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Question 2 (30marks)
Fatt Fatt Fatt Limited is a company listed on the Singapore Exchange and it wishes to
borrow the sum of S$500 million to purchase all 300 units of Infinity Towers
condominium in an en bloc sale. The purpose of the purchase is to redevelop Infinity
Towers into a new 450-unit luxury condominium. Fatt Fatt Fatt Limited approaches itsbank, SDE Bank, about lending it the S$500 million that it requires for the purchase.
Due to a number of reasons, including not wanting to lend so much money to one single
borrower, SDE Bank is not willing or able to lend the S$500 million to Fatt Fatt Fatt
Limited. It is only able to grant a loan of $100 million.
However, Fatt Fatt Fatt Limited is a long-time customer of SDE Bank and the bank does
not want to disappoint Fatt Fatt Fatt Limited by not being able to provide the loan that it
needs.
Discuss the following:
. (a) The different methods whereby the full loan of $500 million may be made to FattFatt Fatt Limiited without SDE Bank exceeding the loan amount of S$100 million
that it is prepared to grant; and
. (b) The method that you would recommend SDE Bank to adopt and the reasons foryour recommendation.
Multilender financing methods
Syndication
Club loans
Pros and cons of syndicated loans, sub participations and club loans
Heng Property Private Limited is a private company incorporated in Singapore and it
wishes to raise the sum of S$20 million to purchase a high-tech factory in Paya Lebar
Singapore as part of its business expansion strategy. It would like to raise the amount by
way of equity rather than through debt financing. Heng Property Private Limited has 5
shareholders cum directors but between them, they can only come up with additional
equity amounting to S$2 million.
Tony, one of the directors of Heng Property Private Limited, is borrowing $400,000 from
his good friend, Ah Long, to pay for his additional shares. Ah Long is a not a licensed
moneylender and he does not intend to charge Tony any interest for the loan. Tony is
also able to get 10 of his friends to take equity stakes in Heng Property Private Limited.
However, because the company has not been regularly making money in the last few
years, they are each only willing buy S$100,000 worth of shares in the company. None
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of the other directors are able to find anyone interested to take equity stakes in Heng
Property Private Limited. This means that there is an outstanding sum of S$17 million to
be raised.
Discuss the following:
. (a) The various methods whereby the balance sum of S$17 million may be raised inthe form of equity; (15 marks)
Raise capital by issuing shares
Raise fund from current shareholders
Raising Equity
Get more shareholders
IPO
Grant
Debts
Issues bonds (easier if they are listed)
Borrow from Banks
Bilateral and multilateral
Get money from spring
. (b) The problems that Heng Property Private Limited might encounter in raising theadditional equity and (10 marks)
.Legislation put in place
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-More scrutiny
-Account and auditing
-May lose say because decisions made by the shareholders.
_less flexibility
. (c) The legal position between Tony and Ah Long. (5 marks)Glory Private Limited is a small property investment company belonging to 3
shareholders cum directors, Ee Nee, Mai Nee and Moh. Glory Private Limited recently
entered into an agreement to purchase a piece of land in Upper Thomson Road for the
price of $50 million and paid a 10 per cent deposit. They managed to have a clause in
the agreement to allow them to complete the purchase of the land in one years time
because they needed the time to seek financing for the purchase of the property.
For a number of reasons, Ee Nee Mai Nee and Moh do not wish to borrow moneys from
any bank or financial institution for the purchase of the property. The company does not
have any substantial assets left after the payment of the 10 per cent deposit but the 3
shareholders are able to each inject another $1 million into the company.
Discuss the following:
. (a) The different methods that may be used by the directors and shareholders tofinance the purchase of the land without resorting to any borrowings from banks
and financial institutions; and (equity financing)
. (b) The legal issues or problems (if any) that may be faced in the different methods.. Private Equity Financing.. Loss of autonomy. Terms and conditions. Expectation of annualized returns
and performance benchmarks
.
. When u take equity stake unless uhave market to sell to u will be stuckwith shares.
.
. Initial Public Offering
.
. Prospectus
.
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. Initial Listing Fee for Main board50,000
. Wont even be able to list there arerequirements cumulative pretax
profit
.
. The ways in which Layman can raiseequity capital.
.
. Private company with 5 shareholders and directors. Easier step to raise equity isto get more shareholders. (up to 50 no need change anything). Then convert to
public if still not enough unlimited shareholders. Together with IPO (restricted in
most cases in Singapore), section 144a offering to sophisticated investors in the
us, similar provision in other financial cenroes. List in other countries (downside
inverse relationship to control)
.
. Existing shareholders to take up more shares.
You are a consultant working in the Singapore office of an international firm of real
estate consultants.
Maguro, Sukiya and Kikunoi are three wealthy Japanese citizens having permanent
residence status in Singapore who have come to get advice from your firm. Maguro has
S$6 million in his savings account, while Sukiya and Kikunoi each have S$2 million intheir savings account. Sukiya also has the option of borrowing up to S$3 million from his
father, a medical doctor who is living and working in Tokyo. They are keen to buy a piece
of land to build a modern ryokan (i.e. Japanese style hotel) in Singapore as there is an
increasing number of Japanese tourists coming to Singapore. The three of them did their
calculations and agree that S$9 million would be sufficient to buy the land and complete
the entire construction of the ryokan project.
Discuss the following:
. (a) how they ought to structure this business venture of theirs and the related issuesthat they may encounter; and
. (b) whether they should finance their project entirely by cash and the reasons foryour conclusion.
