vote, sue, sell, yell
- separate legal entity
- perpetual existence
- limited liability
- centralized mgmt
- transferability of ownership interest
- aka organic docs or constitutive docs
- articles - one pg constitution
- bylaws - details including powers of D&Os
- directors - elected by shs
- officers - elected by dirs
- stakeholders -employees, creditors, & others
- debt securities (loans)
- equity securities (common and preferred shares)
corp officer duties
fiduciary duty of care - take care in making decisions
fiduciary duty of loyalty - putting corp interest ahead of your own
cts' rule of abstention. cts defer to the jdmt of the BOD absent highly unusual circumstances, like a conflict of interest or gross inattention. presumes dirs. decisions are 1. informed, 2. serve a rational biz purpose, 3. are disinterested, 4. are made independently.
status of shares
- authorized - in articles
- issued - sold to sh's
- outstanding - owned by sh's
- treasury shares - bought back by co
internal affairs doctrine
in general, the law of the state of incorp governs the "internal affairs" of the corp. (incl relationships btwn sh's and d&o's)
Under what circumstances may the board change the annual meeting?
- DGCL 211,222
- * mtng place may be designated by AOI or bylaws; if not there then board can determine.
- * (unless elected by written consent) must have annual mtng to elect dirs
- * when sh'er vote will be taken, written notice of mtng is req incl place, date, time
- * notice must be given 10=<60days to all sh'ers with voting rights
when can't the board change the meeting?
improper purpose - bd can't act with a purpose to interfere with the effectiveness of a vote. See Schnell and Stahl.
Schnell v Chris-craft
F: board tried to move the meeting date to prevent sh'ers from having a proxy contest (electing new bd). they complied with DGCL 211&222 rules, but they still had the effect of preventing proxy contest by moving the date earlier & to a remote area.
Rule: when the bylaws fix the ate of the annual mtng, mgmt. can't attempt by amendment to advance that date in order to obtain an inequitable advantage in a proxy contest.
Stahl v Bancorp
F: Stahl announces tender offer & wants to take over. bd sets record date, then later removes the record date in order to push back annual meeting while they figure out how to stop the takeover. annual mtng wasn't req'd until sept if no record date.
R: for bd. postponing annual meeting where no meeting date has yet been set and no proxies solicited doesn't impair the SHs vote. bd doesn't have to call a mtng before it is obligated to do so.
state:state. Internal affairs doctrine
what laws govern corporations?
federal laws - do not governs incorporation, but they do govern some corp activity
state laws - statutes and CL govern incorp and some corp activity. mostly governed by the state where incorp.
policy supporting internal affairs doctrine?
increased predictability; hard to administer any other rule if corp is multi state
what are "internal affairs" in the IAD?
- * sh rights to vote, receive dividends, info from mgmt. about corp affairs, to lmt the powers or corp to specified activities to bring derivative suits
- * duties that mgmt. owes to shs
if corp is incorporated in state A, but does all its biz in State B, what law governs?
this is a "pseudo foreign corp." most states, incl DE, still follow IAD, see McDermot(Panamanian reincorp that gave sub 10% voting shares in parent & those votes were controlled by parent & could prevent take over). But a few states, incl CA, will impose their own laws on pseudo foreign corps, see Wilson (enforcing CA voting rights on a pseudo foreign corp).
CA law regarding choice of law for pseudo foreign corps.
- Cal Corp Code $2115 - CA law will appy to internal affairs even tho corp is inc elsewhere it:
- 1. for the most recent full income year the avg amt of prop, payroll, and sales is 50% in CA; AND
- 2 more than 1/2 outstanding securities are held by CA residents. UNLESS
- 3. the corp is publicly trade on stock xchnge or designated to be.
Is application of CA corp law to pseudo foreign corps constitutional?
* Yes according to Wilson CA case, if Congress hasn't exercised its Commerce Clause powers to regulate on the particular issue, then the state can do it under the negative implications of dormant congressional authority so long as the state is not discriminating against out of state corps (must apply its law evenly to domestic and pseudo foreign corps).
