LESSON 8:

Corporate finance

1 Introduction
One of the main advantages of running one’s business in the form of a company is that a company
has a separate legal or jurustic personality from its shareholders. This means that a company is the
owner of its own assets and is responsible for its own obligations.
Another major advantage of the company as a business form is that it affords the opportunity to raise
money from a wide range of investors. In this chapter, we explain the different ways in which a
company can raise money. You will also learn how dividend payments work.
In certain circumstances, a company may buy back shares it previously issued, and financially assist
a person to buy shares in that company. You will learn when a company may buy back shares. Finally,
we pay attention to the circumstances in which a company may assist a person financially to purchase
shares in that company.
A company obtains the funds it needs for its business by two possible means: equity financing and
debt financing. Equity financing entails the issuance of shares in return for money, which then makes
up the company’s share capital. Debt financing takes the form of loans, either in the form of bank loans
or debt securities. Debt securities are issued in a similar way to shares. The traditional debt security
is called a debenture.
The providers of equity financing are the company’s shareholders. They receive a return on their
investment in the form of dividends. If the company is wound up, and after all the company’s creditors
have been paid, the shareholders are entitled to the balance of the company’s assets.
The providers of loan capital are called company creditors. The return on their investment is interest
and the principal amount of the loan which must be paid back at a specified time as agreed.
We only highlight the characteristics of shares and debentures, the procedure for the issuance of
shares, and the procedure for making distributions. In other words, you are only required to study
para 1 (including its sub-paragraphs) and para 4 in chapter 3. In chapter 4, you only need
to study paras 1, 2 (including all sub-paragraphs) 4 and 5 in the textbook.

You will know that you understand this lesson if you are able to answer the following key
questions:

Textbook: chapter 3 para 1

• Companies ActWhich types of preference share may a company issue?
• When must the board of directors obtain the approval of the shareholders before issuing
shares?
• What are the differences between shares and debentures?
• What is meant by the pre-emptive rights of shareholders in private companies?
2 The definition of a share

Prescribed study material

Textbook: chapter 3 para 1
o Companies Act: section 35
Important terms Meaning
 Distribution Any direct or indirect transfer of money or other property of the company,
whether out of capital or profits, to shareholders in their capacity as
shareholders.
Share Incorporeal, movable property transferable in the manner provided for by the
Companies Act.
Deferred shares A class of shares commonly issued to the founders of the company. (The right
of the holder to receive dividends is deferred (delayed) until dividends have
been issued to all the holders of other classes of shares in the company.)
Debenture A document issued by a company acknowledging that it is indebted to the holder
in the amount stated therein.
Dividend A distribution by a company to its shareholders of part or all its profits.
Ordinary shares The residual category of a company’s shares that does not carry any special
class rights, such as special voting rights or preferential rights to payments of
dividends.
Preference shares A class of share that provides a preferential right, including a preference to
receive dividends when declared, for its holder.

The Companies Act defines a “share” as “one of the units into which the proprietary interest in a profit
company is divided” (section 1). Shares are movable, transferable property without a nominal or par
value.
A shareholder is essentially one of the contributors to the fund that sets up a company. This fund is
the share capital of the company. A “share” is the unit of the contribution made to the share capital. It
is property and can be traded.
The number of shares must be authorised in the Memorandum of Incorporation. The Memorandum of
Incorporation of a company must set out the classes of shares and the number of each class that a
company is authorised to issue. This is referred to as the “authorised share capital” of a company.
A company may only issue shares that are authorised by the Memorandum of Incorporation. However,
a company’s board of directors may increase or decrease the authorised share capital. They may
further reclassify any shares authorised but not issued.
If a company issues 100 shares and the price per share that a shareholder pays is R1, the company
will have a share capital of R100. In other words, the company will have raised R100 to use in its
business. After the initial issue, the share will be worth what the market is willing to pay for it.
In Standard Bank of SA Ltd v Ocean Commodities Inc, the court held that a share usually entitles its
holder to vote at a shareholders’ meeting, to share in dividends if declared by the board, and to share
in any assets of the company after it has been wound up. Therefore, there are personal rights attached
to shares. The extent of these rights depends on the class of shares held.

