This is a process by which companies avail securities to the public for subscription. It enables companies to raise capital from the public.
This is only done by public companies since private companies are prohibited by their articles from doing so.
A private company which intends to have its capital floated off to the public must:
a) Alter its articles in such manner that they no longer:
(i) Restrict the right to transfer shares
(ii) Restrict the maximum number of members and
(iii) Prohibit an invitation to the public to subscribe for any shares or debentures of the company
b) Within fourteen days after altering its articles, deliver to the registrar for registration a prospectus relating to the company which complies with the Third Schedule
If a private company “floated off” its shares to the public without altering its articles, the company would cease to be entitled to privileges and exemptions which the Act confers on a private company and would henceforth be governed by the provisions of the Act as if it were not a private company.
If the company altered the articles but failed to deliver the statement in lieu of the prospectus the company and every officer of the company who is in default shall be liable t o a default fine.
The following methods are generally used in flotation or raising capital:
1. Direct offers/ issue by prospectus
2. Offers for sale
4. Offer by Tender
5. Bonus issue
6. Right issue
1. Direct offers /issue by prospectus: By this method the company issuing the securities prepares and issues a prospectus inviting subscriptions. The prospectus must be prepared in accordance with the provisions of the Companies Act and must be accompanied by an application form.
The company is responsible for the administrative tasks of the issue and bears the risk if the issue is unsuccessful.
To spread this risk, the company may arrange for the issue to be underwritten, whereby an underwriter undertakes to take up all or a specified number of shares if they are not taken up in return for a commission which is payable whether or not they are taken up.
The underwriter may also arrange for the securities to be sub-underwritten whereby the sub-underwriter undertakes to take up a specified number of shares in return for a commission.
2. Offer for sale: Under this method, the company allows the securities of an offer to an issuing house which in return prepares and issues a prospectus inviting subscriptions. Company……..sells shares to…….Issuing House…………Resells the shares ……….to Public (Issues a document called “Offer for sale”)
The securities are offered at a premium.
The issuing house bears the risk of the issue being unsuccessful and may arrange for the same to be underwritten.
On application, the issuing house may renounce the allotment in favour of the applicant. This method has two advantages:
It ensures that the amount due on securities is paid to the company in full.
It relieves the company of the administrative tasks of the issue.
3. Placing: By this method the securities on offer are purchased by an issuing house or taken up without a purchase. The issuing house then places them with its clients privately; there is no direct or indirect invitation to the public. The securities are offered to specific persons and institutions. Company…………………………………….Broker sells the shares
to. Public (acts as the company’s agent)If the issuing house has not purchased the
securities, it acts as broker in the transaction and is entitled to brokerage for the services rendered.
4. Offer by Tender: The Company or issuing house may invite tenders from persons who desire to take up the company’s shares and sells them to the highest bidder. This is done with a view to obtaining the best price possible for the shares. Under this method, the company fixes the minimum number of securities (shares) as well as price in much the same way as an auctioneer who sells goods subject to a reverse price. The company or issuing reserves the right to accept tenders in parts
This approach has 2 advantages:
• It makes available to the company or issuing house any excess above the issue price.
• It discourages stags who submit tenders for speculative purposes.
In addition to these 4 approaches, a company may further raise capital from existing members and debentures holders by way of bonus, rights, script or conversion issue.
5. Bonus issue: This is a capitalization issue where a company issues extra shares to existing members in proportion to their current holding at no direct consideration. The shares are financed by retained earnings for the company.
In this method instead of the company paying a cash dividend to its members, it retains the cash but issues new shares to the members. The total nominal value of shares issued equals the retained cash.
For a bonus issue to be effected the following conditions are necessary:
• It must be authorized by the Articles of the company.
• The nominal capital of a company must be sufficient.
• The shares must be issued in the proportions prescribed by the Articles.
• The issue must be recommended by the board at a board meeting.
• It must be authorized by an ordinary resolution of members in the general meeting.
• It must be sanctioned by CMA
• A return must be made to the Registrar of companies within 60 days.
Advantages of bonus issue
Advantages to existing shareholders
1. It will increase the existing shareholders security for loans in case he needs further finance.
2. It will increase the existing shareholders stake in the business and possible increase in dividends in the future
3. Existing shareholders get more shares in the company without any dilution of control since bonus issue is issued in proportion to existing shareholding.
4. Existing shareholders will realise tax free profits for this capital gain
5. In case of future sales of these shares, the existing shareholders will make a capital gain.
6. Right issue: This occurs if a company which has been trading for some time makes an offer to the existing members to buy shares of a new issue in proportion to the number of shares they hold. The existing members, rather than the public, are thereby given a “right” to buy new shares.
The advantages of this method is that the company avoids the substantial expenditure that is incidental to an offer to the public and as far as the member is concerned, it enables him to buy shares at a price that is usually below their market price.
For a rights issue to be effected:
• It must be authorized by Articles of the company.
• It must be sanctioned by CMA
• It must be recommended by the board at the board meeting.
• It must be authorized by an ordinary reduction of members in the general meeting.
• A return must be made to the Registrar.
Advantages of rights issue to existing shareholders
1. This issue will increase the shareholders voting rights over and above their previous levels thus boosting their influence in the company’s decision making process.
2. The issue increases the shareholder’s shares in the company and this will boost his future dividends from the company
3. In case the shareholders sell their rights shares, they will earn a profit on this shares thus boosting their income
4. The right issue will increase the amount of shares he owns in the company and this will boost his securities for loans using his shares as security
5. The right issue will reserve the company’s control on existing shareholders in case some of them do not sell their shares this avoiding dilution of control.
