Corporations:
A Contemporary Approach
Chapter 1
Introduction to the Firm
Slide 1
of 22
Alicia Martin, Book Sculptures (2013)
Module IV – Corporate Finance
Chapter 10
Corporate Financial Structure
Bar
exam
Corporate
practice
Law
profession
Citizen of
world
Corporations:
A Contemporary Approach
• Capitalizing the corporation
– Equity: common and preferred
– Debt: compare to equity (D/E ratio)
• Tax attributes
• Leverage: risk of insolvency
– Debt-equity mix
• Legal capital
– Money in : legal “consideration”
– Money out: illegal “distributions”
• Dividend policy
– Board discretion
– CHC vs PHC
Chapter 10
Corporate Financial Structure
Slide 2
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1.
Fundamentals
–
–
2.
Corporations and policy
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–
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3.
Chapter 10
Corporate Financial Structure
Sale of control
Antitakeover devices
Deal protection
Close corporations
–
–
Corporations:
A Contemporary Approach
Securities markets
Planning
Securities fraud class actions
Oppression
Insider trading
Corporate deals
–
–
–
10.
Shareholder litigation
Board decision making
Board oversight
Director conflicts
Executive compensation
Corporate groups
Stock corporations
trading
Close
–
–
–
9.
Shareholder voting
Shareholder information rights
Public shareholder activism
Fiduciary duties
–
–
–
–
–
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8.
10.
Piercing corporate veil
Corporate environmental liability
Corporate criminal liability
Corporate governance
–
–
–
7.
Numeracy for corporate lawyers
Capital structure
Corporate externalities
–
–
–
6.
Organizational choices
Incorporation
Locating corporate authority
Corporate finance
–
–
5.
Corporate federalism
Corporate social responsibility
Corporate political action
Corporate form
–
–
–
4.
Introduction to firm
Corporate basics
Planning
Oppression
Slide 3
of 25
Capital (money in)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 4
of 58
Capital - attributes
Return
Risk
Common
stock
Variable dividends
High
• from earnings
• board’s discretion
• growth potential
• voting rights
Preferred
stock
Fixed dividends
Moderate / high
• from earnings
• before pay common
• participating (growth)
• cumulative (certain)
• contingent voting
Bonds
(LT debt)
Principal + interest Moderate / low
Notes
(ST debt)
Principal + interest Low
Corporations:
A Contemporary Approach
• from future ops
• K – not discretionary
• from current ops
• K - not discretionary
• no growth potential
• sometimes secured
• personal guarantees
• no growth potential
• not secured
Chapter 10
Corporate Financial Structure
Tax
Double
corporate tax
Double
corporate tax
Interest
deductible
Interest
deductible
Slide 5
of 58
Financing an acquisition
(recapitalizing a business)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 6
of 58
Justin
(buyer)
Widget Bros
(sellers)
Widget, Inc.
ACQUIRES
Kathy
(buyer)
Lorenzo
(buyer)
JKL Corporation
First National Bank
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 7
of 58
Seller financing
Widget Bros agree to sell their
business for $2.0 million. The
buyers don’t have enough cash
(and also want some extra cash for
expansion).
Terms: $1.25 million in cash +
$750,000 (10-year note @ 12%
(with acceleration upon default).
By the way, isn’t their debt really a
kind of “contingent ownership”?
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 8
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Bank financing
First National Bank will lend
$500,000 to finance the
acquisition and help recapitalize.
Terms: 10-yr note (12% interest /
$100,000 repayment of principal
in years 6-10)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 9
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Owner financing
Justin lacks cash, but wants some
control.
