Guide

How to unlock capital from inefficient equity structures

Gateley Legal

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Welcome to the ninth post in our 'Building a resilient balance sheet for 2021' series looking at solutions and opportunities viewed through the balance sheet. In this post, we look at whether and how capital can be unlocked from inefficient equity structures.

Why could a company reduce its share capital?

A company could reduce its share capital for a number of reasons: 

  • to create or increase distributable reserves; 
  • to reduce or eliminate accumulated realised losses (to make distributions in the future); 
  • to return surplus capital to shareholders; or 
  • to distribute non-cash assets to shareholders. 

How can capital be unlocked from inefficient equity structures?

A reduction of capital which does not involve a repayment to shareholders results in the creation of a reserve equal to the amount of the capital cancelled and is generally treated as a realised profit. This would generally be credited to the company's P&L, showing a stronger balance sheet.

Many companies have over time built up substantial share premium accounts. These can be reduced or cancelled with the proceeds being treated the same way. The process is not difficult, expensive or time-consuming.

A company may also wish to increase its distributable reserves. This could be to carry out a demerger, where the value of the assets or the shares to be transferred exceeds the amount of the company's distributable reserves. It could also be to buy back or redeem its shares.

Whatever the reason, if the appropriate conditions set out in the Companies Acts can be satisfied to allow it, a reduction of capital and the creation/increase of distributable reserves, or even the reduction or elimination of accumulated realised losses, will create a much healthier balance sheet and increase a company’s flexibility at a time when it may be urgently required.

In our final post, we look at dividends. At a time when balance sheets are constrained it is important to understand when dividends can be paid, especially given the consequences of getting it wrong.

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