3 Classes of shares

Prescribed study material

Textbook: chapter 3 para 1.1–1.3
o Companies Act: sections 36 and 37

A company may divide its shares into different classes of shares

Shares are divided into classes according to the specific rights that a share confers on its holder.
The rights, which differ among the various classes, can usually be divided into the following:
• the right to vote
• the right to information
• the right to share in the profits that have been declared as a dividend
• the right to share in the assets that are left on the winding-up of a company after the company’s
creditors have been paid
The classes of shares most commonly found are preference shares, ordinary shares, and
deferred shares.

3.1 Preference shares

Preference shares provide their holders with a preference over other shareholders to dividends and/or
return on capital on winding-up. One needs to consult the Memorandum of Incorporation of the
company, as well as the terms of issue of the preference shares, to find out in which respect they
confer a preference on their holders. If the preference shareholders have the right to receive dividends
first, this right is usually subject to a dividend being declared. In other words, if the company has not
made any profit, or if the directors decide rather to use profits in the business than to declare them as
dividends, the preference shareholders do not have a right to demand a dividend payment.
In return for the preferential rights to dividends, the right of preference shareholders to vote is usually
curtailed in the Memorandum of Incorporation. However, even if the Memorandum of Incorporation
provides that preference shareholders do not have the right to vote, the Companies Act provides that
they have an irrevocable right to vote on any proposal to amend the preferences, rights, limitations,
and other terms associated with their shares.
There must always be at least one class of shareholders of the company that can vote at a meeting
of shareholders, and at least one class of shareholders that is entitled to the net assets of the company
upon its liquidation. In other words, a company is not allowed to issue only preference shares that do
not grant their holders the right to vote.
The following types of preference share can be distinguished:
• Cumulative preference shares: Holders enjoy a right of priority in respect of both arrear dividends
and current dividends. If a dividend is not declared in a specific year, the shareholder’s right to a
dividend is carried over to the next year. When a dividend is declared the next year, the
preference shareholder will have to be paid two years’ dividends before the ordinary shareholders
can receive their dividends.
• Participating preference shares: After receiving their preference dividends, preference
shareholders may be given the right to also receive normal dividends along with the ordinary
shareholders or just after the ordinary shareholders.
• Preferential right to capital on winding-up: Preference shareholders could be given the
preferential right to receive repayment of the capital they contributed to the company on its
winding-up. Additionally, they can be given the right to share in any surplus assets of the company
upon its winding-up after receiving their capital contributions, but this is the exception rather than
the rule.
• Convertible preference shares: The right to convert the preference shares to shares of another
class after a certain date attaches to the preference shares.

3.2 Ordinary shares

Such shares constitute the equity share capital of the company; the amount of the dividend paid
fluctuates in accordance with the profits of the company.
Ordinary shareholders usually receive dividends after the preference shareholders have received
theirs. Ordinary shareholders also usually have the right to receive any surplus assets of the company
after it has been wound up.
Normally, ordinary shareholders will have the right to vote at meetings of shareholders. In terms of the
Companies Act, this right may be curtailed, so that one class of ordinary shareholders will not have
the right to vote.
However, there must always be at least one class of shareholders that has the right to vote, and, if
there is only one class of shareholders, they must all have the right to vote.
3.3 Deferred shares
Occasionally, shares are issued to the founders of a company that entitle them to dividends only if the
dividend amount exceeds a certain threshold, and after the ordinary shareholders have been paid. In
other words, deferred shareholders are last in line to receive dividends.