Terms: 40% common for
$100,000 in cash and $100,000
note (escrow shares)
Kathy has more cash, and wants
control
Terms: pays $200,000 for 40%
common
Lorenzo is less worried about control,
but wants steady income
Terms: Pays $600,000 in cash
for 20% common + $500,000
preferred (10% dividend rate,
cumulative, non-participating,
convertible – like VC)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 10
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Sources / uses of financing
Sources of
capital
Sellers
$2,000,000
Corp (expansion)
Loan (sellers)
250,000
$750,000
Loan (bank)
500,000
Preferred (cash)
500,000
Common (note)
100,000
Common (cash)
400,000
TOTAL $2,250,000
Corporations:
A Contemporary Approach
Use of
proceeds
Chapter 10
Corporate Financial Structure
$2,250,000
Slide 11
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Balance Sheet
(JKL Corporation – before acquisition)
ASSETS
LIABILITIES
Current assets (inc $)
$2,830
Current liabilities
$1,750
Prop, plant, equip
$4,000
Long-term debt
$2,000
Accum depreciation
Intangible assets
Total assets
Corporations:
A Contemporary Approach
($1,620)
50
$5, 260
Total liabilities
$3,750
EQUITY
$1,510
Total Liab + Equity
$5,260
Chapter 10
Corporate Financial Structure
Slide 12
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Balance Sheet
(JKL Corporation - as of acquisition date)
ASSETS
Widget pre-acquisition
assets
$5,260
New assets
Note receivable
100
New cash (expansion)
150
Acquisition goodwill
490
Total assets
Corporations:
A Contemporary Approach
$6,000
LIABILITIES
Widget pre-acquisition
liabilities
$3,750
New liabilities
New note (sellers)
750
New note (bank)
500
Total liabilities
5,000
Equity
Preferred stock
Common stock
Paid-in
Total equity
500
1,000
Total Liab + Equity
$6,000
Chapter 10
Corporate Financial Structure
500
Slide 13
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What is leverage?
Outside debt
– Financial returns
– Effect on business
“Equity is soft,
debt is hard”
Inside debt
– Tax
– Bankruptcy
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 14
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Compare two capital structures …
Leveraged
All Equity
(D/E = 4/1)
Owners
$1,000,000
equity
Owners
$200,000
equity
Corporation
Corporations:
A Contemporary Approach
Debt
$800,000 debt
(10% interest)
Corporation
Chapter 10
Corporate Financial Structure
Slide 15
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Favorable results (“the good”)
Operating
income
Interest
Net income
(dividends)
Return on
equity
Corporations:
A Contemporary Approach
All equity
Leveraged
(no leverage)
($1,000,000
invested)
(D/E = 80/20)
($200,000
invested)
$180,000
$180,000
--
$80,000
$180,000
$100,000
18%
50%
($1,000,000
invested)
($200,000
invested)
Chapter 10
Corporate Financial Structure
Slide 16
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Moderate results (“the bad”)
Operating
income
Interest
Net income
(dividends)
Return on
equity
Corporations:
A Contemporary Approach
All equity
Leveraged
(no leverage)
($1,000,000
invested)
(D/E = 80/20)
($200,000
invested)
$100,000
$100,000
--
$80,000
$100,000
$20,000
10%
10%
($1,000,000
invested)
($200,000
invested)
Chapter 10
Corporate Financial Structure
Slide 17
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Unfavorable results (“the ugly”)
All equity
Leveraged
(no leverage)
($1,000,000
invested)
(D/E = 80/20)
($200,000
invested)
$40,000
$40,000
--
$80,000
Net income
(dividends)
$40,000
($40,000)
Return on
equity
4%
minus 20%
($1,000,000
invested)
($200,000
invested)
Operating
income
Interest
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 18
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Effect of outside leverage
All equity
(no leverage)
Leveraged
(D/E = 80/20)
($1,000,000 invested)
($200,000 invested)
Good results
18%
50%
Moderate results
10%
10%
Bad results
4%
(20%)
Return on equity
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 19
of 58
What if owners take on debt …
Leveraged
All Equity
(D/E = 9/1)
Owners
$500,000
equity
Owners
$50,000
equity
