Corporate Financing: Debt and Equity Overview
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Questions and Answers

What is the primary advantage of equity financing for a company?

  • Dividends may not need to be paid or can be low. (correct)
  • No interest payments are required.
  • Control remains solely with existing shareholders.
  • Allows immediate access to fixed assets.

Which of the following best describes a debenture?

  • An equity instrument representing ownership.
  • A document acknowledging a loan received. (correct)
  • A short-term loan agreement with high interest.
  • A fixed charge on specific company assets.

What happens to the priority of secured debts in the event of company insolvency?

  • Secured debts are prioritized in repayment. (correct)
  • All debts are treated equally regardless of security.
  • Unsecured debts are paid before any secured debts.
  • Secured creditors can demand additional collateral.

Which of the following is NOT a characteristic of bonds compared to shares?

<p>Bonds represent ownership in the company. (B)</p> Signup and view all the answers

What is a fixed charge in the context of secured borrowing?

<p>A charge that is limited to determined assets. (B)</p> Signup and view all the answers

What characterizes the essential nature of a floating charge?

<p>The charger has complete freedom to use and remove assets before crystallization. (C)</p> Signup and view all the answers

Which of the following events can lead to the crystallization of a floating charge?

<p>The appointment of an administrative receiver. (D)</p> Signup and view all the answers

In what context do floating charges operate differently in Scotland compared to England?

<p>In Scotland, crystallization occurs only on statutory triggers. (C)</p> Signup and view all the answers

Which of the following assets would be classified as a floating charge?

<p>Inventory that changes as goods are bought and sold. (C)</p> Signup and view all the answers

What detail differentiates the ranking of fixed charges from floating charges?

<p>Floating charges prioritize certain creditors like liquidators. (B)</p> Signup and view all the answers

How can a floating charge be characterized prior to its crystallization?

<p>The chargor can freely deal with the charged asset. (A)</p> Signup and view all the answers

What is the primary effect of a floating charge before it crystallizes?

<p>The charger is free to use the asset in the ordinary course of business. (D)</p> Signup and view all the answers

Which of the following accurately describes floating and fixed charges?

<p>Fixed charges cannot be set aside by an administrator without a court order. (D)</p> Signup and view all the answers

What does the concept of the 'prescribed part' refer to in relation to floating charges?

<p>An amount of money that must be ring-fenced for unsecured creditors from the floating charge assets. (D)</p> Signup and view all the answers

A debenture is a document that solely proves equity financing.

<p>False (B)</p> Signup and view all the answers

In a fixed charge, legal title of the asset is transferred to the lender.

<p>False (B)</p> Signup and view all the answers

Floating charges provide the highest priority in the case of company insolvency.

<p>False (B)</p> Signup and view all the answers

A company maintains its control structure when financing through debt.

<p>True (A)</p> Signup and view all the answers

Bonds and shares can be traded in the same manner within public listed companies.

<p>True (A)</p> Signup and view all the answers

A floating charge can be created by incorporated and unincorporated bodies.

<p>False (B)</p> Signup and view all the answers

The essential characteristic of a floating charge is that the asset subject to it is finally appropriated as security until a future event occurs.

<p>False (B)</p> Signup and view all the answers

Crystallisation of a floating charge occurs automatically upon a company's decision to cease business.

<p>True (A)</p> Signup and view all the answers

In Scotland, floating charges can convert into fixed charges contractually by notice.

<p>False (B)</p> Signup and view all the answers

Floating charges provide the charger complete freedom to deal with charged assets prior to crystallisation.

<p>True (A)</p> Signup and view all the answers

Vehicles and machinery are typically secured with floating charges due to their changeable nature in businesses.

<p>False (B)</p> Signup and view all the answers

The 'prescribed part' refers to a fixed amount that is ring-fenced for unsecured creditors in the event that floating charge assets are insufficient.

<p>True (A)</p> Signup and view all the answers

Accounts receivable are often considered a fixed charge due to their static nature in business operations.

<p>False (B)</p> Signup and view all the answers

In England, floating charges can crystallise by notice, allowing flexibility in terms of timing.

<p>True (A)</p> Signup and view all the answers

Once a floating charge crystallises, it can no longer be set aside by a liquidator or administrator.

<p>False (B)</p> Signup and view all the answers

Flashcards

Security (in finance)

A charge over a specific asset. A mortgage is the strongest security; it's a fixed charge.

Debt Financing

Raising capital by borrowing money. The company is the debtor, and the lenders are creditors.

Debenture/Bond

A document acknowledging a loan, often traded like shares. Companies promise repayment with interest (coupon).

Fixed Charge

A security that specifically attaches to identifiable assets.

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Debenture Holders

Lenders who have a loan (debenture) against a company.

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Floating Charge

A charge on a class of assets that can be used by the company until a specific event (crystallisation) occurs.

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Crystallisation

The point at which a floating charge becomes a fixed charge, attaching to specific assets.

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Event of crystallisation

A trigger that transforms a floating charge into a fixed charge.

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Winding-up Order

A court order ceasing a company’s business operations, leading to crystallisation.

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Administrative Receiver

An appointed person managing the company's assets during administration, triggering crystallisation of floating charges.

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Prescribed Part

A ring-fenced amount of money a company must allocate to unsecured creditors before paying off secured debts.

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Floating vs. Fixed Assets

Floating assets can be changed/rearranged, while fixed assets are permanent.

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Scottish Floating Charges

Floating charges in Scotland are different from England: crystallisation is only possible through statutory triggers (like winding up or appointment of a receiver).

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England Floating Charges

Floating charges in England can crystallize via statutory triggers. Companies can also make contractually arrangements.

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What is a security in finance?