4 Issue of shares

Prescribed study material

Textbook: chapter 3 para 1.3
o Companies Act: sections 38 and 41

The board of directors has the power to issue shares without approval of the shareholders, but these
shares must be authorised by the Memorandum of Incorporation, either before the shares are issued
or within 60 business days after the issue. The board of directors has the authority to increase or
decrease the authorised number of shares, except to the extent that the company’s Memorandum
provides otherwise. The shareholders may also amend the scope of the authorised share capital by
way of an amendment to the Memorandum of Incorporation by means of a special resolution.
In the following circumstances, a resolution by the board of directors to issue shares must be approved
by a special resolution of the shareholders:
• where the shares are issued to a current or future director or prescribed officer of the company
(A “future director” or “future prescribed officer” does not include a person who becomes a director
or officer more than six months after the shares were issued.)
• where the shares are issued to a person related or interrelated to the company, a director, or a
prescribed officer of the company
(A natural person is related to another natural person if he or she is married to that person or
lives together with that person as if they were married, or if they are separated by no more than
two degrees of natural or adopted consanguinity; in other words, a person’s parent, child, sister
or brother, or grandparents. A natural person is related to a company when she or he directly or
indirectly controls the company by either having the majority of voting rights or by having the right
to appoint the majority of directors of the company. A juristic person is related to another juristic
person if it directly or indirectly controls the other by either having the majority of voting rights or
by having the right to appoint the majority of directors of the company, or if it is a subsidiary of
the company, or if it controls the business of the company.)
• where the shares are issued to a nominee of a director of prescribed officer
• where the shares are issued to a nominee of any of the persons mentioned above
• where the voting power of the shares to be issued will exceed 30% of the voting power of the
shares of that class held immediately before the issue.

No special resolution is required where the issue is:

• in terms of an underwriting agreement
• in the exercise of pre-emptive rights
• in proportion to existing shareholdings and on the same terms and conditions as have been
offered to all shareholders
• in pursuance of an employee share scheme
• in pursuance of an offer of shares to the public
A company may not issue shares to itself.
5 Right of pre-emption or pro rata offer

Prescribed study material

Textbook: chapter 3 para 1.4
o Companies Act: sections 39 and 40

In terms of section 39 of the Companies Act, every shareholder in a private company (and a personal
liability company) has the right, before any other person who is not a shareholder of the company, to
be offered and to subscribe (within a reasonable time) for a percentage of any shares issued or
proposed to be issued equal to the voting power of that shareholder’s general voting rights immediately
before the offer was made. However, a company’s Memorandum of Incorporation may limit, negate,
or restrict this right with respect to any or all classes of shares of that company.
A company’s Memorandum of Incorporation may, however, restrict or exclude this right in respect of
any or all classes of shares in the company. (See the discussion on alterable provisions contained in
the Memorandum of Incorporation.)
Therefore, the general rule is that shareholders of private companies have a right of pre-emption to
new shares issued by the company. This means that, when the company issues new shares, these
shares must be offered to existing shareholders first, pro rata to their current shareholdings. However,
the right of pre-emption will not apply if the shares are issued in terms of options or conversion rights
as capitalisation shares or if the shares are issued for future consideration.
The reason this provision was included in the Companies Act is to guard against the dilution of
ownership in private companies. Dilution of ownership can be explained as follows: Suppose that
Fidelity (Pty) Ltd has two shareholders who each hold ten shares. At a meeting of shareholders, they
will have equal voting power. Suppose that Fidelity (Pty) Ltd wants to issue twenty more shares. If a
third person acquires all twenty of these shares, that person will have half of the voting rights at a
meeting of shareholders. The original shareholders will now only have 25% each of the voting power
at meetings of shareholders. If they had exercised rights of pre-emption, each of them would have
been entitled to half of the twenty shares, and, consequently, they would retain the same percentage
voting power in the company.

6 Debentures

Prescribed study material

Textbook: chapter 3 para 4
o Companies Act: section 43
Prescribed case law
You need only know the following case as discussed herein:
• Coetzee v Rand Sporting Club 1918 WLD 74

A debenture is an acknowledgement by a company that the company owes the debenture holder a
certain sum of money, as evidenced by the document. Debenture holders are creditors of the company
by virtue of having extended loans to the company.
The duties of the company towards the debenture holders can be secured or unsecured. A trustee will
usually be appointed to hold security on behalf of the debenture holders. If the company defaults on
its commitments to the debenture holders, the trustee will be able to enforce the security on their
behalf, without the need for every debenture holder to institute action individually.
 The board of directors may authorise the company to issue debentures without approval of the
shareholders, unless otherwise indicated in the Memorandum of Incorporation.