Corporation
Corporations:
A Contemporary Approach
$450,000 debt
(20% interest)
Corporation
Chapter 10
Corporate Financial Structure
Slide 20
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Tax advantage of inside debt
Operating income
Interest
All equity
(no leverage)
Leveraged
(D/E = 90/10)
($500,000 invested)
(D$450,000 / E$50,000)
$200,000
$200,000
--
$90,000
(20% interest on $450,000)
Income before taxes
$200,000
$110,000
Corporate tax (15% rate)
$30,000
$16,500
Net income (pay dividends)
$170,000
$93,500
Total return (interest + div)
$170,000
$183,500
Return on investment
(equity + inside debt)
34%
36.7%
($500,000 invested)
($500,000 invested)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 21
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Too much inside debt …
(IRS and bankruptcy)
(1) IRS recharacterizes
(2) Bankruptcy court recharacterizes
• Inside debt treated
as equity
• Inside debt treated as equity
– “equitably subordinated”
• Remedy: interest
not deductible
• Remedy: outside creditors reclaim
place in line
– Deep Rock doctrine
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 22
of 58
Equity-Linked Investors, LP v Adams
(Del Ch 1997)
• Facts
– Company in dire straights
– Preferred vs common (BoD)
– Preferred doesn’t want new debt
• Issue
– Duties of board when on “lip of
insolvency”?
– BJR or special duty to preferred/debt?
• Holding
– Judicial review: Until “point corporation
must be liquidated is …BJR”
• Analysis
– Short-term interests of preferred vs
long-term of common
– “no duty owed to preferred …
protections contractual in nature”
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 23
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Legal Capital
“Validly issued, fully paid
and non-assessable”
(money in)
Legal distributions
(money out)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 24
of 58
Issuance of
equity securities
(money in)
Corporations:
A Contemporary Approach
Hypothetical #1
JKL Corporation has 1,000 no-par
common shares that are
authorized, and were issued to
Justin, Kathy and Lorenzo.
– If the company wants to issue
new common stock, what must
it do?
– What are treasury shares? Can
they be issued?
– At what price must the company
sell the stock?
Chapter 10
Corporate Financial Structure
Slide 25
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Protect proportionality
Hypothetical #2
JKL Corporation shares are held
as follows: Justin (400), Kathy
(400) and Lorenzo (200). Kathy
and Lorenzo, a majority
shareholders and a majority of the
board, decide to authorize and
issue 600 new shares – 400 to
Kathy and 200 to Lorenzo.
– Can they do this without
offering Justin his
proportionate share?
– What protection does Justin
have against dilution?
Corporations:
A Contemporary Approach
Preemptive rights
• What are they?
– shareholder right to purchase
newly issued shares
– proportionate voting and
financial rights
• How create?
– Once mandatory, then
default, now opt-in
– MBCA: No preemptive rights
unless in articles
• Needed?
Chapter 10
Corporate Financial Structure
– Issuance at fair price
– Voting agreements
Slide 26
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Assure equity cushion
Hypothetical #3
Remember that Justin paid
$100,000 cash and gave a
$100,000 personal note for his
JKL shares. Kathy and Lorenzo
paid cash for theirs.
– Was Justin’s note lawful
consideration?
– What protection do
creditors have if JKL
Corporation becomes
insolvent?
Corporations:
A Contemporary Approach
Del. GCL § 152 (old)
… cash, services rendered,
personal property, real
property, leases of real
property or a combination
thereof ....
***
Del. GCL § 152 (as of 2004)
… cash, any tangible or
intangible property or any
benefit to the corporation …
Chapter 10
Corporate Financial Structure
Slide 27
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“Validly issued, fully paid and non-assessable”
Hypothetical #4
MBCA § 6.21
Justin, Kathy and Lorenzo want
some assurance that once
they’ve paid for their shares,
there will be no further payment
obligations.
