Solution 14.1

Public and private companies

A private limited company is a corporate body, which has a legal existence quite separate from the owners (between two and fifty shareholders) that have restrictions on the transfer of their share, but are protected by limited liability. A public limited company is a corporate body, which has a legal existence quite separate from the owners (minimum of seven shareholders) that are protected by limited liability. Shares are freely transferable as they can be traded publicly and are quoted on a stock exchange.

Shares and debentures

A person invests or buys ownership of a company by purchasing shares in that business. The term debenture is used when a company seeks people or other companies to lend it money. Debentures are a fixed interest loan which can be secured against the assets of the company. A share relates to ownership of a company while a denture relates to a loan to a company with no ownership rights.

Ordinary shares and preference shares

Holders of ordinary shares are the real owners of the business as each share carries voting rights and a right to a share of the profits of the business. Ordinary shareholders receive the remainder of the total profits available for dividend and, in the case of liquidation, are the last to receive any payments of cash and as a result will generally receive no repayment of capital. Holders of preference shares get an agreed, fixed rate of dividend each year. This dividend is paid before any ordinary share dividends are paid. Preference shareholders generally take less risk than ordinary shareholders and thus are not considered the real owners of the business and do not vote on company resolutions such as the appointment of directors etc. In the case of the company going into liquidation they will be repaid their investment before the ordinary shareholders are paid, if there are any monies left in the company.

Capital reserves and revenue reserves.

Capital reserves are reserves that are not available for distribution in the form of dividend to shareholders. Example of capital reserves would be a share premium reserve and a fixed asset revaluation reserve. Revenue reserves consist of unused profits remaining in the appropriation accounts (retained profits) or any amounts that have been transferred to a reserve account from the appropriation account

Bank Loans and debentures.

A bank loan occurs where an individual or business applies to a financial institution for a loan or loan facility. The institution assesses the loan application and decides on whether to grant the loan application.

The term loan note/debenture is used when a public company seeks individual investors or other companies to lend it money. In return the loan providers will get a debenture or loan note certificate on which will be stated the annual interest rate and the repayment date. Debentures can be secured against the assets of the company. Obviously investors may require security before giving a company a loan and hence these debentures are termed mortgage debentures. Unsecured debentures whose interest rate would be higher to compensate investors for the lack of security, are termed simple or naked debentures. Debt is normally arranged for a fixed period and hence can be short-term in nature (less than twelve months) medium term (between two and ten years in duration) and long-term (greater than 10 years). For public companies, debentures or loan note certificates are marketable instrument, which can be sold on to other investors at any time between the date of issue and the redemption date. Thus a bond holder can cash in a bond at any time between the date of issue and redemption in a similar way to selling public company shares. This option of liquidity makes debentures popular for investors. The company that originally issued the bond is not affected by this transaction and cannot be asked to repay a bond ahead of time even if ownership of the bond changes.