Financial ABC’s
Concise explanations of financial terms commonly used by commercial law practitioners
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- A shark repellent, also known as a porcupine provision, is a strategy used by corporations to fend off unwanted or hostile takeover attempts.
Examples shark repellent:
Fair Price Provision Requires a bidder to pay the same price to all shareholders. This raises the stakes and discourages tender offers designed to attract only those shareholders most eager to replace management.
Golden Parachute A contract with top executives that makes it prohibitively expensive to get rid of existing m [...]
- Shark repellent
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- Consideration is a fundamental concept of contract law in common law jurisdictions. Indeed, it is usually required to make a contract enforceable. In this context, consideration is a bargained-for exchange of benefits that is sufficient to make a promise legally binding. Simply put, consideration is the price one pays for the other party's promise.
Consideration can take a number of forms: a promise, money, real or personal property, or the performance or non-performance of an act.
The [...]
- Consideration
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- A poison pill is a takeover defense used by publicly-traded companies to discourage unwelcome acquisitions by making the stock less attractive to the acquirer. There are a number of ways to achieve this, but two popular poison pills are:
A flip-in which allows existing shareholders (except the acquirer) to buy more shares at a discount; and
The flip-over which allows stockholders to buy the acquirer's shares at a discounted price after the merger.
The poison pill was invent [...]
- Poison Pill
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- In many leases there is a clause known as a Mother Hubbard clause which states that any property adjacent to property described on the lease is automatically included in the lease.
In Oil and Gas leases the Mother Hubbard clause usually found in the Granting clause, provides that the grant will cover other lands owned or claimed by the lessor in the area, even if they are not specifically described.
In Texas it protects the lessee against inaccuracies in a legal description caused by incor [...]
- Mother Hubbard clause
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- A noisy withdrawal is the public withdrawal of legal representation in which the lawyer, having knowledge of the client's existing or potential improprieties, such as a serious breach of securities law, disavows work done for the client and notifies the proper authorities of his/her withdrawal. [...]
- Noisy withdrawal
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- A Greenshoe Option is an option available to the underwriter of an initial public offering, ("IPO") to issue more shares if the IPO is oversubscribed. It is named after the Green Shoe Company which was the first to issue such an option. [...]
- Greenshoe Option
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- A recent Wall Street scandal has brought the term Ponzi scheme into the news again. Named after Charles Ponzi, a Ponzi scheme is a fraudulent investment scheme promising high rates of return with minimal risk. Typically, it generates returns by acquiring new investors whose investments then become the returns promised to early investors.
Ponzi schemes differ from pyramid schemes in that the individual(s) behind a Ponzi scheme gathers funds from new investors and then distributes them. Under t [...]
- Ponzi scheme
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- A venture capital fund is a form of investment in which third party investors, such as investment banks and individuals, pool their money in order to invest in projects. Such projects are often high-risk projects and the business promoting the project may be unable to acquire traditional bank funding or unwilling to pay the interest rate associated with high-risk loans.
Venture capital funds may vary in structure, but generally speaking they have a 10-year fixed life. Investors commit to the [...]
- Venture Capital Fund
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- Venture capital is form of business financing. It generally takes the form of a cash investment in exchange for shares in the company. Venture capitalists may also contribute managerial and technical expertise and indeed most venture capitalists require a large say in the running of the business as a condition of the advancement of the venture capital. Venture capital is most often sought by new start-up companies that do not have access to traditional capital markets or sources of finance as [...]
- Venture Capital
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- The useful life of an asset.
Last month we discussed depreciation, an accounting method that allows a company to allocate the costs of an asset over its life.
In accounting, the period of time over which an asset is to be depreciated is referred to as its useful life i.e. the period of time over which the asset is expected to be in use. The determination of what constitutes an asset’s useful life depends on the outlook of the owner. For example, the owner of a computer may intend [...]
- Useful Life
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- When a business purchases an asset, the life span of the asset is determined. For example, cars usually have a life span of 5 years whereas for other machinery the life span may be 20 years. The business will also determine the value of the asset that is used up every year by the asset over its life span as a consequence of being employed by the business. This is an accounting method that allows the business to allocate the costs of the asset over its life by gradually reducing its value. This r [...]
- Amortization vs. Depreciation
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- Accounting conventions have evolved to help practitioners overcome some of the practical problems associated with preparing accounting statements. They have developed in an attempt to ensure that the accounts reflect the true ‘substance’ of the business, i.e. that they present a “true and fair view”. The conventions act as guidelines in the preparation of accounts so that the accounts can be presented consistently and accurately. However, it should be noted that conventions are not black [...]
- Accounting convention
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- A type of debt financing that gives the lender the right to convert to equity or ownership if the debt is not repaid in time and in full.
It is usually used to finance business expansion but has also been popular as a form of financing for limited partnerships (“LPs”) and limited liability partnerships (“LLPs”). Though often subordinated to other forms of secured debt or debt provided by banks and venture capitalists, it ranks before other forms of unsecured debt. This may have distr [...]