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Equity Financing
You may have some cash you want to put into the business yourself, so that will be yourinitial base. Maybe you also have family or friends who are interested in your business
idea and they would like to invest in your business. That may sound good on the surface
to you, but even if this is the best arrangement for you, there are factors you must
consider before you jump in. If you decide to accept investments from family and
friends, you will be using a form of financing called equity financing.
One thing that you want to be clear about is whether your family and friends want to
invest in your business or loan you some money for your business. That is a crucial
distinction! If they want to invest, then they are offering you equity financing. If they
want to loan you money for your business, then that is quite different and is actuallyconsidered debt financing.
Advantages of Equity Financing:
You can use your cash and that of your investors when you start up your business forall the start-up costs, instead of making large loan payments to banks or other
organizations or individuals. You can get underway without the burden of debt on
your back.
If you have prepared a prospectus for your investors and explained to them that theirmoney is at risk in your brand new start-up business, they will understand that if your
business fails, they will not get their money back.
Depending on who your investors are, they may offer valuable business assistancethat you may not have. This can be important, especially in the early days of a new
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firm. You may want to considerangel investorsorventure capital funding. Choose
your investors wisely!
Disadvantages of Equity Financing:
Remember that your investors will actually own a piece of your business; how largethat piece is depends on how much money they invest. You probably will not want to
give up control of your business, so you have to be aware of that when you agree to
take on investors. Investors do expect a share of the profits where, if you obtain debt
financing, banks or individuals only expect their loans repaid. If you do not make a
profit during the first years of your business, then investors don't expect to be paid
and you don't have the monkey on your back of paying back loans.
Since your investors own a piece of your business, you are expected to act in theirbest interests as well as your own, or you could open yourself up to a lawsuit. In
some cases, if you make your firm's securities available to just a few investors, youmay not have to get into a lot of paperwork, but if you open yourself up to wide
public trading, the paperwork may overwhelm you. You will need to check with
theSecurities and Exchange Commissionto see the requirements before you make
decisions on how widely you want to open up your business for investment.
Debt Financing
If you decide that you do not want to take on investors and want total control of the
business yourself, you may want to pursue debt financing in order to start up your
business. You will probably try to tap your own sources of funds first by using personalloans, home equity loans, and even credit cards. Perhaps family or friends would be
willing to loan you the necessary funds at lower interest rates and better repayment
terms. Applying for abusiness loanis another option.
Advantages of Debt Financing
Debt financing allows you to have control of your own destiny regarding yourbusiness. You do not have investors or partners to answer to and you can make all
the decisions. You own all the profit you make.
If you finance your business using debt, theinterestyou repay on yourloanis tax-deductible. This means that it shields part of your business income from taxes and
lowers your tax liability every year. Your interest is usually based on theprime
interest rate.
http://bizfinance.about.com/od/angelfunding/a/ovangelinvest.htmhttp://bizfinance.about.com/od/angelfunding/a/ovangelinvest.htmhttp://bizfinance.about.com/od/angelfunding/a/ovangelinvest.htmhttp://bizfinance.about.com/od/investors/a/vcbasics.htmhttp://bizfinance.about.com/od/investors/a/vcbasics.htmhttp://bizfinance.about.com/od/investors/a/vcbasics.htmhttp://www.sec.gov/http://www.sec.gov/http://www.sec.gov/http://bizfinance.about.com/od/generalinformation/tp/howtobusinessloans.htmhttp://bizfinance.about.com/od/generalinformation/tp/howtobusinessloans.htmhttp://bizfinance.about.com/od/generalinformation/tp/howtobusinessloans.htmhttp://bizfinance.about.com/od/debtandequity/bb/interest_rates.htmhttp://bizfinance.about.com/od/debtandequity/bb/interest_rates.htmhttp://bizfinance.about.com/od/debtandequity/bb/interest_rates.htmhttp://bizfinance.about.com/od/glossaryoffinanceterms/g/What_is_a_Loan.htmhttp://bizfinance.about.com/od/glossaryoffinanceterms/g/What_is_a_Loan.htmhttp://bizfinance.about.com/od/glossaryoffinanceterms/g/What_is_a_Loan.htmhttp://bizfinance.about.com/od/debtandequity/a/prime_rate.htmhttp://bizfinance.about.com/od/debtandequity/a/prime_rate.htmhttp://bizfinance.about.com/od/debtandequity/a/prime_rate.htmhttp://bizfinance.about.com/od/debtandequity/a/prime_rate.htmhttp://bizfinance.about.com/od/debtandequity/a/prime_rate.htmhttp://bizfinance.about.com/od/debtandequity/a/prime_rate.htmhttp://bizfinance.about.com/od/glossaryoffinanceterms/g/What_is_a_Loan.htmhttp://bizfinance.about.com/od/debtandequity/bb/interest_rates.htmhttp://bizfinance.about.com/od/generalinformation/tp/howtobusinessloans.htmhttp://www.sec.gov/http://bizfinance.about.com/od/investors/a/vcbasics.htmhttp://bizfinance.about.com/od/angelfunding/a/ovangelinvest.htm7/28/2019 Finance Law Exams
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The lender(s) from whom you borrow money do not share in your profits. All youhave to do is make your loan payments in a timely manner.
You can apply for aSmall Business Administration loanthat has more favorable termsfor small businesses than traditional commercial bank loans.
