WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK. FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON
We will conclude our look back at the story of
BBE with the final previously posted chapter. Here is a portion of
the seventh blog, which was called The Final Monday With The Venture Capitalists:
"Everyone agrees that BBE will amend
its Articles of Incorporation to increase the number of authorized
shares from the original 1,000 shares of common stock to 10,000
authorized shares with a par value of $1 each. There
had been earlier discussions about more shares being authorized, but to
keep the math simple, 10,000 shares at $1 par value is the agreed upon
number. This is equivalent to the original 1,000 authorized shares with
$10 par value. BBE will have 9,500 shares authorized, but unissued
shares of common stock plus the original 500 issued and outstanding
shares. With that many
shares now authorized, the board of directors will declare a stock split
of the issued shares on a 10 for 1 basis. The original 500 outstanding
shares with a par value of $10 each will become 5,000 shares with a par
value of $1 each. The existing shareholders will continue to own the
increased number of issued shares in their original percentages.
Based
on BBE's earnings of $5,000 for the last year of operations and its
retained earnings of $10,000, the old 500 shares might be valued at $30
per share ($10 par value and $20 per share of retained earnings). Those
figures are reduced for the 5,000 split shares by a factor of 10. The
new 5,000 shares could be valued at $3 per share. The $1,500 of
dividends would now be shared in the same proportion. Before the stock
split, each of the original shares received a $3 dividend. The 5,000
shares would now receive a 30 cent per share dividend. Someone recalls
our president's previous joke about the customer asking for his pizza to
be cut into 4 slices as opposed to 8 because he is not that hungry.
The income and dividend numbers continue to apply; they are just spread
among more shares.
When
VFI purchases common shares, those numbers will be divided among even
more shares. In order to allow the original shareholders to retain
control of BBE, VFI will purchase 4,000 shares of common stock.
Although the par value for the new shares is $1, VFI agrees to pay $2.50
for each share of common stock. The par value has continued to lose
its meaning, and it now becomes even less important. The value of a
share of common stock is not its par value or its book value, but rather
what someone will pay for it. Consequently, BBE will issue 4,000
shares of common stock to VFI for a purchase price of $10,000. After
that, BBE will still have 1,000 authorized but unissued shares of common
stock. VFI will also purchase 600 shares of cumulative, convertible
preferred stock with a par value of $100 per share. Unlike par value
for the common shares, the par value for the preferred shares does
matter. The preferred shares will have a yield (their fixed dividend)
of 2% per share. BBE will pay $1200 in annual dividends on the 600
preferred shares. Based on the most recent declared dividend of $1,500,
this leaves only $300 in dividends for the common shares. Everyone
hopes that the earnings will continue to increase, resulting in an
increase in the dividend paid on the larger number of issued shares.
The original shareholders retain the control they want, but they have to
give up dividends to get it. If the directors of BBE were to decide,
for financial reasons, not to pay the preferred dividend for three
consecutive years, VFI will have the right to convert its preferred
shares into common stock, again on a 10 to 1 basis.
Focusing
on the possibility of such a conversion, we realize that the Articles
of Incorporation must authorize more common shares than the 10,000 we
had initially proposed in order to keep the par value in balance.
Everyone agrees that the par value is not that important any more except
for accounting purposes. Our treasurer assures us that it is not a
problem to get rid of par value for the common stock. Both sides agree
that the Articles will authorize a total of 50,000 common shares with no
par value and 600 preferred shares each with a $100 par value. If the
preferred stock were to be converted because no dividend had been paid
for three years, the 600 shares of preferred could be converted by VFI
into 6,000 shares of common. This would give VFI a total of 10,000
shares of common stock, enough to outvote the 5,000 shares held by the
original shareholders. Since the preferred shares always remain worth
their par value, VFI would also have the right to convert the preferred
shares into common if BBE is sold to other investors or taken public.
By converting the preferred to common, VFI can share in any increase in
the value of BBE and, consequently, its common stock. With final
agreement reached, the legal papers are completed, and VFI's money is
received. BBE buys the servers, expands the office and hires new
employees."
Here is a link to the entire blog, which was posted on March 14, 2011.
We will now continue BBE's story in the next blog.
Comments are always welcome.
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