Financial Structure

Chapter 35

Initial Financing

• 1. Debt Securities (bonds) – Debtor/Creditor relationship

• 2. Equity Securities (stock)– Shareholders ownership interest

Debt Financing

• Short Term – Securing short term bank credit– Assigning Accounts Receivable– Issuing short term promissory notes

• Long Term– Sale of Bonds– Debtor-Creditor Relationship between the

corporation and the security holder

Bonds

• Negotiable securities which express the corporations promise to pay the amount of the bond at a future maturity date (generally principal) and the interest (typically semiannually at a fixed rate)

• Must be paid out, regardless of the corporation’s financial condition

• Usually issued by the board of directors without shareholder’s authorization or consent

Types of Bonds

• Usually Registered– Secured– Unsecured

Variable Rate Bonds

Income Rate Bonds

Convertible Bonds

Callable Bonds

Equity Securities (shares)• Articles of Incorporation usually specify the number

of authorized shares and the classes of stock.– Authorized capital can not be increased/ decreased

without amending the articles– The Board can choose to issue all, part or none of the

authorized stock.– Until shares of stock have been issued, they are

“authorized but unissued” shares. Afterward they are “issued and outstanding”

– Any issuance of stock in violation of state corporate law is voidable (not void) at the option of the recipient shareholder

• Stock can be issued for cash, property (tangible or intangible) or past services rendered. RMBCA permits stock to be issued for promissory notes and future services. Value decided by board, business judgment. As long as no fraud, courts wont interfere with value of cconsideration

Classes of Shares

• Common• Preferred

– Cumulative– Non-cumulative– Participating – Convertible– Callable/Redeemable

• Redemption rights

• Treasury

Consideration

• Value of consideration is decided by the Board, leave it to their business judgment.

• Par Value stock– stated capital– capital surplus

• No par value

Preemptive rights

• Gives shareholders the option to subscribe to a new issuance of shares in proportion to the shareholder’s “current interest” in the corporation.

• Protects shareholders from “dilution” • Preemptive rights must be expressly provided for in the

charter• No preemptive rights (p. 716)

– Compensation to directors, officers, agents– In satisfaction of conversion/option rights– Shares issued within 6 months after incorporation– Shares issued for consideration other than money

Amount of Consideration

• Par value stock– stated capital– capital surplus

• No par value stock

• Treasury stock

• Types of consideration

• Valuation is a matter of opinion

Blue Sky Laws• Securities Act of 1933

– Disclosure statute– Deals with the original offering and distribution of

securities

• Securities Exchange Act of 1934– Deals with secondary distribution (re-sale)– Requires periodic reporting, up-to-date statements– Imposes liability on insiders for short swing profits– Anti-fraud provisions; reporting requirements

Preemptive Rights• Gives shareholder the option to subscribe to a

new issuance of shares in proportion to the shareholder’s current interest in the corporation

• Protects shareholders from dilution of their proportionate interest in the corporation

• Must be expressly provided for in the Articles

• Not all issues of stock triggers preemptive rights. Know the exceptions.

Terminology (OLD!)

• Stated capital - par value X issued shares. If no par, entire amount of consideration

• Capital Surplus - capital in excess of par. (Additional paid in capital)

• Earned Surplus - Surplus equal to aggregate balance of corp’s net profits, income, gains & losses from date of incorporation less all dividends paid or transfers of earned surplus to other accounts. (Retained earnings)

• Surplus - Excess of net assets over stated capital. Sum of capital surplus and earned surplus. (Dinosaur!!)

• Restricted surplus - Surplus that’s restricted in use (to pay bonds)