Disadvantages of Debt Financing
The disadvantages of borrowing money for a small business may be great. You mayhave large loan payments at precisely the time you need funds for start-up costs. If
you don't make loan payments on time tocredit cardsor commercial banks, you can
ruin your credit rating and make borrowing in the future difficult or impossible. If you
don't make your loan payments on time tofamily and friends, you can strain those
relationships.
For a new business, commercial banks may require you to pledge your personal assets
before they will give you a loan. If your business goes under, you will lose your personal
assets.
Any time you use debt financing, you are running theriskofbankruptcy. The more debt
financing you use, the higher the risk of bankruptcy. Calculate thedebt to equity ratioto
determine how much debt your firm is in compared to its equity.
Some will tell you that if you incorporate your business, your personal assets are safe.
Don't be so sure of this. Even if you incorporate, most financial institutions will still
require a new business to pledge business or personal assets as collateral for your
business loans. You can still lose your personal assets.
Which is best; debt or equity financing? It depends on the situation. Your financial
capital, potential investors, credit standing, business plan, tax situation, the tax situation
of your investors, and the type of business you plan to start all have an impact on that
decision. The mix of debt and equity financing that you use will determine yourcost of
capitalfor your business.
Two More Traditional Sources of Capital for your Business
Besides debt and equity financing, there are two other traditional sources of capital for
your business. Operating revenue and thesale of assetscan also generate money for
your firm.
Make your financing decisions wisely!
http://bizfinance.about.com/od/sba/a/SBA_loan_programs.htmhttp://bizfinance.about.com/od/sba/a/SBA_loan_programs.htmhttp://bizfinance.about.com/od/sba/a/SBA_loan_programs.htmhttp://bizfinance.about.com/od/creditcards/a/Credit_Card_Financing.htmhttp://bizfinance.about.com/od/creditcards/a/Credit_Card_Financing.htmhttp://bizfinance.about.com/od/creditcards/a/Credit_Card_Financing.htmhttp://bizfinance.about.com/od/startyourownbusiness/a/Financing_Your_Small_Business_Yourself.htmhttp://bizfinance.about.com/od/startyourownbusiness/a/Financing_Your_Small_Business_Yourself.htmhttp://bizfinance.about.com/od/financialratios/f/what-is-the-gearing-ratio.htmhttp://bizfinance.about.com/od/financialratios/f/what-is-the-gearing-ratio.htmhttp://bizfinance.about.com/od/financialratios/f/what-is-the-gearing-ratio.htmhttp://bizfinance.about.com/od/businessbankruptcy/a/bizbankruptcy.htmhttp://bizfinance.about.com/od/businessbankruptcy/a/bizbankruptcy.htmhttp://bizfinance.about.com/od/businessbankruptcy/a/bizbankruptcy.htmhttp://bizfinance.about.com/od/financialratios/f/Debt_Equity_Ratio.htmhttp://bizfinance.about.com/od/financialratios/f/Debt_Equity_Ratio.htmhttp://bizfinance.about.com/od/financialratios/f/Debt_Equity_Ratio.htmhttp://bizfinance.about.com/od/cost-of-capital/a/overview-cost-of-capital-for-small-businesses.htmhttp://bizfinance.about.com/od/cost-of-capital/a/overview-cost-of-capital-for-small-businesses.htmhttp://bizfinance.about.com/od/cost-of-capital/a/overview-cost-of-capital-for-small-businesses.htmhttp://bizfinance.about.com/od/cost-of-capital/a/overview-cost-of-capital-for-small-businesses.htmhttp://bizfinance.about.com/od/obtainingfinancing/f/internal-sources-of-business-capital.htmhttp://bizfinance.about.com/od/obtainingfinancing/f/internal-sources-of-business-capital.htmhttp://bizfinance.about.com/od/obtainingfinancing/f/internal-sources-of-business-capital.htmhttp://bizfinance.about.com/od/obtainingfinancing/f/internal-sources-of-business-capital.htmhttp://bizfinance.about.com/od/cost-of-capital/a/overview-cost-of-capital-for-small-businesses.htmhttp://bizfinance.about.com/od/cost-of-capital/a/overview-cost-of-capital-for-small-businesses.htmhttp://bizfinance.about.com/od/financialratios/f/Debt_Equity_Ratio.htmhttp://bizfinance.about.com/od/businessbankruptcy/a/bizbankruptcy.htmhttp://bizfinance.about.com/od/financialratios/f/what-is-the-gearing-ratio.htmhttp://bizfinance.about.com/od/startyourownbusiness/a/Financing_Your_Small_Business_Yourself.htmhttp://bizfinance.about.com/od/creditcards/a/Credit_Card_Financing.htmhttp://bizfinance.about.com/od/sba/a/SBA_loan_programs.htm7/28/2019 Finance Law Exams
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MAS and approach
The mission of the Monetary Authority of Singapore (MAS) is to promote sustained and
non-inflationary economic growth and a sound and progressive financial services
sector. To carry out this mission, MAS conducts exchange rate policy, manages the
official foreign reserves, regulates and supervises the financial sector, and works with
the industry to develop Singapore as an international financial centre.
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In 1997, MAS launched a comprehensive review of Singapores financial sector. We
fundamentally changed our regulatory approach, from one-size- fits-all prescriptive
regulation towards a more risk- focused supervisory approach. We liberalised the
industry, allowing freer competition and greater risk taking by financial institutions. We
actively promoted activities in which we had competitive advantages.
