Corporate Finance for Lawyers - Case Study Example

Corporate Finance for Lawyers 1. A: Capital in the context of the word may mean wealth, a factor or means of production, the value of those means of production, the net worth of a business enterprise, and the present value of a future sequence of receipts, money, the money value of assets and possibly other things as well. Capital is this thought of in physical terms, in value terms and in money terms (Farrar, Fury and Hannigan, 1991). It has also been stated that capital has a single technical meaning which prima facie should be attributed to the word in any statutory provision (Incorporated Interest Pty Ltd v Federal Commission of Taxation, 1943). There are those theories that would suggest that capital the actual money or assets that are subscribed by the shareholders in payments for their shares, or it is the actual assets into which those contributions are then converted (Res theory). Finally capital could also be understood in terms of a sum of money which represents the abstract value of a corporation’s assets- this is opined by the quantum theory of capital. The case in point at present would in essence mean a small company, a startup that is looking for investments and would therefore be dealt with accordingly. The amo9unt of capital needed would for example be small, and could be borrowed from a financial institution or as is the case in this instance from members of the family interested in backing the proprietor and the business. The law relating to corporate finance is concerned principally with two sources of corporate finance: 1. Share Capital and 2. Debt capital The main consequence of raising finance by issuing shares is that the suppliers if the finance-the shareholders-become members of the corporation. For this reason equity funding is not used for long term financing. The kind of rights that the shareholders would have would be decided and incorporated in the company’s constitution (English, 2006). Share capital would also be known as equity capital and is essentially permanent given the fact it is the money invested in the business by its owners. The idea here would be that is starting the business primarily from the investments that she has been able to get from her network of friends and relatives. She has also agreed to part with 20,000 of her shares to Bob and Ami in return for the $20, 000 that are willing to invest in her business. This would translate to the business being run mostly on external equity capital. The problem here might be that since they would have a stake in the business Sarah would have to put with their meddling in the running of the business affairs if they chose to do so. It is clear that the shareholders would have to bear the risk that they would lose their investment, especially in this case where the company is one that is based on the foundation of a patented invention .any invention would need research and testing and in case this one falls through the investments would turn to dust as well. It has therefore been suggested that it is justified that the shareholders take a part in the process of management. On the other hand if Sarah was to decide the mode of investments that have been made by the people who have given $1, 00,000 would be termed as creditors and not as shareholders, show would be able to rule out the possibility of continuous engagement in her business by the network. The risk however would be on Sarah’s shall thus in this case because the creditors would exercise control in terms of interest payments. The amount, rate and time of interest payments would have to be determined by the contract. The idea in this case would therefore be that it is most advisable that Sarah keeps Ben and Ami as her partners, and make them shareholders given the fact that they are professionals who would be able to help her in running her business in the long term as well. Since she has already decided to part with 20,000 shares in this respect it is evident that the share capital is one way in which she would raise money. The creditors on the other hand are a different game. Here the primary merits are that they would have to role to play in the day-to-day functioning of the company thereby giving Sarah managerial independence (Tomasic, Bottomley and McQueen, 2002). The rates of interest on their investments would therefore need to be decided and kept at the bare minimum. Legally, Sarah would have the choice about which source or sources of finance she would like to use and the level of reliance on pone source or another. There are no legal requirements concerning the balance between share and debt capital. The decision would ultimately be based on [priorities-whether Sarah in her capacity as owner wishes to have control over the organization or whether or not she is fine with a dilution of this control by addition of new shareholders to the corporation register. 