Distinctions between shareholders and debenture holders:

• A shareholder of a company has the right to a share in the profits of that company (provided that
a dividend is declared by the company), and a right to a share in the net assets of the company
if it is wound up. However, a shareholder is also under a duty to abide by the company’s
Memorandum of Incorporation.
• As a debenture is a debt instrument, the holder of a debenture has effectively loaned a sum of
money to the company on certain terms.
• Accordingly, the debenture holder is entitled to repayment of the sum of money loaned to the
company and is, therefore, a creditor of the company. A debenture is a document issued by a
company acknowledging that it is indebted to the debenture holder in the amount stated therein
(Coetzee v Rand Sporting Club 1918 WLD 74).
• Debenture holders may have a right to attend and vote at general meetings and to appoint
directors, and have special privileges regarding the allotment of securities, unless the
Memorandum of Incorporation provides otherwise (section 43(3)). This was, however, not
previously the case under the Companies Act 61 of 1973.

7 Company distributions

Prescribed study material

Textbook: chapter 4 para 4
o Companies Act: sections 1 (definition of “distribution”) and 46 (requirements for
distributions)

Section 46 of the Companies Act regulates distributions. A distribution is any direct or indirect transfer
by a company of money or other property of the company (except its shares) to one or more of its
shareholders or beneficial holders of shares, whether as the payment of dividends, payment for the
purchase by a company of its previously issued shares, the incurrence of a debt for the benefit of one
or more of the shareholders of the company, or the forgiveness of a debt owed to the company by one
or more of the shareholders of the company.
A distribution may be made in the following circumstances:
• The board of directors must authorise the distribution.
• It must reasonably appear that the company will be able to satisfy the solvency and liquidity
tests immediately after the distribution has been made.
• The board must acknowledge by way of a resolution that it has applied the solvency and
liquidity tests and reasonably concluded that the company will satisfy the tests immediately
after completion of the proposed distribution.
� The solvency and liquidity tests are set out in section 4 of the Companies Act:
Solvency test: That, in considering all reasonably foreseeable financial circumstances of the company at
that time, the assets of the company, fairly valued, equal or exceed the liabilities of the company.
Liquidity test: That, in considering all reasonably foreseeable financial circumstances of the company at that
time, it appears that the company will be able to pay its debts as they become due in the ordinary course of
business for a period of 12 months after the distribution. If the distribution was in the form of giving a loan to
a shareholder or forgiving a loan made to a shareholder, the period runs from 12 months after the test was
considered.

The distribution must be made within 120 days after the test was applied, otherwise the resolution by
the board must be taken again and the test must be applied again.
If these requirements are met, dividends can be paid out of the share capital of a company. However,
usually dividends are paid from the profits of a company. The board of directors decides how much of
the profits it wants to pay out to shareholders. It is free to decide that it is going to keep all profits for
the expansion of the business of the company. Normally, in such circumstances, the shareholders are
not entitled to dividends.

8 Company or subsidiary acquisition of a company’s shares

Prescribed study material

Textbook: chapter 4 para 5
o Companies Act: sections 46 and 48

The board of a company may determine that the company will acquire a number of its own shares.
The board of a subsidiary company may determine that it will acquire a number of shares in its holding
company. The company or subsidiary may then, in terms of section 48 of the Companies Act, make
an offer to the shareholder/shareholders. This offer may then be accepted or rejected.
Section 48 of the Companies Act does not require that an offer be made to all shareholders or that
the offer must be made according to the interest that the shareholders hold in the company.
If the shares are to be acquired from somebody who is related to the company or from a prescribed
officer of the company, the board’s decision to acquire the shares must be approved by the
shareholders by way of a special resolution. If a company wishes to acquire more than 5% of the
shares of a particular class, specific requirements apply. A subsidiary may likewise not own more than
10% of the number of any class of shares after acquiring shares from its holding company, and the
shares so acquired will not enjoy voting rights in the holding company for as long as the subsidiary
remains a subsidiary. An acquisition of shares which would have the effect of leaving only convertible
or redeemable shares is prohibited.
The acquisition of its own shares by a company is a “distribution”. Therefore, the requirements of
section 46 of the Companies Act must be complied with. If the solvency and/or liquidity criteria as
required in section 46 as well as section 48 of the Companies Act are not complied with, the acquisition
of shares cannot be enforced. In such a case, the company may within two years after the acquisition
apply to court for an order reversing the acquisition of the shares. The court has a discretion to order
the return of the amount paid by the company and the return of the shares.
Directors who are present at a meeting, or who participate in authorising the acquisition, may be held
personally liable for the loss or damages suffered by the company resulting from a failure to vote
against a decision, despite knowing that the requirements of sections 46 and 48 of the Companies Act
were not complied with.
Should the company have agreed to buy back shares, and it later becomes clear that it will not be
capable of complying with its obligations in terms of the agreement, since it will not be able to satisfy
the requirements of section 48(2) and (3) – which includes the requirements of section 46 regarding
a distribution (thus the solvency and liquidity tests) – the agreement between the shareholder and the
company in terms of which the company would buy back the shares, remains enforceable. The
company, in such a case, must apply to the court for an order suspending the acquisition of the shares.
The company bears the onus of proving that it is unable to comply with the requirements of the
Companies Act. The court may make any order that it deems justified and fair which ensures that the
person from whom the shares were purchased will be paid at the earliest opportunity, which is feasible
for the company, and that the company will also be able to meet its other financial obligations as they
become payable.
 9 Financial assistance for the purchase of securities

