Business organisations and procedures - Finance

Learning Outcomes

This article explains business finance for organisations in England and Wales, including:

• The principal forms of business finance and the distinctions between equity and debt, including their effects on ownership, control, risk allocation, and commercial decision-making
• Capital maintenance requirements and lawful distribution rules, with emphasis on distributable profits, interim and final dividends, and the basics of share buybacks and reductions of capital
• Directors’ authority to allot shares, statutory pre-emption rights on new issues for cash, and how those rights may be waived or disapplied in practice
• The nature and essentials of company security, distinguishing fixed and floating charges, and the rules on charge creation, registration, and the maintenance of priority between competing security interests
• The impact of insolvency on business finance, including creditor ranking, the prescribed part ring-fenced from floating charge realisations, and circumstances in which security may be challenged or avoided
• Application of these rules to typical client scenarios, such as issuing and transferring shares, disapplying pre-emption rights, implementing basic buyback structures, and advising lenders and investors on creditor priorities

SQE2 Syllabus

For SQE2, you are required to understand business finance concepts and their practical relevance to organisations, with a focus on the following syllabus points:

• the main methods of raising business finance (share/equity and debt/loan finance)
• directors’ authority to allot shares (statutory authority vs member authority) and the effect of articles
• pre-emption rights on new issues for cash and how they may be waived or disapplied
• the principles of capital maintenance, lawful dividends, and basic buyback/reduction of capital procedures
• differences between secured and unsecured borrowings, and typical loan covenants
• the purpose and practicalities of company charges and security (fixed and floating), including debentures
• registration of charges (MR01, 21-day period), keeping charge copies, and Land Registry registration for mortgages
• priority of security and the role of negative pledge clauses; basic charge avoidance (preferences and late floating charges)
• how insolvency and liquidation procedures affect business finance, security enforcement, prescribed part, and creditor priorities

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which type of finance allows shareholders to vote at general meetings—equity finance or debt finance?
2. What is the legal requirement for a company when issuing new ordinary shares for cash—must it first offer them to existing shareholders, or can the board allocate freely?
3. What is the main difference between a fixed charge and a floating charge?
4. When can a company lawfully pay a dividend to its shareholders?
5. If a shareholder's shares are fully paid and the company is wound up, what is their maximum financial liability for company debts?

Introduction

When advising business clients, understand how strategic finance choices affect ownership, control, risk, and creditor outcomes. Financing may be raised through equity (shares) or debt (loans and borrowings). For companies, capital maintenance is central: returns to shareholders must follow statutory routes and be funded from distributable profits or via controlled capital procedures. Issuing new shares engages director authority and pre-emption rights. Borrowing often involves security—fixed and floating charges—whose registration, priority, and enforceability determine outcomes if the business fails. Only companies and LLPs can grant floating charges; sole traders and ordinary partnerships cannot. In insolvency, creditor priorities, the prescribed part ring-fenced from floating charge realisations, and the validity and timing of security are critical.

Key Term: equity finance
Raising business capital by issuing shares to owners/members, who become shareholders of the company.

Key Term: share capital
The total nominal value of shares issued by a company, representing ownership and the sum invested by shareholders.

Key Term: debt finance
Raising money for a business by borrowing, where the company becomes legally obliged to repay the loan or debt plus interest.

Types of business finance

Most organisations require start-up and ongoing capital. Finance for business may broadly be divided into equity finance (shares) and debt finance (loans and borrowings). The choice often reflects the desired balance between retaining control (equity dilutes voting power whereas debt typically does not), cost and tax treatment (interest is generally deductible; dividends are not), and the risk appetite of investors vs lenders.

Equity finance (shares)

Equity finance means raising money by issuing shares. Those who buy shares become owners of the company and may be entitled to vote at meetings and receive dividends. Share capital is foundational finance for a company and forms part of the fund to which creditors look in insolvency. Shares are personal property and a bundle of rights defined by the company’s constitution and the Companies Act 2006 (CA 2006). A company may have different classes—most commonly ordinary shares with voting rights and preference shares carrying economic preferences but often limited voting rights.