Singapores financial sector held up well against the full impact of the Asian financial
crisis, the SARS outbreak and other external shocks. Despite the more volatile
environment, it has grown and matured. Our financial system is robust, and our legal,
supervisory and institutional framework is sound. Today, over 600 local and foreign
financial institutions are in Singapore. They offer a comprehensive range of world-class
financial services and with 5% of our workforce, contribute 11% of Singapores GDP.
MAS SUPERVISORY APPROACH
MAS seeks to promote a sound and progressive financial services sector through both
financial supervision and developmental initiatives. We supervise the banking and
insurance industries, as well as the capital markets. At the same time, we work in
partnership with the private sector to identify and implement strategies for developing
Singapore as an international financial centre. Working with the boards and managers of
financial institutions, MAS encourages the effective management and mitigation of risks
taken by financial institutions. We aim to do so in a way that does not unnecessarily
hinder the competitiveness and dynamism of financial institutions, or the efficiency of
financial markets. In super vising the financial sector, MAS is guided by 12 key principles
which collectively characterise our approach as risk-focused, stakeholder reliant,
disclosure-based and business-friendly.
RISK-FOCUSED
Principle 1: Emphasise risk-focused supervision rather than one size-fits-all regulation.
In a prescriptive one-size-fits-all rules regime, a supervisor prescribes activities and risks
that institutions can and cannot take. This approach is increasingly ineffective in a
rapidly changing environment, and also unnecessarily restrictive for the stronger
institutions. With risk-focused supervision, MAS evaluates the risk profile of an
institution, taking into account the quality of the institutions internal risk management
systems and processes. This allows us to give greater business latitude to well-managed
institutions while retaining higher requirements or tighter restrictions for weaker ones.
Principle 2: Assess the adequacy of an institutions risk management in the context of
its risk and business profiles.
MAS takes a proportionate approach in assessing an institutions risks. Rather than have
a fixed view of what constitutes acceptable business risks or risk management
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standards, MAS assesses whether risk management systems and internal controls are
commensurate with the institutions risk and business profiles. Institutions engaging in
complex financial businesses must demonstrate that their risk management capabilities
match their risk appetite and operations, while institutions engaging in less complex or
risky financial activities may find simpler risk management processes adequate.
Principle 3: Allocate scarce supervisory resources according to impact and risks.
We categorise financial institutions according to the potential impact they would have
on Singapores financial system, economy and reputation in the event of a significant
mishap (e.g. financial failure and prolonged disruption), and also the likelihood of these
significant mishaps occurring. More resources are channeled towards supervising
systemically-important institutions and institutions with higher risk profiles.
Principle 4: Ensure institutions are supervised on an integrated (across industry) and
consolidated (across geography) basis.
As the home supervisor of local financial groups, MAS takes an integrated supervisory
approach, evaluating them on a whole-of-group basis across their banking, insurance
and securities activities. We also supervise these financial groups on a consolidated
basis, taking into account both their Singapore and overseas operations. For foreign
banks operating in Singapore, we ensure that they are subject to consolidated
supervision by their home regulators.
Insurers that are part of a wider insurance group or conglomerate are monitored on a
solo and group-wide basis to assess the potential impact on the Singapore insurance
operations. We also cooperate and share information with foreign supervisors foreffective supervision of internationally-active insurers and insurance groups.
Principle 5: Maintain high standards in financial supervision, including observing
international standards and best practices.
MAS continually strives to maintain high standards in financial supervision,
benchmarking itself against international standards and best practices. As an
international financial centre with a strong stake in global financial stability, MAS
participates actively in regional and international initiatives to enhance regulatory
standards and supervisory training.
Principle 6: Seek to reduce the risk of failure rather than prevent the failure of any
institution.
MAS does not aim to prevent all failures. We require financial institutions to observe
prudential standards, such as appropriate capitalisation, liquidity and exposure limits.
We have the power to intervene if we believe that the interests of depositors,
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policyholders or investors are at risk. But we cannot (due to the complexity of financial
activities) and should not (due to moral hazard and the undesirable consequences of
excessive regulatory burden) guarantee the soundness of financial institutions.
Consumers should recognise that there are risks involved in dealing with financial
institutions. Like other regulators, MAS faces the challenge of educating the publicabout this reality and managing their expectations. Deposit insurance and policy
owners protection schemes make explicit the level of protection available to depositors
and policy owners. They also help consumers realise that risks are inherent in financial
transactions.
While we cannot prevent failures, we are conscious of the systemic impact that failures
can have and the damage they can do to consumers and Singapores reputation as a
financial centre. MAS will seek to reduce the risk of failure of institutions through
increased supervision where it is appropriate and effective. In the case where increased
supervision is ineffective, we will take measures to limit the impact of a failure.
STAKEHOLDER-RELIANT
Principle 7: Place principal responsibility for risk oversight on the institutions board
and management.
The primary responsibility for the prudential soundness and professional market
conduct of a financial institution lies with its board of directors and senior management.
By encouraging best practices by boards and management, we minimise the need to
interfere with institutions business decisions.
Principle 8: Leverage on relevant stakeholders, professionals, industry associations
and other agencies.
Apart from MAS, other stakeholders such as shareholders, creditors, counterparties,
depositors, policyholders and home supervisors also have an interest in the continued
financial health and stability of financial institutions. Likewise, professionals such as
external auditors, internal auditors and actuaries, as well as credit rating agencies, are
specialists in assessing the risks inherent in the institutions and the adequacy of risk
management and internal control systems. In addition, many financial institutions here
are members of their respective industry associations.
