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Dear John
I understood the answer for calculation in part (a), however, part (B) Examiner’s answer confused me quite a bit:
If directors buys some of Gupte VC’s shares themselves-
“The directors can avoid this by buying some of Gupte VC’s shares themselves, but this represents money which is not being put into the business.”
QUESTION1:
Does above mean: Directors could have invested their own cash into business directly, but now used to pay the VC instead?.“In addition, the amount of shares which the directors would have to purchase would be greater if results, and therefore reserves, were worse than expected”
QUESTION2:
why the amount of shares directors need to purchase can be greater? shouldn’t it be the 10m shares owned by VC?
Or,
does it actually mean the Market Value of VC’s share, since director will need to pay market share price if themselves buy from the VC?
but if so, the share price should also drop and pay less if result and reserves are worse?Thank you for your help!
They want to avoid breaking the covenant which would happen if Gupte demands that the company buys back his shares at par.
If the directors were to buy some of Guptes shares themselves using their own money, then if Gupte did demand later that the company buys back his shares then because he will own fewer shares the company would not have to pay out as much.
The second problem you write occurs because the company would have to repay Gupte’s shares at par, whereas if the directors buy some shares from Gupte they will buy at whatever the market value of the shares is. The company want to avoid having to pay too much to Gupte if he demands repayment, but because repayment is at par, the directors would have to buy more shares from him if the value is lower to avoid the same amount of repayment.
Thank you sir i think i understand it now.
The target is to aviod breaking covenant, which here is a minimum equity level
Eg: Covenant requires equity minimum 100
Current equity 120 = reserve 20 + shares held by director 60 + shares held by Gupte 40if company forced to buy back all Gupte shares at par now, then these shares are cancelled and equity = 20 + 60 = 80 and covenant breached.
if director buy 30 from Gupte first, then:
current equity 120 = reserve 20 + shares held by director 90 + shares held by Gupte 10
even company later forced to buyback Gupte the remaining 10, equity will still be at 110, above covenant.if Reserve drop to 5 due to profit, then equity become:
105 = reserve 5 + shares + shares held by director 90 + shares held by Gupte 10
and company later forced to buyback Gupte the 10, equity will still be at 95, and breach covenant;
therefore, directors now will have to buy at least 30 + another 5 total 35 from Gupte to ensure covenant not breached.
and this is what examiner mean by
“In addition, the amount of shares which the directors would have to purchase would be greater if results, and therefore reserves, were worse than expected”
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