When a company is incorporated, subscribers agree in the memorandum of association to take at least one share each. Over time, further shares may be issued to raise capital. The nominal value is the fixed face value of a share and does not reflect market value. New shares can be issued at a premium to nominal value if the company has grown in value; the excess is typically credited to a share premium account (a non-distributable reserve).

Key Term: nominal value
The fixed face value attributed to each share. It does not change with the company’s commercial value and is distinct from the price paid for shares.

Key Term: preference shares
Shares carrying preferential rights (e.g., fixed priority dividend or preferential capital return) but commonly limited or no voting rights.

Shares may be fully paid or partly paid on allotment. If not fully paid, the company can make calls for the unpaid amount at a later time. Legal title passes when the allottee’s name is entered in the register of members; until then, the allottee has only an unconditional right to be registered.

Transfers of existing shares do not raise capital for the company (proceeds go to the selling shareholder). In private companies, articles often restrict transfers. Under Model Articles (MA) 26(5), directors may refuse to register a transfer if doing so is in the company’s best interests, subject to notification and reasons. If refusal occurs, legal title does not pass; the transferor remains on the register holding on bare trust for the transferee pending any court rectification.

Key Term: pre-emption rights
Existing shareholders’ legal right to be offered new shares first, on a pro-rata basis and for cash consideration, before the shares are offered to outsiders.

Debt finance (loans and borrowings)

Debt finance involves borrowing from banks or other lenders. Typical arrangements include overdrafts (flexible, repayable on demand), term loans (fixed term and schedule), and revolving credit facilities (flexible drawdowns subject to clean-downs and fees). Companies may also issue debt securities (e.g., debentures or bonds). Lenders are creditors; they do not acquire ownership. Loan agreements often include covenants limiting dividends, restricting disposal of assets, requiring information provision, maintaining financial ratios, and preventing further security (negative pledge). Events of default commonly include non-payment, breach of covenants, and insolvency, allowing acceleration and enforcement.

Key Term: debenture
A company’s written debt instrument that typically grants security over assets (via fixed and/or floating charges) to secure repayment of borrowings.

Worked Example 1.1

A small company has no cash for a warehouse purchase. The directors want to preserve existing shareholder ownership, yet secure property. Should the company issue new shares to raise funds or negotiate a bank loan?

Answer:
If the owners want to avoid diluting shareholder control, borrowing might be preferable. However, the company would be subject to repayment obligations, covenants, and likely need to grant security over assets. Equity would avoid fixed repayment risk but dilute ownership and may require pre-emption compliance.

Issuing shares: authority and pre-emption rights

After incorporation, directors require authority to allot new shares. In a private company with unamended Model Articles and only one class of shares before and after the issue, directors have statutory authority to allot further shares by board resolution without prior member approval. Otherwise, authority must be given by an ordinary resolution of shareholders or by provision in the articles.

When a company proposes to issue new ordinary shares for cash, statutory pre-emption rights apply: it must first offer them to existing shareholders in proportion to their holdings on the same terms. This protects existing shareholders from dilution unless the right is disapplied by special resolution or excluded by the articles. Pre-emption does not apply to non-cash consideration or certain employee share schemes. Offers usually specify an acceptance period; unaccepted entitlements may be renounced or reallocated.

In practice, companies often seek a standing member authority to allot and a disapplication of pre-emption for a period (e.g., up to a limit of nominal amount), enabling timely fundraising and investment rounds.

Worked Example 1.2

A company has 10,000 existing shares owned by five shareholders. The company wants to issue 1,000 new ordinary shares for cash. What must it do before allotting shares to an outside investor?

Answer:
The new shares must first be offered to existing shareholders pro rata, at the same price and on the same terms, for an acceptance period. If shareholders do not take up their entitlements, the board may allot to the outsider. Members can waive or disapply pre-emption by special resolution in advance to expedite the allotment.

Capital maintenance

A company must protect and maintain its share capital, which forms a creditor fund on insolvency. Maintenance of capital means a company cannot return capital to shareholders except via strictly controlled processes. Permissible routes include properly declared dividends out of distributable profits, redemption or buyback funded from profits (or, for private companies and subject to a detailed solvency-based procedure, out of capital), lawful reduction of capital by special resolution backed by a solvency statement, and winding-up distributions when solvent.