No under VantagePoint DE case that declined to apply CA's law to internal affairs of corp incorp in DE but operating in CA.
what is the dominant type of voting for electing corp dirs.?
straight voting. you get one vote per share, but can vote your full number of votes for each open seats. this puts majority sh'er at a great advantage and can prevent minority sh'ers from winning any seats.
what is the other type of voting for dirs. besides straight voting?
cumulative voting. you can pool your votes and put them all on one seat. this facilitate minority rep on the board.
what type of voting for dirs. is used in CA?
MBCA default rule, CA rule, & DE law on voting on important txns like mergers
MBCA default & CA - class voting. each class of stock (common, preferred) votes separately and all classes must approve by a majority. makes it harder for txns to get approved.
DE - all classes vote together. a majority of the total votes wins. makes it easier for transactions to get approved.
Why does CA require cumulative voting and class voting for pseudo foreign corps?
It helps protect sh's by making it easier for minority groups to get their candidate on the board and to block approval of a merger.
what is vertical federalism?
relationships between federal and state corp law. federal law is controlling.
MITE Corp, 1st gen anti-takeover reg
Illinois tried to regulate sale of shares to prevent hostile takeovers. Held: law requiring approval of merger by state secretory was unconstitutional because it applied to foreign corps as well as domestic.
2nd generation anti-takeover statutes; CTS Corp
tried to regulate internal affairs of domestic corps to prevent hostile takeovers. Held: state law requiring sh'er of a tender offer to gain majority approval of disinterested sh'ers in order to exercise voting rights was constitutional because it only applied to domestic corps and it did not discriminate.
3rd generation anti-takeover; DGCL 203
- cts uphold laws that aim at domestic corps and strike down laws that aim at foreign corps.
- DGCL 203 - 3 yr moratorium on merger by target after hostile takeover, unless bidder acquired 85% control in initial tender offer.
other ways to protect against takeovers
supermajority voting reqs, staggered boards
offer to buy shares during a specified period subject to certain conditions - permits bidder to acquire control of the corp w/o dealing with the incumbent BOD. instead of approaching board for merger, skips board and goes directly to sh'ers. after buying enuf shares, the bidder can replace the board with its own peeps and neg a "back-end merger."
competing theories of what a corp is.
- * private property - only for benefit of sh's. dir's should maximize profit
- * social institution - exist because state allows it. dir should focus on the corp's long term int as an econ entity
DE theory on corp purpose/existence
corp as private party. dir maximize sh wealth
Ohio theory on corp existence/purpose
in determining best int of corp, dir can take into acct sh wealth, creditor/employee int, economy of state/nation, community int, long-term in of sh'er.
ALI principles 2.0
- * corp must have objective of enhancing corp profit and sh'er long-term gain
- * but corp can also consider ethics and public welfare
Rule: corp is primarily for the profit of SHs. Ct gave Ford deference based on BJR
Rule: corp charitable contributions
R: charitable contrib must be reasonable. Theodora v Henderson (husband & wife, divorce, donations to boys camp, reasonable because it was 5% which is w/in fed tax deduction allowable of 10%)
legal arbitrage arises when a person or biz identifies a difference in legal tx in two diff jurisd like moving manufacturing to a co with low wages but selling product in place where goods sell high.
Old rule & underlying policy about whether corps can support political candidates.
R: corps can't spend $ on elections to support or oppose. PACs were ok where corp made a PAC and SHs individually donated to it.
P: protect SHs from having to subsidize the political views of corp mgmt.
how are partnerships formed?
- * GP - arises by op of law when 2 people operate biz together for profit. It can be formed on purpose or inadvertently.
- * all of the limited partnerships require filing with state.
New rule on corp spending on political candidates
- Citizens United - (attack ad against Hillary Clinton) R: corp can spend $ on fed elections to support or oppose political candidates; AND requirement requiring disclosure ("this ad supported by IBM") is valid.
- * no dollar limits
- * corps don't have to ask SH'er permission
- P: sh's informed by disclosure and can police bod themselves.
Jane operates a beauty shop and hires keith as a receptionist. when keith asks for raise, they agree in writing that keith will share in profits. the agreement that they area a "partnership." What result?
