Foundations of a young company
This is part seven of the Bermuda Investment Primer, following the continuing launch of a Bermuda business: MamaZina Pizzarina Ltd (Mzee).
A stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings, according to investment website Investopedia.
A bond is a debt investment in which an investor loans money to an entity, typically corporate or governmental, which borrows the funds for a defined period of time at a variable or fixed interest rate.
Stocks (shares) start their business life derived from the formal incorporation of a business — one that may have been operated by two partners, a sole proprietor and so on.
Shares are divvied up in the original incorporation of a private company based upon the percentage of capital contributed by each new shareholder.
While we are more familiar with stocks that are traded on global securities trading platforms such as the New York Stock Exchange, please keep in mind that Mzee is a small privately held company. Mzee shares are not sold on an exchange, that is the so-called secondary market that evolves through incredible company growth.
Could it happen that Mzee “goes public” in the future? Why not, it has been done with Bermuda companies such as Devonshire Industries Ltd with more than 440,000 shares held publicly; Polaris Holding Company Ltd, the parent company of Stevedoring Services, with more than 1.1 million shares in public domain, and Watlington Waterworks with over 1 million shares. All shares can be bought and sold on the Bermuda Stock Exchange. http://www.bsx.com/company_details.php?CompanyID=112
You know these companies. You use their products directly, paint supplies and precious water, and indirectly, through the shipping of goods and offloading into Bermuda. So, why wouldn’t it be feasible to have a pizza company listed on the Bermuda Stock Exchange?
It could happen, in reality. But, we do know that our pizza company is purely hypothetical at this stage of the game. The business incorporation process formalises ownership, establishes the company as a legal stand-alone entity that has unlimited life (ie the business won’t fold when the owners die), embeds specific byelaws and operating procedures, provides protection against liabilities, delineates the management control and voting protocol, division of profits, distributions, and succession planning. The incorporation documents are very serious indeed, never to be taken lightly, considered the company blueprint for growth and success in the future. The rules and regulations contained within these documents will generally overrule any individual’s attempt at personal control or effecting changes.
MamaZina Pizzarina Ltd is here to stay.
The new shareholders agreed on percentage ownership of the company shares based upon their capital contribution to the company. Mamazina owns 70 per cent of the company, with each child owning 10 per cent.
Mzee invested the largest sum, $70,000 and thus, is the primary shareholder with greatest voting rights. George invests $5,000; Juliana invests $1,000 and Desmond, $7,000. The adult children are cash short, one seriously so. The cost of their shares will be worked off (deducted) from their paycheques over time. The company balance sheet (net worth statement) will reflect loans to shareholders in the various amounts owed.
Mzee carries a personal debt to her friend and her parsimonious cousin John, who cheerfully coughed up $25,000 for equipment when they started the business.
She decides that the corporation should assume these liabilities. Loans are in a simple fashion, informal generic unsecuritised versions of capital market bonds. Mzee analyses the possibility of down the line considering offering small bonds for sale to raise capital — allowing some independence from bank financing.
Or, should they offer John a deal where the principal loan value is converted from debt into equity with shares, but a different class — maybe preferred shares with a generous dividend of 6 per cent annually, but no voting rights? A secondary sweetener could say guarantee buyback of the preferreds at 10 per cent over par in five years. Perhaps, John could also act as an impartial director of the company.
Succession planning: Mzee knows only too well that operating a family business is anything but harmonious some days. On her insistence the corporate byelaws are particularly restrictive relative to succession planning.
Shares held by the original owners will revert to the corporation (for redistribution among the remaining owners if said owner passes away, or he/she wants to be bought out. The reversion at death was deemed necessary to protect the family against outsider control, some might say, even intrusion.
One big reason: Desmond’s new wife is disliked, plus she is a US passport holder — perhaps a little nationality discrimination because of all that US Fatca reporting. The other minority shareholders are not enthusiastic about his new love, while Mama is concerned with this lady’s attempt to control the business if Desmond should pass prematurely. Mzee will not allow this company to fail.
The company is legitimate. The net worth (balance sheet) statement provides a clear look at their financial position on day one of the incorporated company. See chart! And explore link to accounting coach https://www.accountingcoach.com/balance-sheet/explanation/4
There are no retained earnings recorded, nor do we have a clear picture of their income and expenses. Serious calculations will result to define their real overhead: the cost of labour and benefits including health insurance, pensions, payroll taxes, life insurance, and other fixed costs: electricity, rent, gas, repairs, equipment, and product costs: raw ingredients, packaging, delivery, etc.
All of this planning and posturing presumes one very important thing — that pizza will continue to sell, and customers will continue to be loyal.
Mzee is ambitious, almost ruthlessly so. She knows without question they must continue to deliver a superior product. Let customer satisfaction slip. No customers, unhappy customers, say goodbye to her dream of offering any Bermuda resident a slice of her pizza business in the form of equity shares for sale. She is determined that this IPO dream will come true.
Reader homework. Currently, the Pizzarina overhead cost is running at $40,000 per month. Readers, how many pizzas must be sold every week to cover this monthly cost? You tell me? How many need to be sold to make a profit? Can the business succeed?
Part 8 — More on this, the place of bonds in businesses and portfolios to come.
Martha Harris Myron CPA PFS JSM: Masters of Law — International Tax and Financial Services; Pondstraddler Life™, financial perspectives for Bermuda islanders with multinational families and international connections on the Great Atlantic Pond. Contact: email@example.com
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