– What legal opinion can
you give them?
– What documents will you
use in giving your
opinion?
Corporations:
A Contemporary Approach
Before the corporation issues
shares, the board of directors
must determine that the
consideration received or to be
received for shares to be
issued is adequate.
The determination by the board
of directors as to the adequacy
of consideration is conclusive
as to whether the shares are
validly issued, fully paid, and
nonassessable.
Chapter 10
Corporate Financial Structure
Slide 28
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Payment of
dividends
(money out)
Hypothetical #5
Since the acquisition 3 years ago,
JKL Corporation has had some
success. This year there were
$90,000 in net profits. Justin,
Kathy and Lorenzo would like to
take some cash out.
– Can they declare a dividend
of $200,000?
– Answer in Delaware?
– Same for MBCA?
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 29
of 58
Legal distribution
Assets
Cash
Accts receivable
Inventories
Prepaid expenses
Total current assets
Fixed assets
Land
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
$ 200
$1,400
$1,300
$ 600
$3,500
Total Assets
$7,000
Corporations:
A Contemporary Approach
$ 600
$1,700
$1,000
$3,300
$ 100
$ 100
Liabilities & Equity
Current liabilities
$2,650
Long-term liabilities
Note (old one)
$2,000
Note (sellers)
$ 750
Note (bank)
$ 500
Debentures (Bernie)
$ 500
Total liabilities
$6,400
Common stock (5000 shs) $ 500
Retained earnings
$ 100
Total equity
$ 600
Liabilities & Equity
Chapter 10
Corporate Financial Structure
$7,000
Slide 30
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Del GCL § 170
(a) The directors of every corporation ... may declare and pay
dividends ... either (1) out of its surplus ..., or (2) in case there shall
be no such surplus, out of its net profits for the fiscal year in which
the dividend is declared and/or the preceding fiscal year.
Del GCL § 154
... The excess, if any, at any given time of the net asset of the
corporation over the amount so determined to be capital shall be
surplus. Net assets means the amount by which total assets exceed
total liabilities.
Del GCL § 154 [paraphrased]
Capital is –
(1) "the aggregate of par value of shares issued having par value"
(2) "that part of consideration [in dollars] specified by the board to be
capital, for shares issued without par value"If the board does not
specify, "the capital ... shall be ... the amount of the consideration for
such shares without par value.“
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 31
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Legal distribution (Delaware)
Assets
Liabilities & Equity
Current liabilities
$2,650
Cash
$ 200
Long-term liabilities
Accts receivable
$1,400
Common
stock
Note (old one)
$2,000
Inventories
Stated capital (5000 $1,300
shs @100/sh)
$ 500
Note (sellers)
$ 750
Prepaid
expenses
$ 600
Capital
surplus
$ -Note (bank)
$ 500
Total current
assets
$3,500
Retained
earnings
$ 100
Debentures (Bernie)
$ 500
Fixed assets
Total liabilities
$6,400
Land
$ 600
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
$1,700
$1,000
$3,300
$ 100
$ 100
Common (5000 shs)
Retained earnings
Total equity
$ 500
$ 100
$ 600
Total Assets
$7,000
Liabilities & Equity
$7,000
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 32
of 58
Legal distribution (Delaware)
Assets
Liabilities & Equity
Current liabilities
$2,650
Cash
$ 200
Long-term liabilities
Accts receivable
$1,400
Common
stock
Note (old one)
$2,000
Inventories
Stated capital (5000 $1,300
shs @1/sh)
$
5
Note (sellers)
$ 750
Prepaid
expenses
$ 600
Capital
surplus
$ 495
Note (bank)
$ 500
Total current
assets
$3,500
Retained
