CHAPTER 10 THE CORPORATE FINANCIAL STRUCTURE © 2013 Delmar Cengage Learning

Corporate Capitalization The corporation’s assets are referred to as the corporate capital. Adequate capitalization of a corporation is important to its financial success and to protect the personal liability of its shareholders. The board of directors is generally responsible for determining the appropriate mix of equity financing and debt financing for the corporation. © 2013 Delmar Cengage Learning

© 2013 Delmar Cengage Learning Equity Financing EQUITY FINANCING The issuance of shares of stock (equity securities) of the corporation in exchange for cash or other consideration that will become corporate capital The statutes of most states provide that every corporation must at all times have issued stock that has unlimited voting rights and the right to receive the net assets of the corporation on dissolution. © 2013 Delmar Cengage Learning

Common and Preferred Stock COMMON STOCK PREFERRED STOCK If stock is not designated otherwise, it is considered common stock. Unless otherwise designated in the articles of incorporation, common stockholders are entitled to: the right to participate in the control of the corporation by voting; a pro rata share of the corporation’s profits ; a pro rata share of the corporation’s assets on its dissolution. Entitled to a priority over other stockholders in the distribution of profits Terms may be flexible and are set forth in the corporation’s articles of incorporation and on the face of the stock certificate. May be voting or non-voting stock © 2013 Delmar Cengage Learning

© 2013 Delmar Cengage Learning Par Value PAR VALUE The nominal value assigned to shares of stock The modern trend is toward authorizing stock without par value as is permitted by the statutes of most states. Stock issued for less than par value is considered watered stock. © 2013 Delmar Cengage Learning

Consideration for Shares of Stock ADEQUATE CONSIDERATION When issuing stock, the board of directors must consider: The value of the stock The value of the consideration received for the stock. © 2013 Delmar Cengage Learning

STOCK CERTIFICATES MUST INCLUDE: Issuance of Stock STOCK CERTIFICATES MUST INCLUDE: The name of the issuing company The name of the shareholder The number and class of shares the certificate represents Summary of the designations, relative rights, preferences, and limitation of the particular class or series of stock © 2013 Delmar Cengage Learning

LOST OR DESTROYED STOCK CERTIFICATES Issuance of Stock LOST OR DESTROYED STOCK CERTIFICATES Lost stock certificates can be replaced when the shareholder submits an affidavit affirming that the certificate was lost or destroyed. The new stock certificate is typically issued with an indication that it is a “duplicate” stock certificate. © 2013 Delmar Cengage Learning

Redemption of Equity Shares Preferred stock may be issued with the right of redemption, providing that the corporation may redeem the stock at a future date upon specified terms and conditions. Redemption may be at the option of the shareholder, the corporation, or a third party. A sinking fund may be used by a corporation to accumulate cash for a planned future acquisition. Treasury shares are previously issued shares of stock that have been reacquired by the corporation. © 2013 Delmar Cengage Learning

© 2013 Delmar Cengage Learning Dividends Dividends are payments to shareholders from the profits of a corporation as a return on the shareholders’ investment. Dividends may be paid only from the profits of the corporation and when the corporation is able to continue to meet its obligations after the dividends are paid. Dividends are paid at the discretion of the board of directors and there is no legal obligation to pay dividends until dividends are declared. Preferred stockholders often have priority over common stockholders with regard to payment of dividends. © 2013 Delmar Cengage Learning

RIGHT TO RECEIVE DIVIDENDS If preferred stockholders have a right to cumulative dividends, they are entitled to payment of any missed dividends from one period before dividends are paid on shares of common stock in the next period. Shareholder approval may be required for the payment of stock dividends. Dividends are declared by the board of directors for payment to all shareholders of record on a specific date. Directors are typically not obligated to declare a dividend on common stock and may decide instead to reinvest profits in the corporation. © 2013 Delmar Cengage Learning

© 2013 Delmar Cengage Learning Stock Splits STOCK SPLITS Stock splits “split” the value of each share of stock into smaller denominations. Stock splits are not considered dividends. © 2013 Delmar Cengage Learning

© 2013 Delmar Cengage Learning Debt Financing Debt Financing—obtaining capital through loans to the corporation, which must be repaid with interest upon the terms agreed to by contract between the corporation and lender. Debt Capital—Capital raised with an obligation in terms of interest and principal payments. The board of directors generally has authority to approve debt financing on behalf of the corporation. © 2013 Delmar Cengage Learning

COMMERCIAL PAPER AND BONDS Debt Financing COMMERCIAL PAPER AND BONDS Commercial papers are short-term, unsecured debt instruments issued by the corporation in the form of promissory notes. Bonds are issued to bondholders with a variety of rights to raise capital for the corporation. Bondholders have no voting rights; a bondholder is more of a creditor than an owner. © 2013 Delmar Cengage Learning

Secured Financing and the UCC A security interest is an interest in property that secures payment or performance of an obligation. When a lender assumes a security interest in the borrower’s collateral, it is a secured transaction. Secured transactions are subject to Article 9 of the Uniform Commercial Code (UCC). © 2013 Delmar Cengage Learning

Equity Capital vs. Debt Capital Represents an ownership in the company. Payment of dividend to shareholders is usually optional. Dividends paid on shares of stock are not tax deductible. Issuance of stock maintains a lower debt/equity ratio. Issuance of stock may dilute current shareholder control. Shareholders entitled to dividends only from profits. Represents a loan of capital to the company that must be repaid. Periodic payment of fixed interest to debt holder is mandatory. Interest paid on debt financing may be tax deductible. Too high a debt/equity ratio increases the likelihood of insolvency. Incurring debt does not affect current shareholder control. Interest must be paid before profits calculated or dividends paid. © 2013 Delmar Cengage Learning

© 2013 Delmar Cengage Learning The Paralegal’s Role Research requirements for debt and equity financing Draft articles-of-incorporation provisions for authorized stock of the corporation, including the par value and the rights and preferences associated with each class of stock issued Draft stock subscription agreements Draft resolutions of the board of directors concerning financial matters © 2013 Delmar Cengage Learning