Even though they refer to themselves as "partners," there isn't an inadvertent partnership because Jane controlled the biz and contributed almost everything to the shop. keith only shared profts as a wage increase. under the UPA, they are not co-owners. their relationship is that of employer-employee, not partners.
statute governing GP
UPA Uniform Partnership Act or RUPA (revised)
governing statute for limited types of partnerships
ULPA Uniform Limited Partnership Act or RULPA
who makes up a GP?
only GP's, 2 or more
Who makes up limited types of partnerships?
at least 1 GP & 1 LP
what are the types of non-corpation biz entities?
GP, LP, LLP, LLLP, LLC
What type of mgmt. for GP?
decentralized (each partner has mgmt rights)
What type of mgmt. for LP?
GP mngs; lim partner has restricted governance rights
what type of mgmt. for LLLP?
decentralized (each partner has mgmt rights)
What type of mgmt. for LLLP?
GP mngs; lim partner has restricted governance rights
What type of mgmt. for LLC?
centralized or decentralized, depends on op agreement
What type of mgmt. for corp?
centralized in BOD
What type of agency for a GP?
each partner is an agent for biz
What type of agency for a LP?
only g. part is agent
What type of agency for LLP?
each partner is an agent for biz
What type of agency for LLLP?
only g.part is agent
voting rights in a GP
gen majority vote; unanimous consent for majority decisions
voting rights in limited types of partnerships
for all partnerships other than general partnerships, LP has no vote, only GP
each GP personally liable for debts & torts of other GP committed w/in the course of the biz
liability in a LP
GP is personally liable. LP is liable up to the capital contrib
Liability in a LLP
All partners lim liab for debts to amount contrib. Gen partner may have personal tort liability
Liability in a LLLP
only the LLP is liable for biz obligations (gen partners personally liable for own tortious conduct or of those they supervise) some discrepancy btwn chart on pg 144 last Par on pg 147 and ex 6.3 pg 148.
Liability in LLC
Limited. member can mng and still have less liability (so better than LP)
4 exceptions to the rule of limited liability
- 1. promoters can be liable when the corp is not properly formed
- 2. sh's can commit to make add'l capital contrib to the corp.
- 3. the veil of limited liability can be pierced, exposing sh's to personal liability, I order to achieve equity or prevent frad
- 4. sh's and other corp participants can be liable under regulatory regmes that trump corp law, like securities regs or environmental law.
Liability in a corp
SH's limited to capital contribution (unless waived)
financial rights in a GP
GPs share gains and losses equally (except when one partner contrib only capital and the other only services, $ partner can't recover losses from other GP)
A and B form a logging GP I which A contributes capital and B equipment to ahaul logs. they don't specify in their agreement how losses will be shared. the biz doesn't generate enough profit to cover A's capital contribtions, and A asks B to share in the net losses. what result?
B has to contribute toward the loss according to his share in the profits. the UPA controls, in the absence of an agreement on sharing losses.
A and B form a remodeling GP in which A contributes all the capital while B contributes only his skill and labor. the GP produces a loss and A seeks contribution from B, including for A's capital losses. B declines. What result?
A can't force B to share in capital losses. generally partners share jointly in both profits and losses, unless otherwise agreed. but when one partner only contributes capital, he can't recover his capital losses from the other partner who only contributed services. Kovacik.
financial rights in corp?
sh's have no rights to profits unless dividend
Financial rights in limited partnerships
Sharing of profit is pro rata based on $ contrib of each partner AND only GPs must share in losses b/c they are personally liable.
How to structure an LP so that all partners have limited liability?
make the gen partner a corp. the corp is then liable for all unpaid obligations of the LP, but the individual directors, officers and SHs of the corp gen partner are shielded.
Most common way limited partners lose their limited liability?
by participating in mgmt. no bright line rule, but it is ok for them to advise the gen partner wrt the biz and to vote on critical transactions. RULPA 303. So some participation is allowed w/o withdrawing from limited partners the protection of limited liability.
Rule on representation of a partnership in a biz transaction.