Disadvantages of rights issue to existing shareholders
1. The shareholders EPS (Earnings Per Share) will decline due to increase in shareholding without a corresponding increase in profits
2. The existing shareholders are issued with short notice to buy the shares which tempts many of them to sell the right issue against wishes. This leads to apathy among shareholders
3. The company’s equity growth may decline because the company will be pre occupied with paying increased dividend due to increased number of shares and as a result of the rights issue thus reducing retained earnings
4. If all or some of the shareholders elect to sell their shares, the supply of shares (in the securities market) of such a company will exceed its demand, thereby lowering the prices of shares which shall lead to capital losses to the shareholders
5. The finance raised through a rights issue is invested at the discretion of the Board of Directors in areas of their interest and this will prejudice the interests of shareholders.
Similarities between bonus issues and rights issue
1. Both are issued at the discretion of directors
2. Both are only issued by limited companies
3. Both issues are reserved to existing shareholders of the company
4. In both cases, shareholders can sell their shares to earn a capital gain
5. Both may be invested without the consent of the existing shareholders
6. Both are issued to ordinary shareholders in proportion to their existing shareholders.
Differences between bonus and rights issue
Bonus issue Rights issue
Under writing commission
A public company which invites the public to subscribe to its shares or debentures must ensure that the issue is subscribed by the public. As such, it is willing to pay anyone a certain commission on all shares or debentures offered to the public if he guarantees that if any of these shares are not taken up by the public he will take them up. The commission so paid, is known as the “underwriting commission”.
Even if the company is sure that all shares or debentures will be taken up by the public it is advisable for it to get the shares or debentures underwritten to avoid the risk arising from certain unforeseen contingencies which may endanger the success of the issue.
In simple words the term underwriting means that a person agrees to take shares or debentures specified in the underwriting agreement, if the public fail to subscribe for them. Consideration for this contract takes the form of a commission whether or not the underwriters are called upon to take up any shares or debentures.
The following conditions however, have to be fulfilled for the payment of underwriting commission:
1. The payment of commission should be authorized by the Articles of the company
2. The commission paid or agreed to be paid must not exceed 10% by the price at which the shares are issued or such lower rates as may be fixed by the articles
3. The amount and rate of the commission and the number of shares which underwriters have agreed to subscribe must be disclosed as:
a) In the case of shares offered to the public for subscription, the disclosure must be made in the prospectus
b) In the case of shares not offered to the public for subscription, the same disclosure must be made in the statement in the prescribed form delivered to the registrar before payment of the commission
This is a payment made to issuing houses and brokers in return for their placing the company’s shares or securities but without undertaking to subscribe for them. It differs from underwriting commission in that it is payment made to an agent who is selling the company’s shares on its behalf without undertaking to buy the shares which he fails to sell.
In Andreae V Zinc Mines of Great Britain Ltd, the court explained that a payment is brokerage only if it is made to “stockbrokers, bankers and the like that who exhibit prospectuses and send them to their customers and through whose mediation the customers are induced to subscribe” as. Consequently, a payment which was made to a lady of a percentage on the amount of capital which she induced third parties to subscribe for shares in the defendant company was held not to be brokerage. The lady could not be regarded as a “broker” on the basis of such an isolated transaction. The person to whom the payment is made must be one who carries on the business of a broker, either exclusively or as part of his general business, as in the case of a banker.
Therefore, though the payment of brokerage results in the company receiving less money for the shares, the payment is nevertheless not prohibited by the Act.
Differences between the position of underwriters and brokers
Definition of Allotment
Allotment is the company’s acceptance of an applicant’s offer to take up the shares. It concludes a legally binding agreement between the applicant and the company.
However it doesn’t constitute the applicant as a member of the company as held in Re: Nicols case where Wilkinson applied for 100 shares of a company and was allotted the same. The company required him to pay £8 for every share held, his name was not entered in the register of members and he did not pay the amount demanded. Three years later, the BOD cancelled the allotment and issued the shares to third parties. Upon liquidation, Wilkinson’s name was put on the list of contributories. It was held that he was not liable as a contributory as he was not a member of the company.
An allotment, legally, is the company’s acceptance of an offer to buy its shares. It is governed by the following common law rules relating to contract:
a. Where a company issues a prospectus, the issue is an invitation to treat but not an offer.
b. The company’s acceptance must be unconditional. If, therefore, the application was for 10 shares and only 5 were allotted, the allotment would be a counter-offer which the allottee could reject. But this might be the only reasonable or just thing for the company to do if the issue was over-subscribed.
c. The acceptance must be communicated to the applicant. This means that the allottee must actually receive the letter of allotment so that he is aware of the allotment. If the letter of allotment is lost in transit there would be no binding contract. However, it was explained in Household Fire Insurance Co. Ltd v Grant that, if the applicant expressly or impliedly authorized the company to communicate the acceptance by post, there would be a binding contract the moment the letter of acceptance is posted. It is irrelevant that the letter was delayed or, as in that case, was lost in transit.
d. The allotment must be made within a reasonable time
Rules for the allotment of shares in a public company
The following are rules provided in section 354 of the Companies Act in the allotment of shares by a public company.
The issue must be subscribed for in full;
The offer is made on terms that the shares subscribed for may be allotted for in any event; or if specified conditions are made and those conditions are satisfied.
A company shall not allot its shares at a discount.
A public company shall not allot share unless at least one-quarter of its nominal value is paid up.
A public company shall not allot shares as fully or partly paid up otherwise than in cash. Consideration to a company in the allotment of shares must therefore be cash.