MAS leverages on the relationships and work of many of these stakeholders, including
the home supervisors, SGX, auditors and industry associations, to complement our own
supervision of the institutions. MAS also works with other agencies, such as the Council
on Corporate Disclosure and Governance, the Ministry of Finance, and the Accounting
and Corporate Regulatory Authority, to strengthen corporate governance and disclosure
standards.
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DISCLOSURE-BASED
Principle 9: Rely on timely, accurate and adequate disclosure by institutions rather
than merit-based regulation of products to protect consumers.
Under a merit-based regime, the regulator assesses the suitability of a product before itis allowed to be introduced in the marketplace. Under a disclosure-based regime, the
consumer makes well-informed decisions when purchasing financial products and
services based on material information being made available to the consumer.
A disclosure-based regime encourages innovation and facilitates the development of a
more sophisticated body of consumers. The role of MAS is to put in a place a regulatory
framework that facilitates timely, accurate and meaningful disclosure of material
information that consumers could reasonably rely on in making financial decisions.
Principle 10: Empower consumers to assess and assume for themselves the financial
risks of their financial decisions.
A disclosure-based regime is meaningless if consumers do not know how to make use of
disclosed information in making financial decisions. Consumers should understand the
nature of different financial products and the issues they should consider in making
their financial decisions. MAS works in partnership with other public sector agencies and
industry bodies on consumer education to facilitate this.
BUSINESS-FRIENDLY
Principle 11: Give due regard to competitiveness, business efficiency and innovation.
MAS seeks to undertake supervision in a way that does not unnecessarily impair the
competitiveness and dynamism of individual institutions and Singapores financial
services sector. We take into account the business and operational concerns of the
institutions and industry, so as not to hinder growth and innovation as long as the risks
are adequately managed.
Principle 12: Adopt a consultative approach to regulating the industry.
MAS actively seeks feedback from market practitioners and the public, so as to help us
develop regulations that take into account market realities and industry practices.Consultation also helps to pre-empt implementation problems, minimise unintended
consequences, and foster better industry understanding and support. In the end, it is
the combined efforts of MAS and the industry that contribute to financial stability and
resilience while promoting enterprise and innovation.
CONCLUSION
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A sound and progressive financial services sector is a vital part of any modern economy.
Apar t from its direct and significant contribution to gross domestic product, the
financial services sector intermediates between savers and borrowers, allocates
financial resources efficiently, and thereby enhances economic growth and job creation.
Promoting a sound and progressive financial services sector is an integral part of
ensuring the success and resilience of the Singapore economy.
MAS is committed to the vision of Singapore as a leading global financial sector, one
which is competitive, fosters enterprise and innovation, and maintains high regulatory
standards. We have made steady progress toward this goal and continue to work with
our stakeholders to achieve our vision.
Limitations and recommendation
In Singapore there are two main methods through which listed firms can raise additional
equity finance: a rights issue (usually underwritten) and private placement. However,
we note that the seasoned public equity market in Singapore is underdeveloped relative
to the rights issue and private placement markets. For example, the Listing Manual of
the Stock (SES) does not provide specific rules on primary seasoned equity offering.
In a rights issue, each existing shareholder has the right to subscribe for new shares on a
pro-rata basis. In a private placement, firms issue new shares to a group of investors
through a placing agent, which is usually a stockbroking firm or an investment banker.
The regulatory agencies require a detailed prospectus in a rights issue, but exempt firmsfrom preparing a prospectus when they issue shares by way of a placement. The
placement shares carry the same voting rights and right to cash flows as do the existing
shares. The exceptions to this rule are the issues for which the new shares do not rank
for dividends payable in relation to the fiscal year ended before the announcement.
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Raising Equity Finance in the UK
Article, Securities and Mergers & Acquisitions Newsletter
September 2010
This is the second of a two part article addressing the United Kingdom's securities,
mergers and acquisitions regimes and it focuses on an overview of the methods, both
public and private, of raising equity finance in the United Kingdom.Part One, which
described the principal UK capital markets and their regulation, was published in our Q2
2010 Securities and M&A Newsletter.
Public Equity Finance
When raising equity finance through the issue of shares to the equity markets, relevant
considerations in determining which method of finance will be most suitable for the
company include:
The purpose of the fund raising; The time available to raise funds; and The anticipated reaction of the market to the fund raising.
There are four main methods that a public company customarily uses to raise capital in
the UK equity markets:
Rights issue; Open offer; Placing/Cash box placing; and Vendor placing.
A private company may seek to raise finance on the equity markets during its initial
public offer (IPO) process, i.e. at the same time as it obtains a first listing for its
securities on an equity market and offers securities to the public for the first time, by
means of an offer for sale or subscription of shares, or by a placing. The IPO process in
the UK is a complicated process and is beyond the scope of this article. We will provide a
review of the IPO process in the UK in a future article.
Rights Issue
Historically the most common method of raising finance (but now for regulatory
reasons, far less common), a rights issue is an offer of new shares or other securities
made on a pre-emptive basis to existing shareholders in proportion to their
shareholdings.
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A rights issue is subscribed for in cash (in most cases at a discount to the market value of
the company's shares). This enables shareholders in a listed company to realise the
value of their right to subscribe for new shares by selling them in the market nil
paid[1].without the need for the shareholders to first pay up the sum required on
allotment. Historically, a discount of 15 to 20 per cent was usual and it was mainly
companies with financial difficulties who offered 'deep discounts' of 30 to 50 percent. Because of the uncertain markets in the UK in recent years, deep discounting has
become more common, most likely to allow greater liquidity in the nil paid rights and
more flexibility.
