CORPORATE FINANCE (Chapter 4, 7 & 8 of Co Act 2006)

The term corporate finance is the combination of two words “corporate & finance”.

Corporate is the form of business organization. This consists of all the features of a corporate
body.

Finance can be defines as the art & science of managing money. Virtually all individuals and
business organization earn or raise money and spend or invest it. Finance is concern with the
process of initiations, markets and instruments involved in the transfer of money among and
between individual, business organization and government.

Finance also can be defined as the management of the flows of money through an organization
whether it be a corporation, banks or government agencies.

Corporate finance is the area of finance dealing with the sources of funding and the capital
structure of corporations and the actions that managers take to increase the value of the firm to
the shareholders, as well as the tools and analysis used to allocate financial resources. The
primary goal of corporate finance is to maximize shareholders value

The main concepts in the study of corporate finance are applicable to the financial problems of
all kinds of firms. Corporate finance deals with the financial problems of corporate enterprises
these problems includes the financial aspects of promotion of new enterprise and their
administration.

The term corporate finance is also associates with investment banking i.e. financier. The typical
role of investment bank is to evaluate the company’s financial needs and raise the appropriate
type of capital that best fits their needs. Thus the term corporate finance and corporate financier
may be associated with transactions in which capital is raised in order to create develop, grow or
acquire business.

The primary goal of financial management is to maximize shareholder value. Maximizing

shareholder value requires managers to be able to balance capital funding between investments
in projects that increase the firm's long term profitability and sustainability, along with paying
excess cash in the form of dividends to shareholders. Managers of growth companies (i.e. firms
that earn high rates of return on invested capital) will use most of the firm's capital resources and
surplus cash on investments and projects of the company so that it can continue to expand its
business operations into the future. When companies reach maturity levels, managers of these
companies will use surplus cash to payout dividends to shareholders.

To achieving the goals of corporate finance, it requires that any corporate investment be financed
appropriately. The sources of financing are, generically, capital self-generated by the firm and
capital from external funders, obtained by issuing shares and debenture.
Corporate finance refers to two main sources of company:

i) Share capital, and

ii) Loan capital

Share capital:

Share Capital (terminology) The term share capital is used to describe the capital represented
by shares.

Nature of a share: The share capital of a company is divided into share which is units defining
the shareholder’s proportionate interest in the company.

A share is the interest o the shareholder in the company measured by a sum of money for the
purpose of liability in the first place and of interest in the second, but also consisting of a series
of mutual covenants as provided by Companies Act 2006 and Securities (Share Regulation) Act,
2063.

A man’s moveable property is of two kinds namely, chosen-in possession and chosen –in action.
Chosen –in-possession means property of which one has actual physical possession, but chosen-
in-action means property of which one does not have immediate possession, but has a right to it,
which can be enforced by a legal action. This right is generally evidenced by a document, e.g a
railway receipt. A share in a company is also a chose-in- action and a share certificate is the
evidence of it. Section 2(n) of the companies Act 2006 defines “share” as the divided portion of
the share capital of a company. Section 2(84) of Companies Act 2013 of India defines “share” as
share in the share capital of the company, and includes “stock”. In India a share is also regarded
as “goods” or assets. Shares or other interest of any member in a company shall be moveable
property. Similarly Sale of Goods Act 1930 of India defines goods as including every kind of
moveable property which includes share stocks as well.

Share vs. Stock: The Share capital of a company is divided into a number of indivisible units
of specified amount. Each such unit is called a share. E.g. if the share capital of a company is Rs.
1,00,000. Into 1000 units of Rs. 100 each , unit of Rs. 100 will be called a share of the company.

The term Stock may be defined as the aggregate of fully paid up shares of a member merged into
one fund of equal value. It is a set of shares put together in bundle. The stock is expressed in
term of money and not as so many shares. Stocks can be divided into fractions of any amount
and such money may transfer like shares.

The main elements and characteristics of a share are:

 It gives a right to receive dividends declared on that class of shares.

 It carries a right to vote at general meetings, such rights are usually defined in relation to
share e.g. one vote for each share or ten shares.
  On a liquidation or reduction of capital a share defines the right to receive assets
distributed to members of that class.

 Where there is liability, it is measured by references to shared, if 100 Rs. Shares are
issued at par, the liability is to pay Rs. 100 for each share.