If you don't properly represent yourself as an agent of the biz entity, then ct will not consider you as acting on behalf of the entity and you will lose limited liability. Ex: You neg to receive a service, you give the vendor a biz card that doesn't have your biz entity listed & you don't otherwise notify them. so when the bill comes you will be personally liable for it.
Ex: Naomi and Oscar form a GP that rents properties. they don't specify who has authority if there is a disagreement. Naomi wants to increase rents, while osar does not. Naomi sues Oscar for lost profits they could have made if rents had been increased. what result?
Naomi loses. in a GP, the decision of the majority governs (unanimous if major decision). if the partners are equally divided, and w/o an agreement for breaking their impasse, the remedy is a dissolution.
continuity of existence & withdrawal for GP
for finite period or at will. At will: dissolved when partner withdraws. Withdrawing partner can demand liquidation of biz. If partner dies, survivor cand continue GP and pay estate for dead GP's share.
continuity of existence & withdrawal for limited types of partnerships
biz continues upon death or voluntary withdrawal of a lim partner, but the LP agreement must specify the latest date for dissolution.
continuity of existence & withdrawal for corp
perpetual existence(unless otherwise specified in AOI). Only voluntarily dissolves if board recommends dissolution and majority of voting sh's approve
mergers and consolidations for partnerships
just agree to combine assets. One partnership will have to dissolve
mergers and consolidations for corps
consolidate thru mergers. Pay SHs. Must be approved by BODs & SHS of both corps
use of partnership trademarks after dissolution
each partner has a right to use the name and style of the former GP when it dissolves as long as it does not deceive the public.
transferability of assets gp
unanimous consent for adding a GP BUT a GP can transfer his financial interest w/o other partner's consent. New guy wouldn't have mgmt voice (ex: 1 gp giving his fin int as collateral for a personal loan)
transferability of assets limited type partnerships
Lim partners can transfer fin int, but assignee won't have mgmt right unless all other partners consent.
Amanda, brian, and carry are equal partners in Beachfront Partners, which owns and rents two identical beachfront condos. Amanda and Carry have a falling out, but Brian wants to keep a partnership with each of them. what to do?
create two new partnerships. give on condo to each. A&B, and B&C. and Beachfront Partners dissolves.
what factors should you consider in picking an entity form?
- * how the form handles majority & minority interests
- * ability to raise capital
- * tax consequences
- * liability
Discuss the pro/cons for majority and minority interest holders in a GP.
- o In
- a GP, the at-will disso rule is important because it caters to majority interests.§ E.g., 3 partners in GP. Two want to expand, one doesn’t. The two can simply dissolve the old partnership, purchase the firm’s assets at judicial sale, and continue the business in new partnership to which the one doesn’t belong§ But note: at-will disso can also cater to minority interests· E.g., 3 partners. One develops special skills hard to replace. This partner can bargain for undeserved concessions from the majority by threatening to withdraw.
Discuss the pro/cons for majority and minority interest holders in a corp.
o The corp is all about the majority§ It is about the prerogatives of the majority SHs who can vote their shares§ Decisionmaking authority is also centralized in the board, all of whom can be elected by majority SHs; and its decisions are insulated from judicial review (if approved by majority) because of BJR
entity form considerations for raising capital
o In corps, you can raise substantial amts of money§ Entrepreneurs with good idea want to invest in corp; if he were to invest in partnership, that good idea could become extinct any time a partner wanted to withdraw (at which point the p-ship would be dissolved)o In partnerships, it is all about raising capital through the partners’ labor
Tax for corps
double tax. forp pays tax, SHs pay if they receive dividends (and SHs can't use corp deductions to reduce tax liability)
tax for partnerships
flow through. individual partner, not the partnership, is the taxpayer. individual partner must pay tax on his proportion of the ownership interest. For tax purposes, any unincorporated entities are taxed as partnerships.
difference between tax liability on partnership v. corp when the biz has a loss
still pay higher taxes with a corp. The corp pays zero tax if there is a loss, but if corp owner is taking a salary then they will pay tax on the salary and can't deduct the loss. in a partnership the loss will reduce tax liability by taking a deduction on personal taxes.
first step to give birth to a corp?