Prescribed study material

Textbook: chapter 4 para 2
o Companies Act: section 44
Prescribed case law
You only need to know the following cases as discussed herein:
• Lipschitz v UDC Bank Ltd 1979 (1) SA 789 (A)
• Gradwell (Pty) Ltd v Rostra Printers Ltd 1959 (4) SA 419 (A)

In terms of section 44 of the Companies Act, a company may give financial assistance by way of a
loan, guarantee, provision of security, or otherwise to a person for the purpose of, or in connection
with, the acquisition of shares and other securities in the company, provided that such assistance is not
prohibited by the Memorandum of Incorporation and that certain requirements are met.
The decision to assist a person to acquire shares in the company rests with the board of directors, but
only where the assistance is in terms of an employee share scheme or where a special resolution
by the shareholders taken within the previous two years authorised such assistance to a specific
person, or to persons that fall in a specific class or category. In the latter case, the person to whom
the assistance will be given must fall in that class.
Section 44 further requires that the board must be satisfied that the solvency and liquidity
requirements will be satisfied immediately after providing the financial assistance (see above), and
that the assistance is given on terms that are fair and reasonable to the company. The Memorandum
of Incorporation may place further restrictions on the provision of financial assistance, and the board
must ensure that these requirements are also met.
The Lipschitz v UDC Bank Ltd decision dealt with the prohibition of financial assistance in terms of the
1973 Companies Act. However, the decision is still important for the application of section 44, because
it gives us guidelines on when the provisions of the section will be applicable to a particular scenario.
In Lipschitz v UDC Bank Ltd, it was held that the transaction must be assessed in two phases:
• Firstly, it must be ascertained whether there was financial assistance. In Gradwell (Pty) Ltd v
Rostra Printers Ltd, the “impoverishment test” was formulated to assist in determining whether
financial assistance was provided. In terms of the impoverishment test, one considers whether a
transaction will have the effect of leaving the company poorer. If so, financial assistance will have
been provided. In Lipschitz, the court held that this is not the only measure of financial assistance,
but that exposing the company to risk will also qualify as financial assistance for purposes of the
Act. For example, if the person obtained a loan to purchase shares in the company, and the
company stood surety for that loan, this will count as financial assistance. If the company buys
an asset from the person to enable that person to purchase shares in the company, it will depend
on the facts whether there was financial assistance. Factors that have emerged from case law to
assist in this regard are whether the company needs the asset in its normal business and whether
the company paid a fair price for it.
• Secondly, it must be determined whether that assistance was for the purpose of acquiring
shares in the company. Suppose Company A is a major creditor of Company B. Company A
acquires most of the shares in Company B. After the acquisition, Company A causes Company
B to grant security over its movable assets to secure the loans. This will be financial assistance
in terms of the first test, but it is not in connection with the purchase of shares. The assistance is
to secure a loan.
When a transaction passes these two phases, it will have to comply with section 44 of the
Companies Act to be valid. If it was not financial assistance, or if the assistance was not in
connection with the purchase of shares, section 44 is not relevant to the transaction.
➔ Reflection

The importance of capital maintenance to ensure that company creditors are not prejudiced by some
of the transactions companies may enter into, is clear. Can you recall the circumstances in which the
solvency and liquidity criteria must be adhered to before a company is allowed to take action?
Companies issue shares and debentures to raise capital. They, however, confer different rights on
their holders. You should be able to identify these differences. We have also explained the
circumstances in which a company may make distributions.