On an underwritten rights issue, arrangements are made for the sale of shares not taken
up by shareholders. Therefore, a shareholder retains the right to receive any value in
excess of the subscription price, if the shares which were provisionally allotted to him in
a provisional allotment letter (PAL) are sold at a premium in the market, even if no
action is taken.
A rights issue by a public company will almost always constitute an "offer to the public",
requiring the preparation of a prospectus, described below.
Open Offer
An open offer is similar to a rights issue to the extent that it is also an offer of new
shares to shareholders on a pre-emptive basis. As a result, the existing shareholders of
a company are faced with the choice of either taking up the offer or allowing the shares
to be taken up by others.
Although an open offer is similar to a rights issue, there are a number of key differences:
Application forms are used which cannot be traded in the market nil paid in the waythat PALs can;
Shareholders are generally offered a guaranteed minimum allocation of shares(equivalent to their entitlement under a rights issue) but can apply for additional
shares;
Shares are offered at a lesser discount than on a rights issue (not more than 10 percent if the Listing Rules apply), which makes them attractive from a company's
perspective as the discounts are generally finer; and
For a fully listed company, if a general meeting is required (for example, to grant thedirectors authority to allot shares), application forms can be posted with the notice of
the general meeting. On a rights issue, PALs can only be posted after the general
meeting has taken place as the UK Listing Authority does not allow shares which can
be traded to be allotted provisionally on a conditional basis. As the notice of the
general meeting and offer period run at the same time on an open offer, the
company will receive the proceeds of the offer sooner.
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Once again, a prospectus is generally required (see below).
Placing
A placing involves the issue of new shares for cash to selected subscribers rather than to
shareholders as a whole and is therefore a form of non-pre-emptive offer. The
recipients of shares are usually institutional shareholders who are likely to hold the
shares as a long-term investment.
Placings are generally used for relatively small issues as it is unlikely that shareholders
would approve a large non-pre-emptive issue. Shareholder approval is required to
disapply statutory pre-emption rights. Typically, a placing would be of shares
representing less than 5 per cent of the company's issued share capital in any one year
(or 7.5 per cent in any three year period) and placed at a discount (including
commission) of not more than 5 per cent, in accordance with Investor Protection
Committee guidelines.
Cash Box Placing
As described below (see below under Companies Act 2006), UK companies are restricted
to the number of equity securities they can issue for cash otherwise than on a pre-
emptive basis to existing shareholders. These restrictions do not apply to the issue of
shares for a non-cash consideration. A cash box placing provides a legal mechanism to
enable a company to issue new ordinary shares (or rights to acquire new ordinary
shares) in return for the transfer to it of shares in a newly incorporated company, the
assets of which comprise entirely of cash in circumstances where seeking shareholders'
approval to the disapplication of the statutory pre-emption rights is impractical or
undesirable.
A cash box placing involves the incorporation of a new company (usually outside the UK
for tax purposes) (Newco) in which the issuer's bank subscribes for redeemable
preference shares and undertakes to pay the subscription price (a sum equal to the
proceeds of the placing) for those shares. The bank identifies persons wishing to take
up ordinary shares in the issuer (Placees) and shares are allotted to the Placees in
consideration of the transfer of the redeemable preference shares in Newco from the
bank to the Issuer. The Placees pay the subscription monies for the placing shares to
the bank and the issuer allots the placing shares to the Placees. The bank uses the
proceeds of the placing to discharge its undertaking to pay the subscription price for thepreference shares.
There are a number of potential legal issues associated with cash box placings and
concerns regarding this structure have been raised by some commentators, including
the Association of British Insurers (an independent body representing the interests of
large institutional investors). Views have been expressed that this structure could be
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challenged as a means of avoiding statutory pre-emption rights. However, the
prevailing view is that the cash box structure is designed to fall within the exemption
from the pre-emption rule afforded to the allotment of shares otherwise than for cash,
and therefore it remains a mechanism for raising equity finance which is used
successfully by some issuers.
Vendor Placing
In practice, a vendor placing is only used where the purchaser wants to issue shares to
fund an acquisition, but the vendor wants to receive cash rather than shares in the
purchaser as consideration. In a vendor placing, shares in the purchaser (Consideration
Shares) are allotted to the vendor in exchange for the transfer of the shares in the target
to the purchaser. The Consideration Shares are then placed by the purchaser's broker
on behalf of the vendors who receive the proceeds of the sale of such shares in cash.
Regulation of the public equity markets
There are a number of regulations and guidelines, as detailed below, which govern the
issue of shares by a company on the public equity markets.
Companies Act 2006
The two key provisions of the 2006 Act relate to the directors' authority to allot shares
and the disapplication of pre-emption rights.
An ordinary resolution must be passed by the shareholders of the company in order to
grant the directors authority to allot shares if such an authority sufficient for current
requirements is not already in place.
Companies can disapply pre-emption rights by the shareholders passing a special
resolution. The life of the disapplication will be limited to the length of the directors'
authority to allot to which it relates.
In accordance with the Investor Protection Committee guidelines, the directors'
authority to allot shares should not relate to more than one third of the existing issued
ordinary share capital of the company or the amount of unissued but authorised
ordinary share capital. However, on a pre-emptive rights issue, the guidelines issued by
the Association of British Insurers permit companies to seek authorisation for theallotment of a further one third of share capital.
Financial Services and Markets Act 2000
The issue of shares by listed companies is regulated by the Financial Services and
Markets Act 2000 (FSMA) and by the EU Prospectus Directive.