- file article of incorporation. incl:
- 1. name of corp
- 2. # authorized shares
- 3. name & address of incorporaters
- 4. name and address of corp's office & agent for service
- May include:
- 1. exculpatory provisions
- 2. indemnification provisions
after filing articles of incorp, what is the next step in creating a corp?
- first meeting.
- * elect dir.s
- * adopt bylaws
- * appoint officers
- * designate bank for deposit of funds
- * approve sale of stock
where to incorp?
home state if you will operate locally. DE if you will be multi state or eventually go public
if you are hired to set up the corp, who do you represent?
you represent the entity even before it exists. you can represent the constituents as well IF al constituents consent. Rule: when the constituents who approached L to help form corp reasonably believed the L represented them, the L rep's all constituents.
when is corp "born"?
when AOI are properly filed. MBCA 2.03
if you are L form corp and constituents and you find out that one of the constituents has an interest that is adverse to the corp?
advise the constituent that you can't represent them and they need to get an independent atty.
IF BOTH PARTIES KNOW THERE ISN'T A CORP, and a promoter signs K before corp is formed, is he personally liable?
Yes, when a promotor Ks for the benefit of a copr that is contemplated but not yet organized, he is personally liable on the K (unless there is agreement otherwise). Later formation of the corp does not remove liability even if the corp adopts the K.
If it is unclear whether both parties knew the corp didn't exist when a promoter enters a K on behalf of the corp, then is promoter personally liable for the k?
- Ct. applies factors:
- 1. form of signature - did promoter sign as an agent of the corp on signature lines
- 2 actions of 3rd party - did 3rd party plan to only hold corp liable?
- 3. partial performance - did the promoter's partial performance of the k indicate an intent to be held personally liable?
- 4. novation - did the actions taken by the parties discharge the promoter's liability?
when is a de facto corp created?
- Equitable doctrine that ct may apply to give one party the limited liability protection of a corp if they mistakenly believed the corp existed when they entered into a K. Must:
- 1. promoters made good faith effort to inc.; AND
- 2. promoters didn't know the inc wasn't official; AND
- 3. promoters used the corp form in a transaction with a 3rd party.
corp by estoppel
even when a corp isn't formed, a ct can prevent a 3rd party from asseting the promoter's personal liability when the 3rd party dealt with the biz on the assumption the only recourse would be against the biz assets.
what result on promoter liability when corp is dissolved for failure to pay admin fees and promoter enters a K?
most states will just let them pay back owed $s, reinstate the corp, and give them retroactive protection.
MBCA rule on liability when corp doesn't exist
promoter is personally liable if he knows there is no corp. Implication: when both parties reasonably but mistakenly believe the corp exits, there is no personal liability.
types of authority that officers and employees can have to act on behalf of the corp
- 1. actual authority
- 2. apparent authority
- 3. inherent agency power
define actual authority
Actual authority exists when the principal (board) gives the agent (officer) express or implied authority.
name the types of authority: P tells A "go put up a for sale sign, and sell my horses for $500 each. 1. A sells horses 2. A accepts $500 check from customer 3. A accepts a car worth $500
- 1. express actual authority to sell horses
- 2. implied actual authority to accept a valid check
- 3. no authority to accept a car as payment.
define apparent authority
Apparent authority exists when the principal, by written or spoken words, causes a third person to believe that the principal has consented to the agent acting for the principal. then the agent can bind the corp
Case where president of co sold land even though he knew he needed board approval, so did the buyer, and the board rejected the sale (but the buyer didn't know that)
Menard v Dage
Priti tells Yana not to sell her prize horse Blackie. Priti sends Meredith a letter saying she can see Yana about buying a horse. Yana sells Blackie to Meredith. What result?
Priti will be bound to the sale of Blackie to Meredith because Yana had apparent authority. Meaning, it appeared to Meredith, the 3rd party, that Yana had authority, even though Yana knew she did not.
