Equity Financing Overview

Equity Financing

• Equity financing involves a statutory procedure in most jurisdictions to protect existing shareholders while allowing the company to raise capital.
• The process balances the company's need for capital with shareholder protection.
• Allotment is the act of adding a shareholder's name to the register, while the issue is the actual transfer of shares. A shareholder is not obligated to take up an allotment.

Pre-emption Rights

• Existing shareholders have a pre-emption right to subscribe to new shares proportionally to their current holdings, preventing dilution of existing ownership. This right is typically for ordinary shares.
• Unless there's a special resolution (75% vote) to waive this, the pre-emption right must be respected.
• Pre-emption rights do not apply to some scenarios like bonus shares, non-cash considerations, employee share schemes, or companies facing financial difficulty.

Equity Financing Process (5 Stages)

• Stage 1: Verify that company articles permit the type of shares desired by investors.
• Stage 2: Confirmation that company articles do not restrict the amount of shares that could be issued.
• Stage 3: Ensure that the board has authority by company articles to issue shares. If not, shareholder approval (ordinary resolution) is needed.
• Stage 4: Determine if pre-emption rights apply; if so, existing shareholders must be offered the new shares proportionately. A 75% vote of shareholders can create an exception if there is no agreement to enforce pre-emption.
• Stage 5: Ultimately, the board must decide on allotment under company duties.

Corporate Financing Case Study (ABC Ltd)

• ABC Ltd has 100 ordinary shares of £1 each, with 5 shareholders (Fred, Pete, Virginia, Alesha, and Lottie) evenly holding 20% each.
• The company’s articles do restrict the amount of shares that can be issued.
• ABC Ltd needs £1 million in equity funding to acquire a distribution business.
• Virginia can only contribute £200,000 of the required money.
• Jatinder, a wealthy investor, is willing to invest £1 million in exchange for ⅓ of the company but wants cumulative participating preference shares.
• Decision making on the acquisition depends on if the company articles are amended (and appropriate resolutions are passed).

Restriction on Share Capital

• Articles of association frequently limit the total issued shares in the company.
• If the proposed share issue exceeds the limit, the shareholders must approve the change to the articles.
• An ordinary resolution by shareholders is needed to modify the share capital.

Pre-emption Rights and Jatinder

• If pre-emption rights apply, existing shareholders must be offered new shares proportionately.
• If 75% of the shareholders vote against the enforcement of pre-emption rights, then it can be avoided.
• Should pre-emption not be waived, Jatinder's offer may not be approved (as it conflicts with other shareholders’ rights).

Share Class and Allotment Authority

• A new class of shares may require a change to the company's articles (special resolution), especially when introducing preference shares.
• The director's authority to create/allot is dependent on the company's articles.
• The model articles generally grant the directors allotting authority unless restricted within the articles of association.
• When issuing a new class of shares, authorisation by the shareholders is usually needed.

Company Decision-Making Process

• Resolutions are prepared and decided at board/general meetings to deal with all matters related to the new shares (increasing share capital, pre-emption rights, new share classes, authority to allot).
• Board meetings create and convene general meetings which allow shareholders to vote.
• The Board reconvenes to execute allotted shares and register the changes legally.