earnings
$ 100
Debentures (Bernie)
$ 500
Fixed assets
Total liabilities
$6,400
Land
$ 600
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
$1,700
$1,000
$3,300
$ 100
$ 100
Common (5000 shs)
Retained earnings
Total equity
$ 500
$ 100
$ 600
Total Assets
$7,000
Liabilities & Equity
$7,000
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 33
of 58
Legal distribution (Delaware)
Assets
Cash
$ 200
Accts receivable
$1,400
Common
stock
Inventories
Stated capital (5000 $1,300
shs no
Prepaid
expenses
$ 600
Capital
surplus
Total current
assets
$3,500
Retained
earnings
Fixed assets
Land
$ 600
Buildings
$1,700
Machinery
$1,000
Total PP&E
$3,300
Notes receivable
$ 100
Goodwill
$ 100
Total Assets
Corporations:
A Contemporary Approach
$7,000
Liabilities & Equity
Current liabilities
$2,650
Long-term liabilities
Note (old one)
$2,000
par)
$
-Note (sellers)
$ 750
$ 500
Note (bank)
$ 500
$ 100
Debentures (Bernie)
$ 500
Total liabilities
$6,400
Common (5000 shs)
Retained earnings
Total equity
$ 500
$ 100
$ 600
Liabilities & Equity
$7,000
Chapter 10
Corporate Financial Structure
Slide 34
of 58
Legal distribution (MBCA)
MBCA § 55-6-40 Distributions to shareholders.
(a) A board of directors may authorize and the corporation
may make distributions to its shareholders subject to
restriction by the articles of incorporation and the limitation
in subsection (c).
(c) No distribution may be made if, after giving it effect:
(1) The corporation would not be able to pay its debts as
they become due in the usual course of business; or
(2) The corporation's total assets would be less than the
sum of its total liabilities …
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 35
of 58
Legal distribution (MBCA)
Assets
Cash
Accts receivable
Inventories
Prepaid expenses
Total current assets
Fixed assets
Land
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
$ 200
$1,400
$1,300
$ 600
$3,500
Total Assets
$7,000
Corporations:
A Contemporary Approach
$ 600
$1,700
$1,000
$3,300
$ 100
$ 100
Liabilities & Equity
Current liabilities
$2,650
Long-term liabilities
Note (old one)
$2,000
Note (sellers)
$ 750
Note (bank)
$ 500
Debentures (Bernie)
$ 500
Total liabilities
$6,400
Common (5000 shs)
Retained earnings
Total equity
$ 500
$ 100
$ 600
Liabilities & Equity
$7,000
Chapter 10
Corporate Financial Structure
Slide 36
of 58
Repurchase shares …
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 37
of 58
Repurchase
of shares
(money out)
Hypothetical #6
Since the acquisition 3 years
ago, JKL Corporation has had
some success. Lorenzo wants
out, and Justin and Kathy agree.
A bank will lend $300,000 to
finance the buyout.
–Can the corporation buy
Lorenzo’s shares for $500,000?
–Answer in Delaware?
–Same for MBCA?
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 38
of 58
Del GCL § 160. Corporation's powers respecting ... redemption.
(a) Every corporation may purchase, redeem, ... or otherwise acquire its ...
own shares; provided, however, that no corporation shall:
(1) Purchase or redeem its own shares of capital stock for cash or other
property when the capital of the corporation is impaired or when such
purchase or redemption would cause any impairment of the capital of
the corporation,
MBCA § 1.40. ACT DEFINITIONS
In this Act: …
(6) "Distribution" means a direct or indirect transfer of money or other
property (except its own shares) or incurrence of indebtedness by a
corporation to or for the benefit of its shareholders in respect of any of its
shares. A distribution may be in the form of a declaration or payment of a
dividend; a purchase, redemption, or other acquisition of shares; a
distribution of indebtedness; or otherwise.