Define inherent agency power
- inherent agency power exists if:
- 1. agent is generally authorized to conduct transactions
- 2. the 3p reasonably believes the agent has authroity
- 3. the 3p has no notice otherwise
- See Menard v. Dage
if you are atty, how can you help client make sure that an officer had authority to enter into a k?
- 1. BEST: copy of mins of board meeting where board adopted resolution formalizing its grant of authority. Even better if it is certified by corp secretary.
- 2. check for statutory authority
- 3. check articles of incorp
- 4. check bylaws
where are officers delegated duties?
if 3p enters a knowing the officer stands to gain personally and it turns out that the officer didn't have authority to enter the k, what result?
- split view
- 1. 3p has duty to investigate if it knows officer has conflict of interest
- 2. k will be upheld if 3p reasonably believed officer had authority. no extra duty to investigate.
rule on corp acquiescence after officer enters into a k w/o authority?
the corp's iaction following a transaction with a 3p can have binding effect.
how many votes do dir's get and how can they vote?
1 vote each. can vote in person or on the phone, but not by proxy. typically in person meeting is required by CL for significant transactions.
what are the voting req for the board to pass something?
you need quorum and it must pass by a majority of dirs. present at the meeting.
can notice of a special meeting be waived?
yes, if dir doesn't receive proper notice they can waive it by signing a waiver or just by showing up at the meeting MBCA 8.23. a director who attends solely to protest the manner in which it was convened is not deemed to have waived notice MBCA 8.23.
notice req's for special board meetings
- * 2 days notice (MBCA default rule)
- * must be reasonably designed to give actual notice (email isn't ok if the person is on a boat in the Bahamas)
what is the quorum req?
- set by statute. usually a majority.
- MBCA 8.24- quorum can be set by AOI or bylaws but it must be at least 1/3.
exceptions to requiring in person board meetings
- these are CL
- 1. Unanimous dir approval
- 2. emergency
- 3. unanimous SH'er approval
- 4. majority shareholder-director approval: dirs. who participate in the informal action constitute a majority of the board and own a majority of the corp's issued and outstanding shares.
- 5. unanimous written consent
bod is 8 ppl. secretary gives 2 days notice of meeting. 4 ppl come and vote in favor. result?
does not pass.
secretary visits a 5th board member in the hospital and she executes a proxy for Wanda to vote in favor of the action. what result?
still invalid. dir can't vote by proxy.
secretary puts the hospitalized dir on the phone with the meeting to vote. what result?
this is ok and then they will likely have quorum and the action will pass.
is there any other way a board can pass an action without having quorum?
yes, by using committees. committees can act on behalf of the board. useful because you don't have to get the whole board together for every action. common committees are the executive committee and the audit committee (req for public cos0
types of legal opinions a lawyer may give on a transaction
- 1. unqualified - you reach a clear legal conclusion w/o doubt
- 2. qualified - you limit it based on something (like, "based on my review of the bylaws")
- 3. reasoned/explained - give your reasoning and state legal conclusions this is good when law or facts are unclear
if you are looking to buy a co, what should you look at on the financial statements?
value of biz assets (may be undervalued), ratio of assets to liabilities, annual revenues, net profits, cash flow, look at short term as well as over time.
fundamental accounting equation
assets = Liabilities + Equity
what is a balance sheet
snapshot in a moment f time
assets that won't be converted w/in a year
- cash and assets that will be converted to cash in the near future (w/in 1 year). incl:
- * cash, accts rcvble, plant equipment, inventory, prepaid expenses.
how to determine the value at which assets are recorded?
- * cost (purchase price0 - longterm assets like land and equipment.
- * mark to market - liquid and marketably tradeable assets can be adjusted to FMV, fair market value (like stock or securities)
what could cause acct rcvble to increase?
increase in sale or more slow paying and delinquent customer accts.
assets. goods held for use in production or for sale to customers.
reasons why inventory may increase
- * increased sales
- * declining customer purchases
what methods can be used for reporting inventory?
