Lecture 3 How Companies Work
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Transcript of Lecture 3 How Companies Work
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8/11/2019 Lecture 3 How Companies Work
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Whitewater LimitedConsulting Engineers & Scientists
FINANCIAL ASPECTS OF PROJECT ENGINEERINGAND CONTRACTING
PROJECT APPRAISAL FOR BIOPROCESS
Richard Hill
HOW COMPANIES WORK
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Investment and Earnings
To profit from any economic activity,you have to invest money
The return which you get variesdepending on:
Risk
Effort involved
Inflation
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Investment and Earnings
The greater any of these three itemsget, the higher the return
A low risk investment involving no work
and which does not suffer from inflationmight give you 1 - 3 % pa
A bank loan to a stable company will bringthe bank 6 - 7%
Credit cards (high risk and admin costs)might earn the lender around 20%
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Investment and Earnings
Investment in a business earns
more, especially if the work inputincludes inventiveness andexpertise
Contracting is a high-risk businessand requires skill and experience
A 44% return on the shareholdersinvestment is not unusual
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Types of Business
Suppose you decide touse your
entrepreneurial andinnovative Engineeringskills to set up abusiness
What type of business?
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Types of Business
How much capital?
Where from?
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Types of Business
Sole trader
Complete controlUnlimited liability
Personal assets at risk
PartnershipShared control
Joint unlimited liability
Personal assets at risk
LLP
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Types of Business
When you own your own business, you only
have to work half a day. You can do anythingyou want with the other twelve hours.
Anon
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Limited Liability
Limited liability company
Most common type of business set-up
The company is treated in law as a person
Owned by shareholders
Shareholders liability is limited to his
original investment
The companys profits are paid to
shareholders as share dividend
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Shareholders
Shareholders own the company
They have no duties in terms of theday-to-day operation
Each shareholder owns a fraction of the
company proportionate to hisshareholding, with voting power inproportion
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Shareholders
A company has a set of rules called theArticles of Association that define
What the company does
How it is structured and run
The company is run by a Board ofDirectors elected by the shareholders
to run the business on their behalf
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Shareholders
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Shareholders
A Companys initial nominal capital is thesum of the face value of its issued shares
When first issued, shares must not be soldfor less than the nominal value, but they maybe sold at a premium
The capital raised by the initial share issue isthe called up share capital plus the sharepremium which remains constant but
Shareholders can agree to create and issuemore shares and sell them to raise capital
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Shareholders
The nominal value of the share is of little realimportance
A shareholder can turn his investment backinto cash by selling his shares
If the company has done well, the priceshould be more than he paid for i t, and viceversa.
If the company goes bust, the shares areworthless, but that is the maximum which ashareholder can lose - hence LimitedLiability
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Shareholders
People invest in shares in the hope ofprofiting by
getting a good dividend from profit distribution
owning shares which can be sold at a profit if thecompany does well
Shares must promise a better return thansafer investments (typically more than 5%pa)
The company may not do well - sharesalways carry some risk.
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Limited Liability Companies
Limited Liability Companies
Limited by guaranteeCharity or not for profit organisation
Prime beneficiary is the charity
No shareholders
Guarantors (or t rustees) have limited liabilitystatus but guarantee to pay a predeterminedsum (typically 1.00) in the event of winding upthe company
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Limited Liability Companies
Limited Liability Companies
Limited by shares
Commercial operation
Prime beneficiaries are the shareholders
Private limited companies (Ltd)
Public limited companies (plc)
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Private Limited Companies