1. B: The need for PP Inc. at present is investors who would be willing to put their money (an amount of $5, 00, 000) in a business that is still relatively new and driven by an invention based technology that might just fall flkat on its face. An arm’s length transaction would mean that in ordere to attract this investment, PP Inc. and more specifically Sarah would need investors to believe in her scheme. The attracti ng force of the deal would have to be underlined by the fact that some would be willing to invest in a business and risk the loss of that investment only when that risk is belied by the opportunity of a gain. This would for example mean that PP Inc. would have to assure investors of a generaour percentage oif the business profits like a cap on the salary of the present executives. The terms of such a contract are negotiable (Steingold, 2009). The targets in this context have to be kept realistic (Copland and Dolgoff, 2005). Expoectations that an investor wiuld have is in essence a clientele effect-where the changes in financial policy would have little to no bearing on the impacts of the expectation drivers as far as the company is concerned. 1. C: Sections 461-462 decide on the matter regulating the issue of a player becoming a shareholder or increasing their shares in a given company. In the context of increasing the stake that CO owns in PP, the relevant articles in the Act state that (Australia, CCH Corporate Law Editors, 2002): 1. First if the company were to issue added shares to the investor in lieu of further investment. This is most likely the case when the company is in need of added capital or increasing range of the company in terms of expansion plans. The player (CO) was to buy shares in the company from an existing shareholder and the company registers the transfer In 1999, major changes were made to the takeover provisions of the Corporations Law with a new chapter 6 being inserted by the Corporate Law Economic Reform Program Act,1999 (CLERP Act, 1999). More recently, the Australian Securities and Investment Commission Act, 2001, which replaced the ASIC Act, 1989 and the Corporations Act, 2001, although not having a significant impact on the takeover provisions, have restored the regulatory environment which existed before the recent High Court decisions in Re Wakim: Ex p McNally and R v Hughes. In most cases what CO is proposing to do in the longer run would ultimatelyu translate into a btakeover bid,m which is the threatening part pof the issue of them acquiring greatrer stake in the company. Given the fact that they are a larger corporate and hence have the It was noted that equal opportunity principle is 'an integral element of the takeover provisions of the Corporations Law. Even if there is no breach of the takeover provisions, depriving shareholders of an equal opportunity to participate in benefits accruing from a bid may constitute "unacceptable circumstances", leading to a referral to the Panel'. It goes on to assert that 'Without the investor protection provided by the equal opportunity principle, it may be less likely that smaller investors would invest directly in the market, which could affect market liquidity and confidence. If one was to view the principle mostly on its face value, one would find that it acts to decrease rather than augment te confidence a small investor like Sarah given the fact that the principle in essence attempts to decrease the right of entry to the market for corporate control (Brown and Rosa, 1998). However, there is an efficiency implication of the equal opportunity principle. It states that 'the equal opportunity principle potentially creates higher costs for market participants, reducing incentives to engage in takeover activity. Without the principle, takeover costs could be lower, thereby increasing incentives to bid for a target company and leading to greater efficiency through the prospect of increased takeover activity". But it is then argued that the increase in shareholder protection afforded by the principle gives rise to greater investor confidence, the benefits of which outweigh the costs Chapter 6 sets out in s 602 which requires the acquisition of shares in companies “takes place in an efficient, competitive and informed market”. In this regard, some assistance may also be gained from some of the Policy documents such as ASIC Policy Statement 57, entitled “takeovers”. In seeking to achieve this goal the commission is enjoined by s602(b( to ensure that the holders of the shares or interests and the directors of the conoaby or body or the responsible entity for the scheme: 1. know the identity of any person who proposes to acquire a substantial interest in the company body or scheme 2. have a reasonable time to consider the proposal 3. that sufficient time is given to the directors and the shareholders of the company. Also adequate information needs to be given to them to enable them to assess the merits of the proposal 4. as far as is practicable, the holders of the relevant class of voting shares or interests have a reasonable and equal opportunity to participate in any benefits accruing to the holders through any proposal under which a person would acquire a substantial interest in the company body or scheme; and 5. That an appropriate procedure is followed as a preliminary to compulsory acquisition of voting shares or interests or any other kind of securities under Pt6A.1. The issue here is with respect to the principles exempting interested players from compliance with the provisions of chapter 6 and to its powers of modification. This would therefore essentially mean that there