GAAP says 3 methods: avg cost, LIFO, FIFO
reasons why cash acct my decline
- * company is financially weak
- * co found attractive biz opportunities & used cash to pay for it
effect of using FIFO
- * if cost of inv is increasing, FIFO will show higher inv values, higher profit, -> higher tax
- * if cost of inventory is decreasing, IFO will show lower inv values, lower profit -> lower taxes
effects of using LIFO
- * if cost of inv is increasing - lower inv value, lower profit, lower tax
- * if cost of inv is decreasing - higher inv value, higher profit, higher tax
current assets. have to be used within one year (insurance)
Property, plant & equipment (and depreciation). - assets the firm uses to conduct ops, as opposed to holding for sale. GAAP requires depreciation.
must be carried at cost, less allowance for amortization (depreciation for intangibles). ex: patents, trade names, goodwill. assets that are purchased are carried at cost less allowance for amortization. assets that are developed or promoted can't be reported as an asset
intangible asset. difference between how much the price a firm pays to acquire another exceeds the FMV of the acquired firm's identifiable assets.
long term liabilities
debts due more than 1 yr from balance sheet date. must show int rate and maturity date
off balance sheet liabilities
- * contingent liabilities - loan guarantees, warranty obligations, claims by P in civil suits
- * special purpose vehicles like with enron
set price for stock. corp must show on financial statements.
what things account for equity?
- * paid-in capital
- *retained earnings
paid in capital
total amt the corp has received from those who have purchased stock
net income (or loss) each year is added, reduced by distributions the corp has made to its SHs as dividends or any amt the corp has paid to repurchase stock.
how to determine if corp has enough assets likely to be converted to cash to meet is financial obligations as they become due?
- 1. current ratio
- 2. debt to equity ratio
- 3. interest rate coverage
- current assets divided by current liabilities 2:1 is good
long-term debt / equity. >1 means they are relying on a lot of debt
interest rate coverage
annual earnings / annual int payments on long-term debt
safe if 3:1
like a motion picture. how much $ firm made or lost over a period. it is the link to the balance sheet. shows p&l which is then added to retained earnings on balance statement.
- GAAP requires it.
- 1. realization principle - put revenue on income stmt when services are rendered or goods shipped
- 2. matching principle - put expenses incurred to generate those revenues in the same period where revenues are recognized.
revenue. top line. it is the total value of revenue for the year.
includes: COGS cost of goods sold, depreciation, selling & admin expense, R&D
net sales (aka revenue) - operating expense = op income
- net sales - (COGS cost of goods sold, depreciation, selling & admin expense, R&D) = op income
- op income aka EBIT
useful for looking at how much money the firm generated. add depreciation & amortization back to operating income.
income before taxes
take net sales - op expense - interest
bottom line, goes to retained earnings. link to balance sheet.
return on equity
- way to evaluate the firm's value. basically what are you getting annually in exchange for having your $ invested? Net income / Equity = return on equity
- * if return on equity is < risk-free investment like treasury then the firm is worth less than its net book value
- * if return on equity greatly exceeds the returns rom risk-free investments, the firm is worth more than book value.
cash flow statement
tracks cash in - cash out = cash balance
what will make cash on hand change?
- o From operating activities
- § If you increase accounts receivable—delaying the time you will get cash—then cash will actually decrease
- § If you increase spending on inventories, then cash will decrease
- § If you increase prepaying your expenses, then cash will decrease§ If you increase accounts payable, then cash will increase (because you haven’t paid yet, so you have more cash on hand)
- o From investing activities
- * If you buy machinery, then cash will decrease
- § if you buy office equip, then cash will decrease
- § if you buy patents, then cash will decreaseo
- From financing activities§
- * If you increase debt, cash will increase; if you decrease your debt, you’ve used cash to pay it off, and thus cash has decreased
- o Subtract these items from net income to end with cash position
What catergories are included in a cash stmt?
- 1. from operating activities
- 2. from investing activities
- 3. from financing activities
why part of a cash stmt do investors look at most and why?
- 1. cash from operating activities - provides guage of how much cash the firm's true operations are generating, and hopefully will generate in the future.