A security, in finance, is a charge over a specific asset, like a mortgage over a house. It ensures the lender can claim an asset if the borrower defaults.

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Equity financing vs. Debt financing

Equity financing is when a company sells shares to raise funds, making the investors owners. Debt financing is when a company borrows money, making them debtors to the lender.

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What are debentures?

Debentures are bonds, they are documents acknowledging a loan. Usually they are traded like shares on the stock market.

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What is a fixed charge?

It is a type of security that is attached to a specific asset, like a mortgage is attached to a home. The asset can't be sold without the lender's permission.

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Fixed vs. Floating Charge

A fixed charge attaches to a specific asset. A floating charge is a charge that floats over a class of assets, giving the lender a claim if the company goes insolvent.

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What are the three characteristics of a floating charge?

  1. It is a charge on a class of assets of a company, both present and future. 2. The class of assets would be changing frequently in the normal course of the company's business. 3. The company can continue using the assets in its business until a specific event.
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What are some examples of events that can crystallise a floating charge?

  1. Winding up order (court order to shut down the company). 2. Appointment of an administrator or receiver. 3. The company ceasing to carry on business. 4. Automatic crystallisation clauses (like breaching a financial ratio or giving security to another creditor).
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Fixed Charge vs. Floating Charge

Fixed charges attach to specific, identifiable assets, limiting the chargor's ability to deal with the assets. Floating charges cover a class of assets that can change; the chargor can use the assets freely until crystallisation.

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Floating Charges in Scotland

Unlike England, floating charges in Scotland crystallise only through statutory triggers (like insolvency) and not contractual agreements. Companies cannot decide when to 'fix' the charge on assets.

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Floating Charges in England

Companies in England can crystallise a floating charge through both statutory triggers (like receivership) and contractual clauses agreed upon with the lender.

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What does 'ambulatory and shifting in nature' mean when applied to a floating charge?

This phrase refers to a floating charge's ability to move and change with the assets it covers. Until crystallisation, it's not attached to specific assets like a fixed charge.

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Why is it important to understand the difference between a fixed charge and a floating charge?

Knowing the difference can determine the priority of creditors if a company goes insolvent. A fixed charge might give a creditor more control over specific assets, while a floating charge can be more flexible for the company until crystallisation.

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Study Notes

Corporate Financing: Debt Financing

  • Security: A charge over an asset (e.g., mortgage). A mortgage is the strongest form of security (fixed charge). From a company perspective, securities are instruments to raise capital.

Equity Financing

  • Method: Issuing shares.
  • Ownership: Shareholders become owners.
  • Pros: Generally cheaper; potential high capital growth.
  • Cons: New shares can dilute existing shareholder control (unless pre-emption rights are used).

Debt Financing

  • Method: Borrowing money. The company is the debtor, and lenders are creditors.
  • Pros: Maintains existing shareholder control; no dilution of shareholder rights.
  • Cons: Interest payments are required, and repayment schedules are crucial. Lenders usually demand security (charges) over company or director assets.

Debentures/Bonds

  • Definition: A written acknowledgement of a loan, a type of document proving the equity financing. In public companies, they are often traded alongside shares.
  • Features: Companies repay the loan with interest (coupon) according to a schedule.
  • Investment: Bonds are often attractive when interest rates are low.

Secured Borrowing

  • Charges: Most common form of security for borrowing. No transfer of legal title or possession.
  • Types of Charges:
    • Fixed Charge: Specific, defined assets (e.g., property, buildings, vehicles)
    • Floating Charge: Applies to a class of assets that change over time during normal business (e.g., inventory, accounts receivable).
  • Floating Charge Characteristics: Assets' use is not restricted until an event (crystallization) triggers the charge.
  • Examples: Cash (floating), and property (fixed); accounts receivables (floating), vehicles (fixed); intellectual property (fixed); machinery (fixed); inventory (floating).

Debenture/Bonds (at a deeper level)

  • Complexity: If a company borrows from multiple parties, a trustee might be involved to safeguard debenture holders' interests.
  • Statutory Basis (Corporate Trustees and Debentures): Debenture includes stock, bonds within Company Act.

Debenture Holders

  • Benefits: A trustee facilitates registration, transfer, and protection of debenture holder interests where there are multiple lenders.

Events of Crystallisation

  • Trigger: Events that convert a floating charge into a fixed charge.
  • Examples: Winding up order, appointment of an administrator, ceasing business operations, and certain contractually specific clauses.

Floating Charges (England/Scotland Comparison)

  • Difference: Scotland has a statutory basis for floating charges, crystallizing only upon statutory triggers; England allows for some contractual triggers.

Fixed vs. Floating Charges (Summary)

  • Fixed Charges: Limited ability to deal with charged assets before crystallisation, ranking ahead of floating charges.
  • Floating Charges: Broader ability to deal with assets until crystallisation. Certain creditors (e.g., liquidators) have priorities regarding floating charge assets.

Registration of Charges

  • Requirement: Charges must be registered within 21 days to be valid against administrators, liquidators, and other secured creditors.
  • Consequences of Non-Registration: The security is rendered void; the underlying borrowing remains.

Priority Issue (Company Insolvency)

  • Order of Priority: Fixed charges rank highest; followed by liquidation expenses, preferential debts, floating charges (with ring-fenced unsecured creditor percentages), and finally unsecured creditors. Note: certain floating charges created within 12 months of insolvency have their validity challenged.

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Description

This quiz covers the fundamental concepts of corporate financing, focusing on debt financing and equity financing. It explores methods, pros and cons of each type of financing, and the implications for shareholders and company control. Test your knowledge on the differences between securing loans and raising capital through issuing shares.

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