 Various rights of membership are given by the Act and by the memorandum and article
of association in terms of shares, e.g. the right to requisition of the holding of a general
meeting or to receive notices.

 Subject to any restriction to the articles of association, a share is transferable by its

nature.

Share capital will be:

Authorised share capital: The amount of share capital which a company authorized by its MOA
to issue. e.g Rs. 1,00,000 divided into 10,000 of Rs. 100 each. This will contain in the capital
clause.

Issued or allotted share capital: The nominal amount of the share capital actually issued at any
time. e.g. Rs. 10,000 divided into 1,00,000 of Rs. 100 each. of which 50,000 Rs. 100 have
been issued.

This represents the liability of the members of the company. They are liable to the extent of the
nominal (par) value of their shares, which means that the Company is entitled to use the full
amount of the sum received for the shares in order to satisfy claim against it.

The issued share capital may be:

 Paid up capital : the amount so far a paid on partly –paid shares. i.e. the actual amount
received is paid up capital
 Uncalled capital: the amount which the company is entitled to call on the shareholders to
contribute.

Classes of Shares: (S. 30).

In the absence of contrary provision in the MoA or AoA , it is presumed that the rights of all
shareholders are equal. They include right to equal liability to calls, dividend, attendance and
voting at meeting and return of capital on authorized reduction of a winding-up.

If a company has more than one class of share, the share will be differentiated by reference to
special rights of the shares of each class.

Class rights will generally consist in one or more rights distinguished from rights of other classes
as follows:
 a. In respect of dividends paid out of profits

b. In respect of assets distributed on a winding up or reduction of capital

c. In respect of voting rights.

Some of the common different types of shares are:

1. Ordinary shares: typically carry normal rights without special definition. If there is only
one class it need not be explicitly described as ordinary.
2. Preferential shares: carry rights in preference to others ( with regards to dividends or
on winding up. (s. 2(o) and S. 65 (1-3 )

3. Redeemable shares: carry a right by the company to redeem or buy back the shares . As
this would reduce the capital of the company there are strict rules about the issue of such
shares. (s.65 (4-13)

Process of issuing shares: Section 23, 24 and Section 27 to 31 of the Companies Act, 2063.

Raising of share capital:

Public companies only: It is illegal for a private company’s securities to be advertises as being
available for public subscription.

Thus it is public companies only which can raise capital by public subscription.

Methods of public subscription: there are varieties of ways in which capital can be obtained
from the public by the issue of shares:

i. Direct invitations to the public

ii. Offers for sale i.e. selling the shares directly to an issuing house.

Allotment of shares: allot the share within three months after the closure of the sale. (S28 of the
C/A 2063).

Power to issue shares at premium: Section 29 of the C/A 2063 states that Any company fulfilling
the following conditions may, with the prior approval of the CRO issue shares at a premium:

a) The company has been making and distributing dividends for three consecutive years,
b) The company/s net worth exceeds its total liabilities,

c) The company’s general meeting decided to issue shares at a premium.

Loan Capital
Loan Capital: (S. 34-35 of Co Act)

In addition to capital raised by the issue of shares companies may need to borrow. This may be
done in several ways: as issue of debentures (secured or non-secured convertible) of loan, bills of
exchange and other commercial short term loans or obtaining bank draft or loan from bank. A
loan capital comprises all amounts which it borrows for long term. Obtaining goods or normal
trade credit is not usually treated as borrowing.

A trading company has an implied power to borrow for purposes incidental to its business. This
may be done by including the object clause an express power to borrow. If the power is implied
it is limited to borrowing for the purposes incidental to company’s business. If the power to
borrow is express then borrowing for purpose other than to fulfill an object will be intra vires the
company, but may be an abuse of directors’ power. (Rolled Steel vs. BSC, 1985). A trading
company has implied power to borrow but non trading company must have express power
to borrow.

Nature of Debenture:

A debenture is a document issued by a company setting out the terms of loan, such loans are
usually medium or long term borrowings. According to S.2(s) “debenture” means any bond
issued by a company whether putting its assets as collateral or not.