Key Term: capital maintenance
The legal principle that a company must preserve share capital and can return it to shareholders only in accordance with statutory rules and not at will.

Key Term: distributable profits
Accumulated, realised profits available to fund distributions, net of accumulated, realised losses. Dividends must not be paid out of capital.

Dividends are distributions of profits; any transfer of value to members is a distribution unless expressly excluded. Ordinary shareholders have no automatic right to dividends—only to properly declared dividends. Final dividends are typically recommended by directors and declared by ordinary resolution (subject to the articles); interim dividends may be declared by directors alone during the year if the articles permit. Before declaring any dividend, up-to-date accounts should support the availability of distributable profits.

If a dividend is made unlawfully, directors who authorised it and members who knew or ought reasonably to have known of its unlawfulness may be liable to repay. Non-cash distributions can take the form of dividends in specie (assets) or scrip dividends (shares). Directors must consider their duties, particularly promoting the success of the company and exercising reasonable care, skill and diligence, when recommending distributions.

Buybacks of fully paid shares may be funded from distributable profits or, for private companies and subject to safeguards, out of capital. A buyback contract requires shareholder approval by ordinary resolution; a buyback from capital requires a special resolution, a solvency statement by directors (with auditor’s report), notices to creditors and an objection period, careful timing, and filings (including SH03 and SH06). Reduction of capital by solvency statement route also demands director certification that the company can meet debts as they fall due for 12 months.

Key Term: dividend
A distribution of realised profits to shareholders, authorised by directors and declared by ordinary resolution where required by the articles.

Loans, security, and charges

Lenders may lend to a company on either a secured or unsecured basis. Security improves a lender’s priority and recovery prospects if the borrower defaults or becomes insolvent.

Secured finance: Fixed and floating charges

Security may be taken via a debenture granting fixed and floating charges.

• Fixed charges attach to specific assets (e.g., real estate, machinery, shares). The company cannot dispose of or further charge the asset without lender consent. On default, a fixed chargee may enforce against the asset and can appoint a receiver over charged property where agreed.
• Floating charges hover over a changing class of assets (e.g., stock, book debts). They permit trading in the ordinary course until crystallisation on trigger events (insolvency, cessation of business, appointment of a receiver, or contractually defined events). On crystallisation, the floating charge becomes fixed over the assets within its scope at that time. Floating charges rank behind fixed charges and preferential creditors and are subject to the prescribed part ring-fenced for unsecured creditors.

Key Term: fixed charge
A security interest over a specific asset, restricting the company’s ability to deal with it without lender consent.

Key Term: floating charge
A security interest over a shifting class of assets, allowing the company to use them in the ordinary course of business until crystallisation on defined events.

Key Term: negative pledge
A covenant by the borrower not to create further security over specified assets or classes of assets without the lender’s consent; often included to protect floating charge priority.

Charges created by companies must be registered at Companies House to remain effective against a liquidator, administrator or creditor in insolvency. Registration (typically on MR01 with a copy of the instrument) must occur within 21 days of creation. Late or non-registration renders the charge void against insolvency office-holders and creditors; the secured debt becomes immediately payable but unsecured. The court has limited discretion to extend time where failure was accidental and not prejudicial.

Certified copies of all charges must be kept available for inspection at the registered office or SAIL address. Where the security is a legal mortgage over land, registration at the Land Registry is also required; priority for such mortgages follows the order of Land Registry registration.

Priority between company charges is determined by date of creation (assuming timely CH registration). Fixed charges take priority over floating charges irrespective of dates. Floating charge holders may insist on negative pledge clauses to guard against later fixed charges taking priority over the same assets. A deed of priority can reorder priorities by agreement.

In some cases, security can be challenged in insolvency. A floating charge may be invalidated if created during the relevant vulnerability period without new value being provided, and both fixed and floating charges can be avoided as preferences if they unfairly put a creditor in a better position ahead of insolvency.