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 39
of 58
Repurchase shares
Assets
Cash
Accts receivable
Inventories
Prepaid expenses
Total current assets
Fixed assets
Land
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
Total Assets
Corporations:
A Contemporary Approach
$ 200
$1,400
$1,300
$ 600
$3,500
Liabilities & Equity
Current liabilities
$2,650
Long-term liabilities
Note (old one)
$2,000
Note (sellers)
$ 750
Note (bank)
$ 500
Debentures (Bernie)
$ 500
Total liabilities
$6,400
$ 600
$1,700
$1,000
Common stock (5000 shs)
$3,300
Borrow
$300 from Bank
$ 100
Retained earnings
$ 100
Total equity
$7,000
Liabilities & Equity
Chapter 10
Corporate Financial Structure
$ 500
$ 100
$ 600
$7,000
Slide 40
of 58
Repurchase shares
Assets
Cash
Accts receivable
Inventories
Prepaid expenses
Total current assets
Fixed assets
Land
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
Total Assets
Corporations:
A Contemporary Approach
$ 500
$1,400
$1,300
$ 600
$3,500
$ 600
$1,700
$1,000
$3,300
$ 100
$ 100
$7,300
Liabilities & Equity
Current liabilities
$2,650
Long-term liabilities
Note (old one)
$2,000
Note (sellers)
$ 750
Note (bank)
$ 800
Debentures (Bernie)
$ 500
Total liabilities
$6,700
Common stock (5000 shs)
Retained earnings
Total equity
Liabilities & Equity
Chapter 10
Corporate Financial Structure
$ 500
$ 100
$ 600
$7,300
Slide 41
of 58
Revaluation of assets …
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 42
of 58
Revaluation of assets
Assets
Cash
Accts receivable
Inventories
Prepaid expenses
Total current assets
Fixed assets
Land
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
Total Assets
Corporations:
A Contemporary Approach
$ 500
$1,400
$1,300
$ 600
$3,500
$ 600
$1,700
$1,000
$3,300
$ 100
$ 100
$7,300
Liabilities & Equity
Current liabilities
$2,650
Long-term liabilities
Note (old one)
$2,000
Note (sellers)
$ 750
Note (bank)
$ 800
Debentures (Bernie)
$ 500
Total liabilities
$6,700
Common stock (5000 shs)
Retained earnings
Total equity
Liabilities & Equity
Chapter 10
Corporate Financial Structure
$ 500
$ 100
$ 600
$7,300
Slide 43
of 58
Revaluation of assets
Assets
Cash
Accts receivable
Inventories
Prepaid expenses
Total current assets
Fixed assets
Land
Buildings
Machinery
Total PP&E
Notes receivable
Goodwill
Total Assets
Corporations:
A Contemporary Approach
$ 500
$1,400
$1,300
$ 600
$3,500
$1,200
$1,700
$1,000
$3,300
$ 100
$ 100
$7,300
Liabilities & Equity
Current liabilities
$2,650
Long-term liabilities
Note (old one)
$2,000
Note (sellers)
$ 750
Note (bank)
$ 800
Debentures (Bernie)
$ 500
Total liabilities
$6,700
Common stock (5000 shs)
Retained earnings
Revaluation surplus
Total equity
Liabilities & Equity
Chapter 10
Corporate Financial Structure
$ 500
$ 100
$ 600
$ 600
$7,300
Slide 44
of 58
Klang v. Smith’s Food &
Drug Centers, Inc.
Plaintiff (an SFD public
shareholder) claims SFD
does not have enough
“surplus” for repurchase
– SFD would have a
“negative net worth” after
repurchase
– Pro forma balance sheet in
proxy statement (filed with
the SEC) shows negative
“capital surplus” of more
than $121.6 million
What is issue?