Share ownership in Ltd companies iscontrolled
Articles of Association typically require ashareholder to find a buyer, agree with him a
price for the shares, and then offer theshares to the existing shareholders at thesame price
This ensures that the shares of a familycompany can be kept in the family
It also limits the ability to raise capital It is very hard to value the shares in a Ltd
company
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Public Limited Companies
A big company may choose to become a plc
It must be accepted by a stock exchange and
there are fixed rules about thatTheir shares can then be sold freely on the
open market (London Stock Exchange andAIM (Alternative Investment Market )
Company has no control over who owns itsshares
Shares can be bought by a competitorSize isnt everything Mars and Sir Robert
McAlpine are both still family owned
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Organisation
Working together
Objective
Cooperation
Leadership
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Organisation
Structure
Goal setting
Planning
Execution
Leadership/motivation
Hierarchy
Chain of command
Resourcing
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Organisation
SALE S DIR EC TO R T EC HNI CAL DIR ECTO R F INANCIAL DIRE CT OR PE RATIONS DIR EC TOR
SALES ENGINEERS ISCIPLINE ENGINEERS ACCOUNTS CONTRACT MANAGERSR&D
PROPOSALS DRAUGHTSMEN PLANNING ENGINEERSLABORATORY
COMMISSIONING PROCUREMENT
ESTIMATORS
COMPANYSECRETARY
CHAIRMAN
MANAGING DIRECTOR
One way of organising a medium sized contractor
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Organisation
One way of organising a medium sized contractor
BOARD OF DIRECTORS
CEO
V-P SALES CHIEF ENGINEER CFO COO
SALES ENGINEE RS DI SCIPLIN EE NGINEE RS ACCOUNTS CONTRA CT MANAGERS
PROPOSALS DRAUGHTSMEN PLANNING ENGINEERS
COMMISSIONING PROCUREMENT
ESTIMATORS
COMPANY SECRETARY
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Organisation
Strategy
Objectives
Work breakdown
MethodologySupport
Monitoring
Feedback
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Organisation
Growth of a company
Euphoric phaseGrowth phase
Financial deprivation
Maturity
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Organisation
Euphoric phase
Entrepreneur(s) set up company
Creativity
Enthusiasm for product/service
Commitment to the company
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Organisation
Growth phase
Product/service becomes established
Sales increase
Organisation expands
Employees lack commitment to company
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Organisation
Financial deprivation
Inadequate working capital to supportcontinued growth
Introduction of new shareholders
Loss of control of company
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Organisation
Maturity
Employment of professional managers
No history with company and have nocommitment to product/service
Entrepreneurs lose control of management
Entrepreneurs become disillusioned andsell company
Company driven by profit
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Organisation
Professional management
Management science?
Understanding the business
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Organisation
In fact, when I know whatis meant by mamelonand ravelin,
When I can tell at sight aMauser rifle from aJavelin
W S Gilbert
Pirates of Penzance
Henry Lytton as MajGen Stanley
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Organisation
Sir John Harvey Jones
ICI
The Troubleshooter
Morgan
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Organisation
And God created theOrganization and gave Itdominion over man.
Genesis 1, 30A, subparagraph VIII
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Directors
A Ltd company or PLC
is run by a Board ofDirectors elected by theshareholders at AGM
Directors may also beshareholders but that isnot necessarily the case
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Directors
The Board must present its audited accountsand report to the shareholders at the AGM
If some major decision has to be made, theBoard or shareholders can convene anExtraordinary General Meeting (EGM)
At EGM the shareholders have the right (butno obligation) to vote on any resolutions putto them
The shareholders can vote to appoint or sackindividual Directors or the whole Board
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Directors
The Board of Directors is controlled by theChairman of the Board although decisionsare supposed to be made by a majority voteof the directors.
Day-to-day running of the company is underthe control of the Managing Director or ChiefExecutive Officer (CEO).
Corporate governance recommendations arethat the Chairman and CEO functions shouldnot be combined.
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Directors
News Corp shareholders have re-elected the media conglomerate's
board of directors and failed toapprove a proposal to oustRupert Murdoch as chairman andCEO.