- Mezzanine Financing
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- Double taxation
The principle of double taxation applies to corporations in which the same income is taxed twice. Taxes are paid firstly at the corporate level on earned income. Dividends subsequently paid to shareholders out of corporat earnings, then attract income-tax liability. In this way, the same income is subject to double taxation
Flow-through taxation
The principle of flow-through taxation is applied to partnership models. With this method of taxation the partners pay tax only on th [...]
- Business Taxation
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- Fixed Assets
Fixed assets are those assets that are held by the company on a continuous, on-going basis and are used to generate wealth. Examples of fixed assets include premises, motor vehicles, patents and copyrights and plant and machinery.
Current Assets
These are items that are not held on a continuous basis and are used to generate cash through the company’s trading activities. Examples include stock, and cash.
Whether an asset is classified as fixed or current depends on the use [...]
- The Balance Sheet – Assets
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- The financial statements of a company are prepared and presented according to financial regulations and are designed to give shareholders and investors an idea of the financial position and performance of the company during a period of time.
The financial statements consist of:
• The Balance Sheet – the financial position of the business at the end of a particular period;
• The Profit and Loss Account – calculation of the profit of the business during a particular period;
• [...]
- Financial Statements
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- audit: (n) the examination of a company’s accounting documentation and the verification or other comments regarding correctness of the documentation; also the review of a company’s accounting by the tax authorities. "The CFO of a company is responsible for ensuring that an audit is conducted prior to the annual report."
audit: (v) the act of conducting an audit. “The company was audited by the Tax Agency.”
auditor: (n) a public accountant with advanced training who is qualified to [...]
- Audit
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- Active market – a securities market or the market for a particular security in which trading is relatively heavy. An active market helps institutional investors wishing to acquire or dispose of large positions without affecting price. [...]
- Active Market
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- Arbitrage denotes a transaction yielding risk-free profit, usually by simultaneously buying and selling the same asset on two different markets to take advantage of price differences on the markets. This is also known as riskless profit. Arbitrage also describes the activity of engaging in arbitrage transactions. [...]
- Arbitrage
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- Hammering the market is the intense sale of stocks by those who believe that prices are inflated. Speculators who suspect that the market will drop may hammer the market by selling short (i.e. the sale of securities not actually owned by the seller). [...]
- Hammering the Market
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- The so-called Revlon rule is a legal precedent derived from a case involving the sale of Revlon, Inc. (Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., Supreme Court of Delaware, 1985, 506 A.2d 173). In that case, Revlon's board fought off a hostile takeover bid by employing a series of defenses and ultimately accepted a lower bid from a white knight. The Delaware court found that Revlon's directors had violated their fiduciary duty of care to their shareholders by accepting the white kni [...]
- Revlon Rule
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- In commercial transactions, one worry common to both buyers and sellers is the unexpected costs that may arise after closing. To avoid these types of problems the parties may elect to set forth ground rules in the Sales Purchase Agreement (“SPA”) in the form of a basket and cap (sometimes cap and basket) provision.
Under this scheme, each time an unexpected expense occurs the buyer puts it into a basket with a predetermined limit (e.g. €20,000). Here, the basket is a de minimis monetar [...]
- Basket and Cap
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- The term nil paid (alternatively, "nil-paid") denotes rights that are tradeable but that were not originally paid for by the seller. Such a right is simply a right to purchase more shares, usually at the current share price or a discount, given to existing shareholders by a company. If the rights are renounceable, the shareholders can choose to sell them on the market. Conversely, if the shareholders decide to exercise the rights, they must pay for the securities they have been given the right [...]
- Nil paid
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- Hedging is a strategy used to limit the risks of an investment. Investors often try to hedge against inflation by using assets that will appreciate (rise in value) faster than inflation. A hedge fund is a mutual fund that uses such techniques to offset risks. [...]
- Hedging
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- Hung up is the expression used to describe the situation of an investor whose securities have dropped in value below the original purchase price, presenting the problem of a substantial loss if the securities were sold. [...]
- Hung Up
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- Odd lot is a securities trade made for less than the normal trading unit, (normally 100 shares of stock or $25.00 face amount of bonds) which is called a round lot. An investor making an odd-lot trade usually pays a higher commission than for a round-lot trade. [...]
- Odd Lot
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- The language of corporate mergers and acquisitions is filled with fairytale imagery which is used to describe various players in and aspects of the transactions. For example:
A Black Knight is a company that makes a hostile takeover offer on a target company. An allusion to the evil villain of many fairytales, this term demonstrates how a targeted company sees its adversary.
A White Knight is a company that is invited to make a friendly takeover offer to a target company that is being face [...]
- M&A Imagery
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- Equity is a term with several meanings, both in the law and in finance. In another part of this issue of the Digest, the term ‘equity’ is addressed in the context of fairness in the application of law.
Equity in a financial context has the following meanings:
• the net assets of a company after payment of creditors is called the shareholders’ equity (also referred to as owners’ equity);
• the ownership interest in an asset minus the debt owed on the asset, e.g. the own [...]
- Equity