Worked Example 1.3

A supermarket grants a bank a floating charge over its present and future stock in exchange for a loan. The company continues to buy and sell goods day to day. What happens if the company goes into liquidation?

Answer:
The floating charge crystallises over stock held at the point of liquidation. The liquidator’s costs and preferential creditors are paid first; a prescribed part is set aside from floating charge realisations for unsecured creditors. The bank then recovers from the charged assets subject to that deduction and any prior fixed charges.

Dividends

A company may only pay dividends out of distributable profits. Directors who recommend unlawful dividends or shareholders who knowingly receive them can be required to repay. The usual process is for directors to recommend a final dividend and members to declare it by ordinary resolution (unless the articles permit directors to declare without member approval). Interim dividends may be declared by directors alone during the year if the articles permit. Companies can also issue scrip dividends (shares) or make dividends in specie (assets).

Directors should consider the latest management or audited accounts to confirm the availability of distributable reserves and any prior losses, ensuring compliance with capital maintenance. They must also consider covenants in facility agreements that may limit dividends as part of lender protections.

Key Term: prescribed part
A statutory ring-fenced amount carved out of floating charge realisations and set aside for unsecured creditors in insolvency before paying the floating charge holder.

Insolvency and creditor priority

If a company is insolvent and wound up, assets are distributed according to statutory priority. Broadly, the order is:

1. Costs and expenses of liquidation (including the insolvency practitioner’s fees)
2. Fixed charge holders (to the value of their secured assets)
3. Preferential creditors (e.g., certain employee claims and some pension sums)
4. Floating charge holders (subject to deduction of the prescribed part for unsecured creditors)
5. Unsecured creditors (pari passu)
6. Shareholders (if anything remains; rare)

Secured creditors generally recover ahead of unsecured creditors; floating charge holders rank behind preferential creditors and the prescribed part. Unregistered charges are void against the liquidator/administrator and creditors, leaving the lender unsecured.

Worked Example 1.4

A company is insolvent and its assets are realised. There are three creditors:

• A bank with a £50,000 fixed charge
• Employees owed £10,000 in wages
• A supplier owed £5,000 with no security

If the company assets realised £70,000, who is paid and in what order?

Answer:
After the liquidator’s expenses, £50,000 is paid to the bank from fixed charge realisations. Then preferential employee claims (£10,000) are paid. Any balance is available to unsecured creditors (including the supplier), usually on a pro-rata basis. If there were floating charge realisations, a prescribed part would be carved out for unsecured creditors before paying the floating charge holder.

Worked Example 1.5

A company grants a floating charge to Lender A over all assets on Day 1. On Day 20, it grants a fixed charge to Lender B over specific machinery and both charges are registered in time. The company later enters administration. Which lender has priority over the machinery?

Answer:
Lender B’s fixed charge has priority over the machinery notwithstanding its later date, because fixed charges rank ahead of floating charges. Lender A’s floating charge continues over other assets but is subordinate to the fixed charge and subject to the prescribed part in insolvency.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• The fundamental differences between equity and debt finance for business organisations, including control, risk, and tax treatment.
• Director authority to allot shares, shareholder pre-emption rights on cash issues, and how pre-emption may be waived or disapplied.
• The process and restrictions on share transfer, including directors’ discretion to refuse registration under MA 26(5).
• The capital maintenance principle, including lawful dividends (final and interim), scrip/in-specie distributions, and the basics of buybacks and reductions of capital.
• Types of debt arrangements (overdrafts, term loans, revolving credit), common loan covenants, and events of default.
• Requirements for security over assets: fixed vs. floating charges, registration at Companies House within 21 days, keeping certified copies, and Land Registry registration for mortgages.
• Priority of security and creditors on insolvency, the role of negative pledge clauses, and the prescribed part ring-fenced for unsecured creditors.
• The order of repayment for creditors and shareholders in insolvency, and key circumstances in which security may be challenged or avoided.

Key Terms and Concepts

• equity finance
• share capital
• debt finance
• pre-emption rights
• capital maintenance
• distributable profits
• fixed charge
• floating charge
• dividend
• nominal value
• preference shares
• debenture
• negative pledge
• prescribed part