Corporations:
A Contemporary Approach
Public
shareholders
repurchase 50% stock
(6.3mm shares)
Smith’s Food
& Drug Centers
Cactus
Acquisition
Chapter 10
Corporate Financial Structure
Yucaipa
Companies
Merger
Smitty’s
3.0mm shares
Slide 45
of 58
PRO FORMA
(DOLLARS IN MILLIONS)
Current portion of long-term debt:
New Term Loans..........………………………………........................ $ 12.3
Other indebtedness...............…………………………………................ 1.4
----------------------------------------------------------------------------------------------------------------
Total current portion of long-term debt...…………………………..... $ 13.7
=============================================================
Long-term debt:
New Term Loans (a)...............……………………………................ $ 792.7
New Revolving Facility (a)(b).........…………………………….............. –
New Senior Notes.............................………………………………..... 150.0
New Senior Subordinated Notes...............………………………....... 350.0
Other indebtedness.....................…………………………………......... 50.4
-------------------------------------------------------------------------------------------------Total long-term debt...............………………………………............. 1,343.1
=============================================================
Redeemable preferred stock, $.01 par value..……………………………...... 3.3
New Preferred Stock, $.01 par value.............……………………………..... 71.2
Common stockholders' equity: Common Stock, $.01 par value (c)...…........ 0.2
Additional paid-in capital.................……………………………………….... 164.9
Retained earnings (deficit)...................……………………………….…..... (286.7)
--------------------------------------------------------------------------------------------------------Total common stockholders' equity (deficit).……………………………….. (121.6)
--------------------------------------------------------------------------------------------------------Total capitalization.................…………………………………………...... $1,296.0
=============================================================
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 46
of 58
DGCL § 160(a): No corporation shall purchase … its own shares …
when such purchase … would cause any impairment of the capital
of the corporation
DGCL § 154: [The board may] determine that consideration …
received by the corporation for … its capital stock … shall be
capital... The excess … of the net assets of the corporation over
the amount so determined to be capital shall be surplus. Net
assets means the amount by which total assets exceed total
liabilities.
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 47
of 58
SFD hires investment firm –
Houlihan - to render solvency
opinion
– compares SFD's "Total
Invested Capital" of $1.8
billion -- valued under the
"market multiple"
approach -- with SFD's
long-term debt of $1.46
billion.
– SFD's "concluded equity
value" equals $346
million, more than
outstanding par value of
SFD's stock
Revaluation of assets
“Market” Balance Sheet
Assets
$1.8 B
Liabilities
$1.4 B
Equity
$346 M
Houlihan gives opinion to SFD
Board that transactions would
not impair SFD's capital
“Figures never lie”
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 48
of 58
Delaware Supreme Court:
“We understand that the books of a
corporation do not necessarily
reflect the current values of its
assets and liabilities.”
***
“Market multiple” approach (FMV of
assets minus liabilities) is OK to
value company’s solvency.
Chief Justice
Norman Veasey
(1992-2004)
Holding: Recapitalization does not
violate DGCL §160!
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 49
of 58
Legal context: Distributions to shareholders are subject
to legal capital rules (in Delaware and under MBCA)
• Delaware: Dividends or repurchases may not “impair capital” -must be paid out of “surplus” = assets minus liabilities minus
capital
• MBCA: Distributions are permissible only if (1) assets exceed
liabilities plus liquidation preferences of preferred stock (treated as
debt) AND (2) corporation able to pay debts as come due
Valuation of “surplus” / “net assets”: Determination of
“assets” and “liabilities” (corporate value) is within
discretion of board of directors.
• Delaware Supreme Court: “We understand that the books of a
corporation do not necessarily reflect the current values of its
assets and liabilities.”
• Corporations may revalue assets to reflect corporation’s “long term
health” (appreciation, goodwill, intangibles) – protect creditors
according to “current realities”
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 50
of 58
Dividend policy
Who sets dividend policy?
Can shareholders challenge dividends?
Close vs public corporation
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 51
of 58
CHC (modern approach)
Waters
(majority)
Litle
(minority)
1/3
2/3
What is judicial standard of
review of dividends in CHC?
Close Corporation
Year
1987
1988
1989
1990
What is effect of no-dividend
policy on each?