- 2. cash stmt corrects for some of the fictions on the other sheets
reasons why cash stmt can differ from balance sheet
- * revenue can be realized on balance sheet before it is collected
- * depreciation must be added back in on cash stmt since it is "made up"
review calculating the statement of cash flows!
- 1. comparables (ratio)
- 2. asset value
- 3. market
- 4. earnings (income)
- 5. DCF (discounted cash flow)
time value of money. what would you prefer, $800 today or $1000 three years from now?
at interest rate of 10% 800 now is better. at 5% then 1000 later is better.
eqn for future value
FV = PV * (1+ int rate) raised to # years
eqn for Present value
PV = 1000/(1+ int rate) raised to the number of years
how to use comparables for price valuation
if comp biz had $1 mm op cash flow and sold for 10 million, then your biz is worth 10 times the op cash flow
flaw with market value approach to biz valuation
- * hard to find others that are the same
- * assumes the other biz are properly valued
how to calculate value using earnings/income approach
- (not always accurate but easier and faster to do)
- 1. price/earnings multiplier - see chart. if you want to earn 20% the multiplier is 5. 5 X annual earnings = purchase price
- 2. cap multiplier - divide expected annual earnings by the required return. Annual earnings / 20% = purchase price
what numbers rates do you need to be given to calculate DCF?
- (most accurate way of valuation)
- discount rate and growth rate. you calculate the capitalization rate. Discount - growth = cap rate
first step to calculate DCF
- normalize net income to calculate co's likely future cash flow.
- 1. add back depreciation (if equip/bldng in good cond)
- 2. add back bonuses because they were disguised dividends (not really expenses)
- 3. adj acct rcvble and inventory downward (subtract) to consider not all accts will be paid or all inv sold.
how to calculate DCF
- after adjusting net income, then
- Normalized Net Income / (discount rate - growth rate) = value
cap rate = (discount rate - growth rate)
features of equity
- * share of corp's assets upon liquidation
- * right to shares are "residual" - subordinate to creditor's claims
- * mgmt./voting rights - elect bod
how do you issue shares?
- * must be authorized by AOI
- * if you need to issue more, must amend AOI. to amend, bod must recommend and SHs must approve
pro/con issuing more shares
- * pro- raise $, more flexible than debt in repayment
- * con - dilutes existing sh's. in close corps sh's may want more control over new shares so won't authorize more shares in aoi than must be immediately issued
two kinds of stock
common and preferred
- * exclusive power to elect corp bod
- * residual claim to assets after creditor and preferred stock
- * ct will consider it common stock unless corp makes it very clear that it is preferred
- * preference over common in receiving dividends
- * preference over common on liquidation
- * limited voting rights
- * only have the rights given to it in aoi
- * no fiduciary duty owed (Equity Linked Investors)
how is preferred stock price set?
corp will set it depending on how much it would cost them to get debt financing. preferred stock is an alternative to debt.
if you are going to issue preferred stock, when should you authorize it?
timing issue because you want to set the price of the stock based on the market rate for financing, but the process of amending the articles to issue more stock takes time. another option is blank check preferred. you put in the aoi ahead of time padding so bod can issue extra PS anytime w/o sher approval and set the terms. however, prolly don't want to do this in a close corp because it gives bod so much control.
Debt general features
- * don't need sh'er approval to take on
- * priority over all else in insolvency (possible exception if debt holder is sh'er)
- * less risky of an investment for debtholder than stock
- * debt have lien on co assets and can protect themselves thru K covenants
- * debtholders don't have any mgmt. control
structure of debt securities
- * terms are fixed in a K (indenture)
- * interest paid at intervals, principal at end
- *acceleration on default
- * may put in covenants that prevent corp from doing things that r risky to debtholder
- *might have convertible debentures (debtholder has right to convert debt to stock)
tax considerations for raising capital
* tax preference for debt because int is deductible (dividends are not)
cons to issuing debt
- * threat of bankcruptcy
- * if you lose $ on the investment, the loss will e even greater if it was financed with debt than with equity
after the break even point of using debt v equity, the more money you make, the greater share you get to keep with debt because debt payments are constant whereas dividend payments to sh'ers will be proportional