Companies have many statutory obligations under the Companies Act and some of these responsibilities involve taking decisions which can impact the rights, holdings and value of the shares held by existing investors. This article explains some of the more common corporate actions available to companies.
Bonus issues
A bonus issue is where new or additional shares of the same class of shares (which can be ordinary or preference shares) are issued to existing shareholders free of charge (on a fully paid up basis). A bonus issue is usually used to declare and pay a dividend instead of utilising the company’s cash reserves (see also scrip issue below).
Capital reduction
A public company can reduce its share capital provided it has received approval from its shareholders by special resolution and has secured a court order confirming the capital reduction. Before approval is given by the court, it needs to be satisfied that company creditors are not prejudiced by the consequences of the capital reduction.
In general, listed companies pursue the capital reduction route when they want to return surplus cash to shareholders by way of a dividend distribution, but are prevented from doing so because of a deficit on its profit and loss account. In order to declare and pay a dividend to shareholders, the company must have sufficient distributable reserves.
To create the distributable reserves needed and eliminate the P&L deficit, a capital reduction can be effected whereby a company’s share premium account (which forms part of the share capital), for example, can be reduced and transferred to the P&L account to create a surplus on that account.
Once the P&L account is in credit, the company has the distributable reserves needed to make a dividend distribution.
Dividends
A dividend is a payment made from the distributable profits of the company to existing shareholders. Dividends can be paid annually, twice-yearly (interim and final dividends) and in some cases on a quarterly basis.
One-off dividends which are not part of a regular pattern of dividends are known as special dividends. These are typically paid when the company finds that it has an unexpected or surplus amount of cash on its balance sheet following the sale of a subsidiary for example.
The dividend is paid in proportion to existing shareholdings and is usually paid in cash but can also be paid in the form of shares known as a scrip issue (see later).
Pre-emption rights
A statutory pre-emption right is the right given to current shareholders in a company to be offered new shares (ahead of non-shareholders) in the same proportion as their existing shareholdings.
The purpose of a pre-emption right is to protect these shareholders from having their share of voting rights diluted by the issue of new shares.
This also applies where an existing shareholder has the right to buy out the shares of any shareholder who wished to sell up some or all of their shares.
Rights issue
A rights issue is the process by which a company raises new equity capital by issuing new shares to investors. This form of corporate action is usually undertaken to fund the growth of the business; for example, to enable the takeover or acquisition of another company or to strengthen the balance sheet, where trading losses have adversely impacted current cash reserves.
In order to encourage take up of the rights issue by existing shareholders, new shares are usually issued by the company at a discount to the prevailing share price. The number of shares that a shareholder can buy is usually expressed as a ratio of their existing holding. For example, shareholders can purchase say three new shares for every nine shares they currently hold, at the discounted price.
In the event that the rights are not taken up by a shareholder, then these can be assigned to the company registrar or sold on the open market for a consideration. However, when a shareholder decides not to take up their rights, this means that their percentage ownership stake in the company is diluted accordingly.
Because of the risks associated with this type of equity fundraising, for example, shareholders may decide not to support the issue (resulting in the company not receiving the amount requested), means that rights issues are typically underwritten by the investment bank or corporate adviser. There are usually significant fees payable for providing an underwriting guarantee.
Scheme of arrangement
A scheme of arrangement is a statutory procedure set out under Part 26 of the Companies Act 2006, whereby court approval is needed for any proposed changes to the rights of shareholders or creditors. This arrangement applies in situations where unanimous approval cannot be secured from those affected by the changes.
For example, this type of corporate action can be used to implement a reorganisation of the company’s capital structure to include a debt for equity swap in an insolvent restructuring; formally reduce the company’s issued share capital (to allow a share buyback to be effected); or it could also be used to obtain court approval for the sale or merger of the company.
In order to implement a scheme of arrangement, approval is needed from at least 75% by value of each class of shareholder or creditor and a majority in number of each class.
Scrip issue
While dividends are usually paid to shareholders in cash they can also be offered in the form of shares, known as a scrip issue or scrip dividends. This means that new shares are issued to existing shareholders on a pro-rata basis.
A scrip issue usually happens when a company wants to preserve cash to expand the business or make an acquisition for example, but at the same time want to maintain a dividend payment record that has been built up over many years.
Share consolidation
A share consolidation is a process by which a company reduces the number of shares in issue. This action is typically carried out as a cosmetic exercise when the share price of the company has fallen significantly; for example, where the price is now expressed as a fraction of a penny and billions of shares have been issued.
While shareholders do end up with fewer shares as a consequence of this corporate action, their percentage ownership of the company remains unchanged on a pro-rata basis. In addition, the value of their holding at the time of the consolidation also remains the same.
Share split
A share split is the opposite to a share consolidation in that the number of shares in issue is increased as a result of this corporate action. This form of action is usually carried out when the share price of the company has increased substantially such that buying one share seems prohibitively expensive (i.e. just one share may cost in the thousands of pounds).
A share split is slightly more than a cosmetic exercise as the company may wish to attract more investors. For example, when there are more shares in issue and they are cheaper to buy, then trading in shares becomes easier (and a more liquid market is created).
With this corporate action, shareholders end up with more shares but their percentage ownership of the company remains unchanged on a pro-rata basis and the value of their holding at the time of the split also remains the same.
Squeeze-out
This corporate action allows the shares of an existing shareholder to be bought out such that the shareholder is then excluded from continued participation in the company. A squeeze-out usually happen in the context of a take-over of the company.
Once the bidder has acquired at least 90% of the shares (either by value or voting rights) in the target company, then the bidder has the right to acquire the balance of the remaining shares on a compulsory basis.
Stocks and shares guide
Corporate actions can impact on shares in many different ways and if you would like to learn more about stocks and shares please click here.
