Morriss – Spring 2014
Corporate Finance Outline
Legal Aspects of Corporate Finance
1. Corporate Finance and The Process of Capital Formation
Why Study?
So we can understand why people entered into transactions. From a legal perspective, because as lawyers we need to encode the contractual protections necessary to effect the business goals of our clients.
Debt Securities
An instrument evidencing a debtor-creditor relationship and containing the obligations of the corporation to pay to the holder of the instrument the borrowed money on a specific maturity date and to pay the interest as specified. Registered debt instruments have the name of the owner registered with the issuer; Bearer bonds, by contrast, assume ownership resides in the person possessing the bond
· Bonds: Secured by a mortgage on the property of the issuer, with a maturity date generally in excess of 5 years. Issued pursuant to an indenture.
· Debentures: Unsecured debt, with a maturity date typically in excess of 5 years. Issued pursuant to an indenture.
· Notes: Secured or unsecured, and may or may not be issued pursuant to an indenture. Typically have a maturity date of five years or less; may or may not be issued pursuant to an indenture
· Subordinated Debentures: Second in line behind creditors holding secured claims; participates pro-rata with the other unsecured creditors of the corporation if insolvency; may be a “junk bond”
· Commercial Paper: Short-term debt instrument issued in denominations of $100k+ with a maturity only a few months hence
Equity Securities
An ownership interest in a business corporation.
· Preferred Stock: Preference over common stock holders with regard to dividends and in distribution of the assets of the corporation upon dissolution. Rights almost exclusively the product of contract, but contract within the articles of incorporation rather than the indenture. Art. of Incorp. must permit issuance, or authorize BOD to issue at their discretion.
· Common Stock: Ownership interest in the corporation, subject only to the rights of the preferred stock holders.
Convertible and Exchangeable Securities
Debt securities and preferred securities may contain a “conversion option” allowing them to convert their shares into common stock at a specified ratio or specified price. The price is typically higher at the time of the offering of the convertible securities, and is sometimes referred to as the Conversion Premium
Convertible securities differ from warrants in that the holder of the senior securities must relinquish the senior security as consideration for the conversion. Warrant holders generally have the right to acquire shares for cash.
Exchangeable securities are senior securities which are convertible into shares of another corporation or securities other than the common stock of the issuer.
American Depositary Receipts
ADRs typically represent the common stock of a foreign corporation, but may also represent a debt instrument. ADRs are desirable because they trade in US $ rather than the currency of the home country. ADRs are created by depositing the security with a financial institution abroad which acts as a depositary for the underlying foreign securities and the issuance by the depositary of receipts. All of the rights and obligations of the issuer are contained within the Deposit Agreement.
Debt-Equity Ratios
Financial measurement used to compare a corporation’s long-term debt to its stockholders’ equity. A high debt-equity ratio means that a corporation is “leveraged.”
Redemption and Repurchase of Debt and Equity Securities
Right of Redemption
Permits the corporation to reacquire the security at certain times and for certain prices, whether or not the holder of the security wishes to sell. Thus, the redemption price includes a premium to compensate for the forced sale.
Put Option
Debt holder may receive right to force the corporation to buy back the debt security after several years, but before the maturity/redemption date. Protection measure for debt holders in case of rising interest rates and attractive to corporation because it can save on interest costs.
Sinking Fund
A provision typically contained within an indenture that authorizes scheduled payments by the corporation to a fund that will periodically reacquire (redeem) outstanding senior securities. The effect is to reduce the number of aggregate senior securities outstanding. The sinking fund may also be used as the vessel for complete repayment on the maturity date. In that case, it has still been funded through installment payments.
Corporations like them because they can issue new debt; Debt holders like them because they are receiving a guaranteed return of their investment, while those who continue to hold securities are more likely to receive payment at maturity.
2. Valuation of the Corporate Enterprise – Purposes & Methodology
§2.02 — Valuation Terminology
· Book Value:
o With respect to assets, the capitalized cost of an asset less accumulated depreciation, depletion, or amortization as it appears on the books
o With respect to a business enterprise, the difference between total assets (net of depreciation, depletion, and amortization) and total liabilities of an enterprise as they appear on a balance sheet.
· Capitalization:
o The conversion of income into value
o The capital structure of a business enterprise (“the total amount of a corporation’s long-term financing, including stock, bonds, and retained earnings.”)
ship after the transaction.
Other Factors: Selected published analysts’ reports; historical market prices and trading volumes, etc.
· Cawley v. SCM Corp (NY COLR)
o Facts: Hostile takeover of SCM; white knight offers friendly buyout and price escalates; hostile offer wins, “squeezing out” minority interest in order to simply operations
§ Squeeze Out: Merger in which unwanted minority shareholders are “squeezed out” after acquisition by new controlling shareholders
o Rule: Post-merger events having impact on the corporate value must be considered in appraisals (here, the tax consequences)
· Friedman v. Beway Realty Corp (NY COLR)
o Facts: Nine close corporations transfer their assets to a partnership. Pl. brings suit demanding value of his proportional assets.
§ Close Corporations because they limit liability; single partnership because it offers pass-through taxation
o Issue: What is the fair value of the shares?
o Rule: Judges valuing minority interests should value as a going concern; to do otherwise would encourage and reward oppression.
§ Examples of what a court looks at when deciding how to value:
· Comparables and Business value (b/c anyone buying in is buying into the business, not the liquid. value of the shares)
· M.G. Bancorporation v. Le Beau (DE COLR)
o Facts: Squeeze out merger causes minority shareholders to demand a statutory appraisal
o Rule: Court may create its own valuation methodology, blending the opinions of the experts on trial, rather than adopt one opinion wholesale
· Global GT LP v. Golden Telecom, Inc. (DE Chancery)
o Facts: Really opaque Russian telecom market, with the added twist that both the acquirer and target have the same two largest shareholders and target refuses to sell to anyone other than acquirer; suggests that the acquisition price may have been below-market in order to allow the acquiring company to buy assets at a price < open market
o Rule: Judges can modify the acquisition price to something more reflective of the actual value
§ DCF valuation because it’s an opaque market.
§ Discussion of three important DCF drivers: 1. Terminal Growth Rate; 2. Tax Rates; 3. Equity Risk Premium Beta, in particular Bloomberg vs. MSCI Barra
