Capital reduction is the process of decreasing a company's shareholder equity through share cancellations and share repurchases , also known as share buybacks. The reduction of capital is done by companies for numerous reasons, including increasing shareholder value and producing a more efficient capital structure. After a capital reduction, the number of shares in the company will decrease by the reduction amount. While the company's market capitalization will not change as a result of such a move, the float , or number of shares outstanding and available to trade , will be reduced.
The act of capital reduction may also be enacted in response to a decline in a company's operating profits or a revenue loss that cannot be recovered from a company's expected future earnings. In some capital reductions, shareholders will receive a cash payment for shares canceled, but in most other situations, there is minimal impact on shareholders. A company is required to reduce its share capital using a set of specific steps.
First, a notice must be sent out to creditors of the resolution of the capital reduction. Second, the company has to then submit an application for entry of the reduction of share capital no earlier than three months after publication of the initial notice. Share capital reduction is then expected to be paid to shareholders no earlier than three months after the entry of reduction in the commercial register.
Many companies decide to reduce capital through repurchase agreements buybacks. Sirius XM will fund the repurchase through cash on hand, future cash flow from operations , and future borrowings. Tools for Fundamental Analysis. Your Privacy Rights.
To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. The assets are overvalued and the balance sheet consists of fictitious assets with debit balance in profit and loss account. In order to reduction of capital will write-off that portion of capital which is already lost and will make the balance sheet look healthy.
So, reconstruction in which the once again reorganized by reevaluation assets and liabilities and writing off the losses by reducing the paid up of shares. Such a process is called internal reconstruction which is carried out without liquidating the company. It is an agreement to pare losses by creditors and shareholders. Moreover, external reconstruction, which is totally different from internal reconstruction, can also take place because of the following reason:.
The share capital of a company is the only security on which creditors rely. So, any reduction of share capital diminishes the fund out of which they are to be paid. As a result, companies with shares are not allowed to reduce the capital frequently. However, there may be genuine reason to reduce capital. The entity applying for reduction of capital will either be a company limited by shares or a company limited by guarantee but having share capital. The company can reduce capital by employing one of the following methods:.
During the times of managing capital reorgansiation issues, investors are told about the ratio of the old to new share, or the number of new shares cancelled or received for each class of shares. In cases where multiple classes of shares are received, the value of each class of share on the date of the capital reorganization is required to share out cost between the shares.
Since reduction of capital is a very sensitive issue, the company has to get approval by the Tribunal on the application made. The tribunal will give notice to every application made for reduction of capital to the Central government, Registrar and to the Securities and Exchange Board of India in case of listed companies. Notices will also be given to all the creditors of the company.
In case no remark is made by these institutions and creditors within three months, then it will be presumed that they have no objection to the reduction of capital.
The order of confirmation of the reduction of share capital by the tribunal will have to be published by the company. If the company fails to comply with the provisions relating to publication of order, it shall be punishable with fine which shall not be less than Rs 5 lac.
Also, the company will deliver a certified copy of the Tribunal mentioning the amount of share capital, the number of shares into which it is to be divided and the amount of each share. In case of forfeiture of shares, a company may if authorized by its articles forfeit shares for non-payment of calls by the shareholders.
Conversion of equity to debt usually involves the conversion ofpreference shares to some form of debenture. Although through the eyesof both companies and investors there is little to choose betweendebentures or preference shares bearing a fixed rate of return, in theeyes of both tax and company law they are very different:.
This procedure might be undertaken to improve security, flexibility or cost of borrowing. For example:. The legal aspects of corporate reconstruction. Reconstruction schemes may be undertaken in companies which are healthy or those in financial difficulties. The boundary line between these two types of scheme is not clearcut. Some provisions of company law can be used by both types ofcompany. For example the capital reduction provisions of S in the UKCompanies Act can be used by a company to tidy up its balance sheetreserves or to write off debit balances arising from trading losses sothat further finance can be obtained.
Revalue assets todetermine their current value to the business. The interests of a number of different stakeholder groups must betaken into account in a reconstruction. A reconstruction will only besuccessful if it manages to balance the different objectives risk andpotential return of:. In a failing company, the reconstruction should be organised sothat the main burden of any loss falls on the ordinary shareholders.
Test your understanding 4. Why is it important to consider the interests of shareholders in developing a reconstruction scheme?
Different stakeholder requirements. Wire Construction plc has suffered from losses in the last threeyears. Its statement of financial position balance sheet as at 31December 20X1 shows:. Sales have been particularly difficult to achieve in the currentyear and inventory levels are very high.
