Janet E. Morgan, Contributor
President of the Small Business Association of Jamaica, Andrea Graham.
THE COMPANIES Act 2004 has opened up opportunities for small companies to finance their activities in ways that were not possible under the old regime of the 1965 Act.
The provisions of the Act which permit companies to redeem shares and to 'buy-back' their own shares were first introduced in the U.K. to encourage equity investment in small businesses because typically, the source of financing for small private companies is either the very members of the company who usually have good ideas, but no available capital, or the banks or other financial institutions whose funding is usually expensive and difficult to access.
These difficulties faced by small companies are sometimes compounded by the altitude of shareholders who are family members who do not wish to invite a non-family member to make an investment in the company, albeit of well-needed capital, for fear of bringing a stranger to the boardroom, or for fear of losing control of the company. Equally, non-family members may not be anxious to invest in a family-based company for fear that they may be either indefinitely locked in the company with no market for their shares or be forced to sell their shares at a loss.
The difficulties that small companies encounter in financing their businesses, as well as the challenges faced by investors who wish to invest in small companies, are well known and documented.
NEW FINANCING OPPORTUNITIES
The new Act provides that a company may issue redeemable shares that the company or the holder, at the option of the company, may redeem. Redeemable shares are issued under the terms under which they may be redeemed. For example, Company A may issue redeemable shares to an investor/shareholder in exchange for capital injection to expand the operations of the business on terms that the shares will be redeemed by the company or by the holder in three years. Dividends may be payable during the term of the three-year period and at the end of the three-year period the option may be exercised by the holder whereupon the holder is repaid the capital and 'interest' on the investment. The company would have had the benefit of the capital received to expand its operations and the investor would be free to re-invest his funds in the same or in another company. Subject to the availability of capital out of which the redemption may be financed, the company and the investor would have benefited from the new provisions of the Act.
It is important to note, however, that the Act provides that shares cannot be redeemed if all that would be left in the company are redeemable shares the risk being that if those remaining shares are redeemed, there would be no capital left in the company and those who gave credit to the company on the assurance that it had a certain amount of capital available to meet its debts, may be unpaid.
The buy back provision was designed for the purpose of making a company able to buy back any of its shares including its redeemable shares at any time in the future, without specifically anticipating the need to 'buy back' at the time of the issue. In a small company scenario, this provision will be particularly useful to buy out a member who may be retiring from the family business; buying the shares of a deceased member; buying out dissatisfied shareholders; buying out members who may be retiring their directorship of the company, or to buy back the shares of company employees who have resigned. The buy back operates without remaining shareholders being required personally to find the money to purchase the shares, in that it is the company which finances the purchase or the buy back. After the buy back, any voting rights attached to the shares are suspended and those shares may be allotted to a new purchaser.
The redeeming provisions and the buy back provision complement one another and together provide a more flexible equity capital structure for small companies.
THE TAX IMPLICATIONS
The manner in which current tax legislation tax will be interpreted to determine the company's and the shareholder's liability to tax on the redemption or buy back of shares will be a matter of great interest to many. Indeed, our tax laws may well have to be amended to deal specifically with these two new methods of raising finance, so as not to deter, but to encourage small companies to adopt these innovative tools.
On Thursday, June 2, Brian Dennning of PricewaterhouseCoopers will explore the tax regime as it will likely apply to the redemption and buy back of shares at a joint workshop with DunnCox, attorneys-at-law at the Jamaica Pegasus Hotel, New Kingston. Our two firms will, among other activities, examine the tax laws and the legal requirements set out in the new Act to redeem and to buy back shares.
Email: Janet.Morgan@dunncox.com
