Chapter 1 • Introduction
Borrowings
Most companies borrow funds on a long-term, occasionally on a perpetual, basis.
Costain Group plc, an engineering, construction and land development business, is a
relatively rare example of a major UK business that has virtually no borrowings.
Lenders enter into a contractual relationship with the company, with the rate of
interest, its date of payment, the redemption date (if the loan is redeemable) and
amount all being terms of the contract. Many long-term lenders require rather more
by way of security for their loan than the rights conferred on any lender under the law
of contract. Typically, lenders insist that the principal and sometimes the interest are
secured on some specific asset of the borrowing company, frequently land. Such secur-
ity might confer on lenders a right to seize the asset and sell it to satisfy their claims
where repayment of principal or interest payment is overdue. Loan notes (or loan
stocks or debentures) are, in the case of many UK companies, traded in the LSE. It is
thus possible for someone owed £100 by X plc to sell this debt to another investor who,
from the date of the sale, will become entitled to receive interest, and repayment of the
principal in due course. Such payment amounts and dates are contractual obligations,
so there is less doubt surrounding them than applies to dividends from shares, more
particularly where the loan is secured. For this reason the market values of loan notes
tend to fluctuate even less than those of preference shares.
The relationship between the fixed return elements (preference shares and loan
notes), in the long-term financial structure, and the equity is usually referred to as
financial gearingor capital gearing(‘leverage’ in the USA). We shall consider in
Chapter 11 the reasons why companies have financial gearing.Raising and repaying long-term finance
Broadly speaking, companies have a fair amount of power to issue and redeem ordin-
ary shares, preference shares and loan notes; also to raise and repay other borrowing.
Where redemption of shares (both ordinary and preference) is to be undertaken, the
directors have a duty to take certain steps to safeguard the position of creditors (that
is, those owed money by the business), which might be threatened by significant
amounts of assets being transferred to shareholders.1.7 Liquidation
A limited company, because it has a separate existence from its shareholders, does not
die when they do. The only way in which the company’s death can be brought about
is by following the legally defined steps to liquidate (or wind up) the company.
Liquidationinvolves appointing a liquidator to realise the company’s assets, to pay the
claimants and formally to lay the company to rest.
The initiative to liquidate the company usually comes from either:
l the shareholders, perhaps because the purpose for which the company was formed
has been served; or
l the company’s creditors (including lenders), where the company is failing to pay its
debts. In these circumstances the objective is to stop the company from trading and
to ensure that non-cash assets are sold, the proceeds being used to meet (perhaps‘
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