22/10/11
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Directors
The Company Secretary who may or may notbe a member of the Board is responsible formaking sure that the company stays withinthe law and maintains proper record booksand accounts
There may be non-executive directors whoare usually there to represent a major financier like a merchant
bankbecause they have some special influence
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Share Trading
Once a company hasbeen formed, thenominal value of theshares becomesunimportant
When buying andselling shares theshare price is afunction of supply anddemand
PLC share prices arepublished in press
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Share Trading
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Bubbles
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The South Sea Bubble
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The South Sea Bubble
1710 George Caswall and John Blunt proposed toLord Treasurer Robert Harley to convert 9.47m of
short-term war debts into equity in South Sea Co Similar debt-equity conversions had been used by
the Bank of England and the New East India Co The South Sea Co would have future profits from a
monopoly on English trade with the Spanishcolonies of South America plus the cash flow on aperpetual annuity from the government paying576,534 pa
The debt conversion was a success
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The South Sea Bubble
Commercial trade depended on peace
Under 1713 Treaty of Utrecht England gained:
monopoly of slave trade to the Spanish W Indies
the right to sail one ship annually for commerce
No trading voyage to South America until 1717and made little profit
By 1718 Britain was at war with Spain
Short-term prospects were poor but thecompany argued that its longer-term futurewould be extremely profitable (jam tomorrow)
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The South Sea Bubble
In January 1720 the British governmentdebt was 50 million pounds
The government was running intodifficulties servicing its debt
Debt conversion would make highinterest, difficult to trade debt, into lowinterest, easily traded shares
All parties could gain
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The South Sea Bubble
The South Sea Company won a competitivebid against the Bank of England but had to:
raise its offer of a lump-sum payment to thegovernment from 3m to over 7.5m
Pay out 1.3m in bribes
To finance the debt acquisition, the companyissued more shares
South Sea share prices started at about 120per 100 share in January 1720 (thatsabout 14,000 at 2009 value)
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The South Sea Bubble
The country became obsessed with shares
IPO (initial public offer) schemes To buy the Irish Bogs
To manufacture a gun to fire square cannon balls
"For carrying-on an undertaking of greatadvantage but no-one to know what it is"(Unbelievably 2000 was invested in this one!)
Stocks increased in all these 'dodgy'schemes
Huge fortunes were made - and lost andsuicides became a daily occurrence
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The South Sea Bubble
South Sea shareprices reached 950pounds in July 1720
Then the bubble
burstShares collapsed
from about 775 onAugust 31 to about290 on October 1
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Share Trading
STOCK EXCHANGE RATIOS
Profit after taxEarnings per share =
Number of shares
Profit after taxDividend Yield =
Share Capital
Share PriceP/E Ratio =
Earnings per share
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Share Trading
The earnings per share is not what theshareholder receives as dividend
because the company will plough backa part of its earnings to increase itscapital
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Share Trading
In most plcs the ratio of the share priceto the companys earnings per share(P/E) is around 12-14 (equivalent to a
return of 7-8%)If the P/E falls below 12 the market
thinks the company is not doing well sothe price has fallen
If the P/E increase above 14 the marketthinks the share is overpriced
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Share Trading
P/E ratio 2000-2010 based onFTSE All-share Index
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Share Trading
P/E ratio 1860-2007 based onStandard & Poors 500 Index
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Share Trading
Why buy shares?
Existing shareholders can sell their shares easily
The company may issue more shares to raisecapital offered first to existing shareholders
Shares in plcs often give a poor return purely interms of dividend
Investors buy shares if they think there is aprospect of improved future trading, with largerdividends and/or the possibility of selling theshares at a profit
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Share Trading
Short selling
Trader borrows sharesTrader sells shares
Trader waits for share price to fall
Trader buys shares back
Trader returns shares to lender
Trader pays lender for loan
Trader keeps profit
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Share Trading
Margaret Thatcher
Milton Friedman
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Share Price
The Directors decide what to do with profits
Paying a large dividend
makes shares attractive
share price rises in the short termmay leave the company under-capitalised
Ploughing profits back into the company
adds to its wealth
value of the shares will rise in the long term
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Share Price
The average tenure of Managing
Directorships in big UK plcs is about 3years
Most Directors of plcs get somepayment in shares so a high shareprice is to his advantage
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Share Price
The stock marketis posh gambling
So is insurance
So is investment
banking
The difference isthat bookiesnever lose!
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Private vs Public
Very occasionally the shares of a plc get into thehands of one or a few owners with a sufficiently largemajority to entitle them to decide to convert it backinto a private limited company
In a private limited company the Board, their friendsand families usually own most of the shares, so theyare working for themselves
The share price is unknown quantity
If the company performs well the directors benefitdirectly by larger salaries or dividends so theyconcentrate on improving its performance
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Summary
The Limited Liability Company is themost convenient form for most tradingventures
It starts by setting up its Articles ofAssociation and selling shares
If its big enough it can apply to a StockExchange to become a public limitedcompany (plc), which makes its sharesavailable to the public.
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Summary
Investors buy shares in the expectationof getting a better return than from
some safer kind of investment, but takethe risk that the company might fail.
The share price is important to a plc,but a private company doesnt reallyhave one