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A prospectus, disclosing such information as to enable investors to make an informed
assessment about the financial position and prospects of the issuer, approved by the
relevant competent authority is required where a company offers shares to the public
or applies for the admission of shares to a regulated market. There are, however, a
number of exemptions to this requirement.
Financial Promotions Regulations
FSMA contains the basic financial promotion restriction which provides that a person
must not:
In the course of business; Communicate; An invitation or inducement; To engage in investment activity;
unless he is an authorised person, or the content of the communication is approved byan authorised person, or the communication is covered by an exemption.
Each limb of the above restriction must be looked at carefully in determining whether a
proposed communication will be caught by it. Similar careful consideration should be
given to the exemptions from the restriction (which are stated in the secondary
legislation). There are many exemptions to the restriction on financial promotion, some
of which relate to all controlled activities and some relate only to deposits and
insurance.
Some of the more commonly used exemptions can be divided into the followingcategories:
Communications to certain recipients; Types of communication; Communications from certain persons; Communications relating to certain securities and listings; Company communications; and Communications relating to corporate transactions.
As referred to above, each of these categories is subject to detailed information andguidance within the legislation and therefore each proposed communication must be
looked at on a case by case basis to ascertain whether an exemption applies. A
commonly used exemption is that relating to communications to certain recipients
(specifically, to (amongst others) investment professionals, self-certified high net worth
individuals, high net worth companies and self-certified sophisticated investors), the
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main reason being because it is usually relatively straightforward to determine whether
a company/individual falls into such a category.
The Financial Promotion Regime and its Territorial Scope
Whether the financial promotion rules apply to incoming and outgoing promotions
to/from the UK will depend on various factors, such as the location of both the sender
of the communication and the recipient of it. The general starting point is that any
promotion with a UK link (whether an incoming or outgoing communication) will be
caught. In general, the UK's financial promotions regime will apply to promotions to
recipients located in the UK, subject to exemptions. FSMA states that promotions
originating outside the UK will be caught if they are "capable of having an effect in the
UK".
In terms of communications into the UK, a person who carries on relevant investment
activities outside the UK but who does not carry on any such activity from a permanent
place of business maintained by him in the UK may be able to take advantage of certainexemptions to the financial promotion restriction. In summary, such exemptions
depend on whether the communications are 'real time' or 'non-real time', solicited or
unsolicited and whether a particular customer is an existing customer of the party
making the promotion.
Consideration must also be given to applicable EU legislation. It is possible that more
than one EU directive could apply to a particular financial promotion, in which case
careful consideration must be given to the territorial scope. In particular, it should be
noted that the exemptions referred to previously are not available to MiFID business
carried on by an investment firm. MiFID is the Markets in Financial Instruments Directiveand, very broadly, applies to investment banks, corporate finance firms, stockbrokers,
portfolio managers, parts of the business of retail banks and building societies as well as
other firms/institutions. It is possible for a firm to be a MiFID investment firm even if it
does not provide investment services to others.
Careful consideration should be given to, and legal advice sought before, any
promotion, or offer, which could be deemed to be a promotion, is communicated to
ensure that there is no breach of the financial promotion restriction.
Prospectus Rules and Listing Rules
The Prospectus Rules govern the content of prospectuses and apply to all offers to the
public by a company, whether the company is trading on the Official List, AIM or PLUS.
In establishing if a prospectus is required, it is important to consider the following
questions.
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Is there an offer to the public? and Is there going to be an application for admission to trading on a regulated market?
In the event that a prospectus is not required, any documentation produced will need to
comply with the general circular requirements detailed in the rules of the relevant
market.
Listed companies are also subject to the pre-emption rules of the Financial Services
Authority detailed in the Listing Rules. Under these rules, even overseas companies
must generally get shareholder approval for a non-pre-emptive share issue, although
overseas shareholders and fractional entitlements can often be ignored for these
purposes.
A prospectus can only be issued with the approval of the Financial Services Authority
following a thorough pre-vetting process. This can involve considerable time and
expense, and many issuers will seek to structure their fundraising to avoid the need fora prospectus if at all possible, often by effecting an institutional private placing.
Private Equity Finance
In many situations, public methods of raising equity such as IPOs and rights issues will
be inappropriate. This may be due to market conditions, unsuitable internal policies
including improper corporate governance practices, or the often off-putting, onerous
and ongoing obligations attached to public listings. In particular, the lacklustre IPO
market in recent times has increased companies' drive to find alternate means of raising
capital, with private equity often being a plausible solution. However, an IPO does, of
course, remain a viable option for an unlisted company to raise equity finance in the UK,subject to it satisfying various requirements which are referred to in Part One of this
article, as well as many of the regulations and legal requirements referred to herein.
Methods of raising finance most frequently adopted in public equity, such as rights
issues and placings, can also be transposed into the realm of private equity, the
difference being that in the latter case they are not tradable securities. March 2009 saw
Aquarius Platinum Limited, the world's fourth largest primary platinum producer,
combine a private placement of convertible bonds with a public rights issue and placing,
raising 125 million in gross proceeds.
Private equity transactions cover a variety of arrangements including buyouts, which are
a process by which management teams acquire a target with the help of external
private equity funding and debt. Across Europe, the number of private equity buyouts
has increased by 23 per cent in 2010[2]and recent announcements include the luxury
shoe retailer Jimmy Choo which is considering a 500 million buyout of the business,
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and the fast food chain Burger King which recently agreed a buyout valued at just over
two billion pounds.