Debenture and shares compared:

Debenture and shares are commonly grouped together as securities. Debenture holders and
shareholders are both providers of finance to a company. The same prospectus rules apply to
both, but there are essential distinctions between the two:

a. A debenture holder is a creditor where as a shareholder is a member of the company.

b. A company may freely purchase its own debentures but shares cannot be purchased.

c. Interest on a debenture is a debt which may be paid out of capital, if there are not
profits. It is an expense for tax purpose. Where a dividend is paid for shares, which is
payable out of taxed profits.

d. Debenture may be issued at a discount e.g. Rs. 100 nominal for Rs. 95 cash. However it
cannot sell at discount, if they carry an immediate right to convert into shares so as to
confer a right to acquire shares at a discount.

e. A debenture is a document evidencing a chose in action (the indebtedness) where as a

share is a chose in action evidenced by a document called a share certificate.

f. A debenture holder has right to be repaid his capital at the due time and to recover
interest on it until repayment.

Types of debenture:
A debenture is usually a formal legal document often in printed form. Broadly there are three
main types:

a. A single debenture e.g. to secure an over draft from bank

b. Debenture issued as a series of debentures in identical form e.g. Different lenders may
provide different amount on different dates. But all the lenders should rank equally for
repayment.

c. The issue of debenture stock to a large number of lenders. Only a public company may
use this method to offer its debentures to the public. If it seeks listing on the Stock
Exchange then the rules on listing particulars must be followed.

Debenture may be issued in bearer form, i.e. made payable to bearer. These are
transferable by delivery. Interest is paid on production of coupons attached to the
debenture.

The more common form of debenture is a registered debenture. This will state that the
monies and interests are payable to the person named in the debenture. This will state that
the monies and interests are payable to the person named in the debenture (the registered
holder). Title to the debentures depends on the holder’s name being entered in a register
maintained by the company. Transfer is affected in the same way as shares are
transferred. (A proper instrument must be delivered to the company).

Issue of debentures: (S. 34.)

Debentures are subject to many of the rules which apply to share. In particular, an offer
of debentures to the public is subject to the same general prospectus requirements as for
an issue of shares and an offer of debentures to the public by a private company is not
allowed S.34(1). According to S. 34(1) A public company may issue debentures or raise
loan or issue debentures with or without pledging or mortgaging its immovable assets, if
it deems necessary to raise loans or issue debentures, specifying the reason there for, a
work plan to be executed from proceeds and budget necessary for that purpose.
Provided, however that no debenture is allowed to be issued unless and until an approval
to commence its business is obtained and its issued capital is fully paid up.

Any company may raise additional loan or issue additional debentures against the
security already furnished by that company with the previous creditors as a security from
such creditors, within the limit of such security, by clearly indicating the previous
creditors as well as amount of loan already obtained.

If a company is to raise loans or issue debentures the company has to give its information
along with the reasons for the same to the office.

Procedures for issuing debentures: (S.35)

A public company will issue debentures after making provisions of a debenture trustee. Such
debenture trustee is to be as licensed by Securities Board. The matters relating to the creditor and
borrower, in issuing debentures with a debenture trustee, will as mentioned in an agreement to be
concluded between such trustee and company.

If the memorandum of association or the articles of association (MOA/AOA) provide that the
debentures can be converted into shares or such term has been specified prior to the issuance of
debentures any debentures may be converted into shares. However, if any debentures are to be
converted into shares this matter has to be clearly mentioned in the prospectus.

S. 35 (5) provided that the court may, if it thinks necessary, issue an order of specific
performance to get performed a contract concluded between a public company and a person in
respect of the subscription of the debentures issued by that company.

Fixed charges and Floating charges: A company which has either an express or implied power
to borrow also has an implied power to charge its assets as security for the loan. A charge
secured over a company's assets gives to the creditor, a prior claim over other creditors to
payment of his debt out of those assets. Such charges may be fixed or floating charges.

A fixed charge is created by the procedure appropriate for mortgaging property of that particular
type e.g mortgage of land by deed, a mortgage of shares of another company by transfer to the
mortgagee.

The essential feature of a fixed charge is that , if property created, it attaches from the moment of
creation(the company cannot deal with the property without the lender’s consent) to the property
in question and gives the holder of the charge an immediate security over the property in priority
to subsequent claimants.

A fixed charge over fluctuating assets is obviously inappropriate as, for example, the company’s
freedom to dispose of its stock-in-trade is essential if it is to carry on the business efficiently. On
the other hand, if it cannot create a suitable security interest over such assets, it is deprived of the
means of raising a loan secured by the use of what is likely to be a substantial part of its assets.
This difficulty has been overcome by the invention of the floating charge.