Reported earnings
$739,000
$909,000
$3.8 million
$3.6 million
Corporations:
A Contemporary Approach
Modern cases:
“Oppression” doctrine requires
that board not frustrate
“reasonable expectations” of
minority.
Can’t use dividend policy to
coerce minority to sell cheap.
Chapter 10
Corporate Financial Structure
Slide 52
of 58
Waters served his own personal
financial interests in having DMGT not
declare dividends.
– receive a greater share of the
cash available for corporate
distributions via loan
repayments
– put pressure on Litle to sell his
shares to him at a discount
– while Litle has to find sources
of cash to pay his tax liability.
Therefore, I must consider Waters to
be an interested director with respect
to the Board’s decision to not declare
dividends.
Chancellor William
Chandler
Lytle v. Waters (Del Ch 1992)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 53
of 58
Kamin v. American Express Co.
(NY Sup Ct 1976)
PHC
(modern approach)
A: Distribute DLJ stock to SHs
(no tax effect on AmEx)
B: Sell stock at Corp level
(AmEx takes tax loss)
Shareholders
Shareholders
stock
Corporation
Corporations:
A Contemporary Approach
stock
Chapter 10
Corporate Financial Structure
Corporation
Slide 54
of 58
“Stated earnings” are
$17.9 million higher (no
effect on cash flow)
$8 million in real tax
savings (increases cash
flow to the company)
Distribute DLJ stock
Income Statement
Sell DLJ stock
Same
Revenues
Same
Same
Operating income
Same
None
Capital losses
$25.9
Same
Taxable income
Less (by $25.9)
Same
Taxes
Less (by $8.0)
Same
Net income
Less (by $17.9)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 55
of 58
Dividend policy in PHC
The directors’ room rather than the
courtroom is the appropriate forum
for thrashing out purely business
questions …
[The board concluded] a reduction in
net income would have a serious
effect on the market value of the
publicly traded AmEx stock.
Kamin v. American Express Co.
(NY Sup Ct 1976)
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
New York
Supreme Court
Slide 56
of 58
Dividend policy in PHC?
Why doesn't corporate law
compel the board to declare all
free cash flow as a dividend?
If management has good
investment projects, it can ask
shareholders to re-invest?
If it doesn't, management should
not keep the money?
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Warren Buffett
Slide 57
of 58
Group hypo
The majority shareholders in a very successful family bakery
refuse to share the dough with the minority.
The majority refuses to pay dividends; instead they eat their cake
by paying themselves nice salaries.
When the minority asks for their piece of the pie and tries to sell
their shares, the majority only offers them crumbs.
The minority complains the board’s dividend policy is meant to
slice them out.
You are lawyer for the corporation. Draft the minutes of the board
meeting (as you would want them to read) at which the minority
demands payment of large dividends. See Wikipedia
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 58
of 58
“First, order of business …
who is eating all the cupcakes?”
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 59
of 58
Minutes - Board meeting (24 Sep 2014)
Attendance: Directors A, B, C, D, E; Pres X, Treas Y, Secy S (absent: F)
Chair C called regular meeting to order at 11:40a. A questioned
company’s no-dividend policy, asks for money. Discussion ensued.
B stated salaries to all concerned were fair, comparable to what paid at
similar companies – citing ExecPayConsult report (attached).
Pres X described need for keeping cash surplus: problems with
acquisition of Gooey Farms; higher flour storage costs than anticipated;
need for new baking equipment, warehouse, etc. Treas Y agreed.
Treas Y says cash position not that strong and Banker advises company
value falling, not to be “profligate.” Concerned discussion ensued.
Board approved motion (4-1 vote) to keep no-dividend policy intact.
Meeting adjourned at 12:40p. Respectfully submitted, Secy S
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 60
of 58
The end
Corporations:
A Contemporary Approach
Chapter 10
Corporate Financial Structure
Slide 61
of 58