Capital reconstruction schemes
Is a scheme whereby a company reorganises its capital structure by changing the rights of its shareholders and possibly the creditors
This can occur in a number of circumstances, the most common being when a company is in financial difficulties, but also when a company is seeking floatation or being acquired.
If a company is in financial difficulties it may have no recourse but to accept liquidation as the final outcome.
Typical financial difficulties:
Large accumulated losses.
Large arrears of dividends on cumulative preference shares.
Large arrears of debenture interest.
No payment of ordinary dividend.
Market share price below nominal value.
However, it may be in position to survive, and indeed flourish, by taking up some future contract or opening in the market.
The only major problem is the cash needed to finance such operations because the present structure of the company will not be attractive to outside investors.
To get cash the company will need to reorganise or reconstruct.
The changing or reconstruction of the company’s capital could solve these problems.
The company can take any or all of the following steps:
write off the accumulated losses.
write of the debenture interest and preference share dividend arrears.
write down the nominal value of the shares.
To do this the company must ask all or some of its existing stakeholders to surrender existing rights and amount owing in exchange for new rights under a new or reformed company.
The question is ‘why would the stakeholder be willing to do this? The answer to this is that it may be preferable to the alternatives which are:
to accept whatever return they could be given in a liquidation;
to remain as they are with the prospect of no return from their investment and no growth in their investment.
Generally, stakeholders may be willing to give up their existing rights and amounts owing (which are unlikely to be met) for the opportunity to share in the growth in profits which may arise from the extra cash which can be generated as a consequence of their actions.