A floating charge does not attach to the property until the charge crystallizes. Until
crystallization of the charge the company is free to dispose of assets subject to it. The person to
whom the assets are transferred takes them free of the charge. It is also possible for the company,
while still owning the assets subject to the floating charge to create fixed charges over them in
priority to the floating charge. The holder of floating charge may also be postponed to certain
creditors of an insolvent company.

Debenture holder’s remedies:

A debenture holder is in a contractual relationship with the company. The terms of the contract,
and obligations there under, are fixed when the debenture is issued and are not variable
subsequently, except on normal contractual principles. Therefore the debenture holder is entitled
to seek a remedy for action taken by the company in breach of contract.

Raising of loan or issuing debentures:

S. 34. : If a public company deems necessary to raise loans or issue debentures, it may ,
specifying the reason therefore, a work plan to be executed from proceeds and budget necessary
for that purpose raise loan or issue debentures with or without pledging or mortgaging its
immovable assets.

However no debentures may e issued unless and until an approval to commence its business is
obtained and its issued capital is fully paid.

While issuing debentures the agreement between the company and debenture trustee must have
been completed (as per S.35).

Under S. 36 An agreement has to be concluded between a company issuing debentures and a

debenture trustee acting as a trustee for the protection of the interest of debenture holders, in
respect of the debentures to be raised by such company.

Under S. 39, where the company violates any of the terms mentioned in the agreement concluded
under S 36 the debenture trustee may instruct such company to fulfill such terms as soon as
possible or to make repayment of the principal and interest of the debenture holder within a time
limit as specified by him

Alteration in its share capital Under S.56 Subject o the provisions contained in its AOA, any
company may, by adopting special resolution at its general meeting, make alteration in its share
capital by increasing share capital or by consolidating or dividing all or by canceling the shares
which, at the date of adopting of the resolution in that behalf have not been taken.

Reduction of share capital : If a company intends to reduce its share capital, it may by adopting
a special resolution to that effect at its general meeting, reduce its share capital by obtaining
approval of the court and make necessary amendment to or alteration in the MOA and AOA
accordingly.

Capital maintenance: Maintenance of capital is a fundamental principle of company law that

limited companies should not be allowed to make payments out of capital to the detriment of
company creditors. Thus Companies Act contains many examples of control upon capital
payment. These include provisions restrictions dividend payment and capital reduction schemes.

The capital which a limited company obtains from its members as share is sometimes called “the
creditors buffer”. Therefore whatever capital the company does have must be held for the
payment of the company’s debts and may not be returned to members without safeguarding
creditors interest. This principle has been developed in a number of detailed applications:
 a. Capital may only be distributed to members under the formal procedures of a reduction of
share capital or a winding up of the company.
b. Dividends may only be paid out of distributable profits. (S.182).

c. Redeem purchase of shares of the company are subject to the basic rules on capital.
(S.61)

In this respect S.6o of the Companies Act 2063 has prescribed the provision regarding the
maintenance of net worth for which directors are made liable in case of loss of net worth of the
company.

Purchase of own shares: According to S 61 of the Act a company is not allowed to purchase its
own shares. However a company may purchase its own shared by fulfilling following conditions:

a. Where the share issued by the company are fully paid-up

b. Where the shares issued by public company have been listed in the Securities Board

c. Where the buy-back of shares is authorized by the AOA of the company

d. Where a special resolution has been adopted at the general meeting of the company
authorizing the buy-back

e. Where the value of shares to be bought back by a company is not more than 20% of the
total paid up capital and general reserve fund of that company

f. Where the buy-back of shares is not in contravention of the directives issued by the office
in this respect.

g. If the buy-back is not made out of reserve fund available for being distributed as
dividends by giving information to office.

Bonus Share: (S. 179) A company may, by adopting a special resolution in the general meeting,
issue bonus shares to its shareholders, out of the amount available for the distribution ad
dividend. Where a company is to issue bonus shares as said above the company should give
information thereof to the office before issuing such shares.

It is a kind of capitalization issue of shares appropriating some part of the company’s reserves to
paying-up unissued shares in full and then distributing those shares as a bonus to shareholders.