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Solution for Business Law 3rd Edition Chapter 11, Problem 1

by Nickolas James
128 Solutions 13 Chapters 13467 Studied ISBN: 9780730305743 Business Law 5 (1)

Chapter 11, Problem 1 : 1.Johnny and Ash have been looking for a...

1.Johnny and Ash have been looking for a source of funding to finance Organicola’s next stage of expansion. Lee is willing to invest $2 million into the company in return for 30 per cent of the issued shares. What are the legal advantages and disadvantages for Lee in subscribing for shares in the company rather than lending Organicola the money? Should Lee purchase preference shares or ordinary shares?

 

Step-By-Step Solution

See Business Lawpp562-566.

The differences between investing in Organicola and lending the money include the following:

If Lee subscribes for shares, he will receive a dividend only if the company makes a profit and only if the directors decide to pay a dividend. If Lee is a creditor he will be entitled to interest payments regardless of whether Organicola makes a profit.

If Lee subscribes for shares, he will be able to get back the amount subscribed only if he can find someone to buy his shares (which will be difficult in an unlisted company) or the company buys back his shares or otherwise carries out a reduction of capital in a manner permitted by the Corporations Act. If Lee is a creditor he will be entitled to repayment of the $2 million principal at the end of the term of the loan.

If Lee subscribes for shares, he will have a right to vote and thereby influence the running of Organicola. If Lee is a creditor, he will not be entitled to vote at members’ meetings.

If Lee subscribes for shares and the value of the business doubles, he may find that the value of his shares has also doubled. If Lee is a creditor, he will not share in the potential growth of the business: he will never make more than the interest plus a return of principal.

The differences between ordinary shares and preference shares include the following:

If Lee is an ordinary shareholder he will share equally in dividends (if declared) with all other ordinary shareholders after all other claimants have been paid. If Lee is a preference shareholder he will receive a fixed dividend provided there are profits available for distribution and a dividend is declared.

If Lee is an ordinary shareholder he will be entitled to vote at general meetings.  If Lee is a preference shareholder he will have no voting rights unless dividends are in arrears, except in certain circumstances.

If Lee is an ordinary shareholder he will be repaid capital on a winding-up only after all other claimants have been repaid. If Lee is a preference shareholder he will be repaid capital on a winding-up in priority to ordinary shareholders.

If Lee is an ordinary shareholder he will share pro rata in any surplus assets on winding-up.  If Lee is a preference shareholder he will have no right to share in surplus assets on a winding-up.

 

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