are wide discretionary factors that would distinguish takeover intentions from the normal proceedings set out in the Corporations Act, 2001. Substantial interest is a phase that is not defined-although the courts have come to regard the meaning of the term substantial holding, which in Section 5 is assumed to have the lower limit of at least a 5% voting shares in a company. Finally, substantial holdings was defined by Intercapital Holdings Ltd v NCSC in terms of the acquisition of a 13.5% shares of company. The idea for PP in such a scenario would mean that they would have to keep the shares that CO have access to, to a minimum. Share buy back would be an option and keep a closer regulatory watch on the acquisition moves by CO. 1.D: There are two essential manners of combining GE and PP Inc- a levearaged buy out and a merger. Given the fact that a leveraged buy out would mean that the owners of PP Inc would lose their company completely, the best manner of combining the two entities would be a merger. Merger laws in Australia over the past decade and half have been reflective of the government policy to encourage and enable Australian companies to compete on the global market (Navalli, 1996). This was done in 1992 following the recommendations of the Senate Standing Committee on Legal and Constitutional Affairs, which attempted to amend Section 50, TPA and the market dominance test was replaced by the substantially lessening competition test. The amended TPA applies to all merger provisions, wherein a corporation may not ‘directly or indirectly acquire shares or assets if the acquisition would have the effect of substantially lessening competition in a given market”. The acquisition if shares or assets may be by way of purchase, exchange, taking on lease on hire or even hire purchase. The basic definition of assets includes both land and property. In the case of PP Inc. and GE Enterprises this would therefore mean that the best manner of merging the two companies would be to for the PP directors to sell some of their stake to GE and maintain management rights over the future of the business. This could be achieved by discounted cash flows or comparable trading. Both these methods entail no takeover operations, thus forming no form of acquisition premium (Hunt, 2004). In terms of advantages and disadvantages, the best advantage a merger would offer PP is that the company would gain access to more capital and assume room for expansion within the market. It would allow the shareholders of PP to own a smaller piece of a larger pie, increasing their overall net worth. The biggest disadvantage would be that the directors would lose autonomy as far company management affairs are concerned. It would also lead to a higher cost unit given the fact that a merger would invariably mean that the diseconomies of scale if business becomes too large. 1. E: If the company is not in default of any of the regulations of the loan agreement the deal can go forward provided, that the other shareholders are in agreement with the merger clauses of the deal as such. This clause is meant to preclude disputes over whether the agreement is the final expression of the parties’ agreement governed by the law. 1.F: Publicly held companies are traded on the various public stock exchanges like the New York Stock Exchange, the American Stock Exchange and the NASDAQ. The shareholders are typically members of the people who never come in direct contacts with each other (Paulson, 2003). The idea in the management of the public listed company is for shareholders to trust the board of directors to manage their investments for them. Privately held or close companies are more common. Their shares are held by a few people, often family members who also sit on the board and participate as officers of the corporation. The shares are also not on offer to the general public. It is held by a small corporation and viewed more often than not as an extension of an individual or a small group of private investors. 1.G: Sections 117, 120 and 601AA-601AD state that a company would have different classes of shares. There are different types of restrictions that are attached to the shares in a class that distinguish it with the other shares in other classes. SSO or shares subject to options mean the number of shares of the class sold over the which he or she has given or written exchange traded that, at the time of the sale, have not expired or been exercised. Every option would have a fixed value at which the exercise would take place. Whenever an option is exercised, the purchase price of 100 shares of stock takes place at that fixed price, which is also known as the striking price of the option. Having an option on Sarah’s part would mean that this would honor the agreement on ensuring that Sarah retains part of ownership in an invention that is hers and the company that she has started, thereby ensuring that she remains part of the management of the company when it goes into expansion mode. Moreover, option shares would mean that there is a claim on the assets of the firm that is senior to the claim of the common shareholders (Clyde, Weil and Schipper, 2009). 