The two main providers of private equity finance are venture capitalists and business
angels.
Business Angels
A business angel investor is simply defined as an individual acting alone or in a formal or
informal syndicate who invests their own money directly in an unquoted business in
return for equity. It is in fact a significant source of equity for early stage businesses in
the UK often providing the first significant injection of capital without which many
ventures cannot grow. In the current economic climate, there has been a significant
increase in demand from entrepreneurs seeking access to alternative sources of
investment.
Many business angels make extensive use of the Enterprise Investment Scheme outlined
below. According to a report published in May 2009 by the British Business Angels
Association, an average of 82 per cent of business angels used EIS for at least one of
their ventures with 53 per cent of investors saying that they would have made fewer
investments were it not for the tax incentives. Together with the benefits of tax relief,
business angel investments have the subjective benefit of limited regulation, which is
restricted specifically to the control of Regulated Activities in accordance with the
Financial Promotions Order.
With regards to the investee companies, the advantage brought by 'angels' is that
together with the financial benefit, they bring expertise in their particular field, as
strategic investors will usually turn their attention to businesses related to their
personal knowledge. A well balanced investor/investee relationship will inevitably
increase the potential for success.
Enterprise Investment SchemeEIS
The Enterprise Investment Scheme (EIS) is aimed at promoting investment in smaller,
higher risk companies that have growth potential but often encounter difficulties in
raising finance.
The decision by individuals to invest in qualifying EIS companies is often incentivised by
the potential tax advantages affiliated with such a transaction, but as is customary, the
reaping of benefits comes hand in hand with the meeting of certain conditions.
In order for a company to be a qualifying company and subsequently, for an investor to
be eligible for tax relief, the company must be 'limited' at the time the shares are issued,
i.e. not listed on the London Stock Exchange or any other recognised stock
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exchange. There are no restrictions on it later applying for listing so long as no
arrangements to list were in place at the time the shares were issued, otherwise the
investor would lose the benefit of tax relief. For the EIS rules, AIM and the PLUS-quoted
and PLUS-traded Markets are not considered to be recognised exchanges, so a company
listed on those markets can raise money under the EIS if it satisfies all other conditions.
However, the PLUS-listed market is a recognised exchange and so a company listed on itcannot take advantage of EIS.
The company must exist wholly for the purpose of carrying out a qualifying trade. Most
trades are qualifying trades provided that they are conducted on a commercial basis
with a view to making profits. The investee company must also be independent in so far
as it is not a 51 per cent subsidiary of another company or under the control of another
company. Guidance to these and further requirements is provided by Her Majesty's
Revenue and Customs (HMRC).
If these circumstances are met, investors may claim relief against income tax up to anannual investment limit, for funds used to subscribe for new ordinary shares issued by
qualifying companies. An EIS investor who qualifies for income tax relief may also be
entitled to exemption from capital gains tax (CGT) on a disposal of those shares.
Additionally, CGT on the disposal of any asset can be deferred by reinvesting in EIS
eligible shares. However, the subscription must be made for genuine commercial
reasons and not purely for the purpose of tax avoidance.
Venture Capital
Unlike business angels, venture capitalists focus their attention on high value
investments, generally inputting a minimum capital injection of around 2 million. Theyprovide a service and source of capital that neither bank lending nor mass shareholder
equity (such as public shareholders) could provide.
Venture capitalists generally seek to invest in businesses with a large earning potential
and a high return on investment within a specific timeframe. Although they do not tend
to get involved in the day to day running of the business, they often help with a
business' strategy.
Closing the Gap - Enterprise Capital Funds
Since 2005, the government has provided a multi-million pound equity finance scheme
in the form of Enterprise Capital Funds (ECFs) to bridge the equity gap where businesses
require greater funding than that which can be provided by a business angel but do not
require the level of input which would attract a venture capitalist. These are a hybrid
solution, investing a combination of private and public money in small, high growth
businesses seeking up to 2 million in equity.
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Regulation of the Private Equity Market
Private equity and venture capital funds have direct impacts on the real economy
through their role as providers of capital to small businesses. The recent global crisis in
the financial markets has led to concerns that the functioning of the real economy is
being distorted. This is due to a buildup of leverage in the financial system, including
private equity funds. The result has been a pressure build up at the European level forlegislative measures to be taken to tighten regulation of the private equity industry.
In April 2009, the European Commission tabled its proposal for a Directive on
Alternative Investment Fund Managers (AIFM), to regulate all alternative investment
managers in the EU currently not covered by EU law, including private equity fund
managers with a portfolio of over 500 million.
Private equity industry bodies have been highly critical of the proposed AIFM Directive.
In a statement published by the BVCA, the Directive was described as being "irrational",
"contradictory", "draconian" ,"manifestly unfair" and "especially counterproductive forBritain", on the basis that a percentage majority of the European private equity industry
is located in the UK.
The Directive is not yet in force but consultations are taking place subject to which the
Directive may come in force by late 2012 to mid 2013.
FSMA and the exemptions to the financial promotion restriction apply in similar ways to
private companies wishing to seek investment, as well as to public companies, and
therefore careful consideration to any form of promotion, or offer which could be
deemed to be a promotion, should be given and legal advice sought, before it is
communicated.
Conclusion
A company looking to raise finance has various options available to it. The difficulty lies
in finding the right option which is both available and suited to its particular
requirements.
Be it public or private, with the current difficulties in obtaining debt finance, the
importance of equity finance in the current market cannot be overstated.
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