Interest has not been paid fortwo years. The debenture holders have demanded a scheme ofreconstruction or the liquidation of the company. Show the likely position of the key stakeholders ordinaryshareholders, preference shareholders and debenture holders if the firmgoes into liquidation.
Assume that. Illustration 2: Wire Construction Part 2. During a meeting of shareholders and directors, it was decided tocarry out a scheme of internal reconstruction. The following scheme hasbeen proposed:.
It is agreed that the value of the interest liability isequivalent to the nominal value of the shares issued. Prepare the statement of financial position balancesheet of the company, assuming that the proposed reconstruction hasjust been undertaken.
Tutorial note: in a question like this, do not waste timeproducing a statement of financial position unless it is specificallyasked for by the examiner. Test your understanding 6: Wire Construction Part 3. Advise the shareholders and debenture-holders as to whether they should support the Wire Construction plc reconstruction.
More detail on the Wire Construction Case Study. Detailed advice to shareholders and debenture holders, relating to the third part of the case study. It follows that the scheme must be favourable to thedebenture-holders if it is to have success. The holders are beingoffered an increased rate of interest but an extended repayment date.
In financial terms it is a matter of comparing the prospective rateof interest with interest rates currently available elsewhere. The preference shareholders are having half of their investmentturned into equity.
This is very reasonable as about half their capitalwould be lost on a liquidation. In addition they will have anincreased dividend rate and are not required to contribute any furthercapital. However, as the shareholders would receive nothing on aliquidation, the additional expected return to them is twice 5. Test your understanding 7: Another reconstruction example. BDJR Computers Global is a company that manufactures a range ofpersonal computers that are sold to retailers, and also directly toindividuals and businesses through online sales.
The company has, as a result, built up losses on itsretained earnings and there is a significant risk of insolvency. The bank loan is secured. In addition to investing in the newmanufacturing process the finance will also be used to repay thepayables. Assume no tax losses. Unbundling is the process of selling off incidental non-corebusinesses to release funds, reduce gearing and allow management toconcentrate on their chosen core businesses.
The main aim is to improveshareholder wealth. Unbundling can take a number of forms:. Test your understanding 8. Spin-offs or demergers. The aim of a demerger is to create separate businesses whichtogether have a higher value than the original company. Following ademerger:. Management buy-outs.
Overall the distinguishing feature of an MBO is that a group ofmanagers acquires effective control and substantial ownership and formsan independent business. Several variants of an MBO may be identifiedand are explained below:.
Prior to thebuy-out the company was the Springfield, Missouri unit of InternationalHarvester, a manufacturer of agricultural and construction equipment inthe USA. In although the unit was profitable, International Harvesterwas in significant difficulties and decided it no longer needed theSpringfield unit. MBOs are not dissimilar to other acquisitions and many of the factors to be considered will be the same:.
For small buy-outs the MBO, the price may be within thecapabilities of the management team, but the acquiring group usuallylack the financial resources to fund the acquisition.
Severalinstitutions specialise in providing funds for MBOs. These include:. The types of finance and the conditions attached vary between the institutions. Points to be considered include:. The management buy-out industry has developed a range of colourful jargon terms over its period of existence, such as:.
Both the management buy-out team and the financial backers willwish to be convinced that their proposed MBO will succeed. It isimportant to ask the following questions:. Test your understanding 9. Numerical example of a management buy-out. Loans are repayable over the next five years in equalinstalments. They are secured on various specific assets, includingproperties. The manufacturing company to be acquired is at present part of amuch larger organisation, which considers this segment to be no longercompatible with its main line of business.
This will be in theform of unused overdraft facilities. As is common to MBOs the gearing level will be very high. The rewards are potentially very high. One consequence of the level of gearing is that it will bedifficult to raise any additional finance. There are unlikely to be anyassets that are not secured, and in any case the level of interest andloan repayments would probably prohibit further borrowing. The annual amount will be:. The redeemable preference shares will be either cumulativeor non-cumulative.
There is a little flexibility inthat if the dividend cannot be met it can be postponed but notavoided. The redeemable preference shares will have to be repaidafter 10 years.
This can either be provided for over the 10 years, or analternative source of finance found to replace the funds. The element of the overdraft used to finance the purchaseprice is effectively a source of long term finance. This will be the first priority of the new company. Themanagement team will need to generate sufficient funds from the onlyavailable source, operations, in order to meet this commitment.
0コメント