1.h: From the private equity holder point of view, the importance of the dhare options lies in the intrinsic value equation of the deal. The intrinsic value method and fair value method require the same measurement date for shares and similar instruments whose fair value does not differ from their intrinsic value. The idea is that in case a forfeiture does not occur, the company’s decision to use the intrinsic value method would then mean that the share options are recognized at intrinsic value at the time of reporting date through the date of settlement and the periodic adjustment in intrinsic value prorated over the service period. This in turn would mean that this would be included in terms of compensation cost for that period. Consequently, the compensation cost recognized each year of the requisite service period would vary based on changes in the share option’s intrinsic method. Question 2: In keeping with the decision in BCE v 1976 it was stated that the director was duty bound to ensure that the wellbeing of the company was upheld. In this context then the duty of the director was that it is their duty to “comprehends a duty to treat individual stakeholders affected by corporate actions equitably and fairly”. This would then remove the possibilities of unconditional rules given the fact that the best interests of the company cannot be unqualified and objectively determined. The court came up with the notion of director duty and the oppression remedy, and upheld that idea the “stakeholder” model of directors’ duties. The idea that the court authorized in the case, and was later relied on by many bondholders was that “the best interests of the corporation” required that the directors to of the company were able to regard the welfare of all stakeholders and not to associate the wellbeing of the company with the wellbeing of shareholders only; there are . e equated to the interests of the company. The judgment on the other upheld the fact that the company is separate legal entity and therefore its interests would even exist separate from the interests of the shareholders. Nevertheless, while largely accepting the bondholders’ view of the directors’ duties, the Court ruled against the bondholders because they did not have a reasonable expectation to anything more than the contractual rights enshrined in the trust indenture under which their bonds were issued. The decision would therefore stand in absolute rejection of the idea that directors of a intended company are entrusted with the responsibility of ensuring that there is a maximization of shareholder value. Nevertheless, given the fact that the Court rejected this part of the duty of care owed by the directors, the Court endorsed the actions of the board, which by virtue of its acts served in essence to satisfy contractual compulsions to shareholders. The decision therefore clarifies that a high degree of respect is to be shown where the decisions of the board are concerned. So long as the are able to get their process right, the law is to respect legal rights. In the context of this case therefore the basic issue would be whether or not the decision made by the board at GE is in the interest of the shareholders or whether it would be in the larger interests of the company given the fact that at present, the company is in the blue, but after the agreement is made, the new loans amounts would be passed on to the new company accounts putting the company in heavy debts thereby raising question on the long term viability of the decisions. The idea therefore should be for the directors at GE to ensure that the new company being acquired is kept away from debt obligation. The idea therefore should be that directors must be able to demonstrate that they have considered the reasonable expectations of all stakeholders and have not merely sought to maximize shareholder value without regard to other stakeholders’ reasonable expectations Reference: Farrar, J., Fury, N., and Hannigan, B., (1991). Farrar’s Company law. Butterworth London. p149 Tomasic, R., Bottomley, S., and McQueen, R., (2002). Corporations law in Australia. The Federation Press. Pp435-438 English, J., W., (2006). How to organise and operate a small business in Australia. Allen and Unwin. P416 Australia, CCH Corporate Law Editors, CCH Autrslai Ltd, (2002). Australian Corporations & Securities Legislation 2009: Corporations Act 2001.   Brown, P., and Rosa, S., D., (1998) Australia's Corporate Law Reform and the Market for Corporate Control. Agenda, 5(2), pages 179-18 Copland, T., and Dolgoff, A., (2005). Outperform with expectations-based management: a state of the art approach. Wiley books. p286 Steingold, F., (2009). Legal Guide for Starting & Running a Small Business. Delta Printing. p126 Navalli, S., (1996). Australia’s Merger Policy and the Caltex/Ampol Merger Case. Agenda. 3(3). Pp305-316 Hunt, P., A., (2004). Structuring mergers & acquisitions: a guide to creating shareholder value. Aspen Publishing. p85   Paulson, E., 2003, The complete idiot's guide to starting your own business. Rediff Books, p73 Stickney, C., P., Weil, R., L., Schipper, K., (2009). Financial Accounting: An Introduction to Concepts, Methods and Uses. Cengage Brain. p663 Supereme Court of Canada Judgement, BCE Inc. and Bell Canada, accessed February 18, 2010, < http://csc.lexum.umontreal.ca/en/2008/2008scc69/2008scc69.html> Read More