
Secured debentures
Debentures with security over a specific asset
Unsecured debentures
Debentures with no security, also called "bare" or "naked" debentures
Redeemable debentures
Debentures that can be repaid
Irredeemable debentures
Debentures that cannot be repaid, also called "perpetual debentures"
Advantages of debentures (for the borrower)
Debentures carry no voting rights, so do not dilute or affect the control of the company
Interest should be tax deductible for the borrower, thus reducing the effective cost of servicing the debt
Disadvantages of debentures (for the borrower)
Interest must be paid out of pre-tax profits, irrespective of the profits of the company
Default may lead to liquidation and/or administration
High gearing may lead to adversely affect the company's share price
Advantages of debentures (for the lender)
Debentures will rank higher in the event of liquidation – therefore a lower risk option than shares
Debentures holders have a contractual right to interest every year
Lender has the option to agree security for the debt, which may reduce their risk even further
Disadvantages of debentures (for the lender)
Return is limited to interest payments – lender is only entitled to receive the nominal value of the debenture at redemption
Debentures carry no voting rights, so lenders are unable to directly influence the actions of directors
Remedies for unsecured creditors in the event of default
Right to sue the company for debt
Right to petition the court for the compulsory liquidation of the company (if sum owed is >£750)
Right to petition the court for an administration order
Remedies for secured creditors in the event of default
Take possession of the asset charged and sell it
Seek a foreclosure order from the court whereby ownership of the property will be transferred to him
Appoint a receiver over the assets
Seek an administration order (without court order)
Fixed charge
Security over a specific asset, which prevents the company from selling the asset without the consent of the creditor (charge holder)
Company has no general freedom to sell the asset
Advantages of fixed charges
The charge provides immediate and greater security for a loan
The asset cannot be disposed of without the lender's consent
The charge ranks higher priority than floating charges – i.e. it is the lowest risk/highest security
Interest rate likely to be lower for the borrowing company due to lower risk for the lender
Company may find it easier to borrow under a fixed charge due to feeling of greater security
Disadvantages of fixed charges
Less freedom to deal with assets for the borrowing company
Lender at risk if the asset deflates in value or is destroyed
Floating charge
Security over a class of assets (e.g. inventory, receivables) where the company has freedom to buy/sell the charged assets in the ordinary course of its business
the charged assets will therefore be subject to change from time to time
Crystallisation
The process by which a floating charge will attach to a specific asset, meaning the company can no longer deal freely with the assets. Turns floating charge into fixed charge
Triggers for crystallisation
Liquidation
The company ceases to trade
Any specified event (e.g. devaluation)
Advantages of floating charges
The borrowing company has freedom to buy and sell the charged assets – so are not tied down
The borrowing company has greater flexibility over the class of assets that can be charged
Assets generally more "liquid" than fixed charge assets
Disadvantages of floating charges
The value of the security is unknown until is crystalises, the borrowing company cannot be made up any loss of value
Rank lower in order of repayment than fixed charges on liquidation
Due to higher risk, interest charged is usually higher than fixed charges
Order of distribution on liquidation
Liquidators' costs
Fixed charge holders
Ordinary (employees) and Secondary (HMRC. For VAT, PAYE, Employer NICs) preferential creditors
Floating charge holders
Unsecured creditors
Shareholders
Factors determining priority of charges
Equal charges rank in order of creation
Fixed charges rank above floating charges
Negative pledge clauses can prohibit future fixed charges from taking priority
Unregistered registrable charge has no priority over a registered charge
Registration of charges
All charges must be registered under s741 CA06
Within 21 days of creation
Duty of the company to register the charge with the registrar of companies, but lender usually undertakes the register
Failure to register the charge will result in the charge being void on liquidation and the company/directors being fined
Veil of incorporation
A company is a separate legal entity from its shareholders
Single legal entity - Sole trader, partnerships
Separate legal entity - Companies
Articles of Association
Bind the company and its shareholders, and the shareholders to each other
Share capital
The interest of a shareholder in the company measured by a sum of money, for the purpose of liability and interest
Types of shares
Ordinary shares
Preference shares
Ordinary shares
Have full voting rights, not fixed dividend rights, and are entitled to surplus assets after repayment of preference shares
Preference shares
Usually have no voting rights, have fixed dividend rights paid in priority to other dividends, and are entitled to repayment of initial capital but cannot participate in surplus
Ordinary shares (investor perspective)
Riskier as they are last to be paid out on a winding up
Can appreciate in value if the company is successful.
Preference shares (investor perspective)
Provide a guaranteed income, and are less risky as they are repaid before ordinary shares
Downside is the shareholder will not benefit from capital appreciation and cannot vote on company business
Ordinary shares (company perspective)
Carry voting rights, so majority might give away control
Advantages of preference shares (company perspective)
Do not dilute control, but dividends must be paid and reduce discretion over use of profits
Varying class rights
1. Is the procedure contained in the articles?
2. Yes - Must follow the procedure set out in the articles
3. No - Variation requires a special resolution or written consent (i.e. 75% majority) of shareholders in that class
Cumbrian Newspapers Group Ltd v Cumberland & Westmorland Herald (1986)
Claimant acquired a 10.67% stake in the Defendant company, with special rights attaching to those shares, including pre-emption rights and the right to appoint a director to the board. Defendant company passed a special resolution to remove these rights, but the courts held this was unlawful as they had effectively created a new class of share, with one shareholder, and alteration requires the shareholder's consent, which they refused.