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Despite
its existence for about half a century, public share
floating for formation of companies has almost been an alien
concept in Ethiopia for quite a long time. Many attribute
this to lack of confidence over management practices in
private companies. Others claim that human beings are
interested in watching their hard earned money very closely.
It is not
uncommon to hear the cliché that Ethiopians would rather
enjoy dining than working with their companions. However, in
a turn of events, the recent proliferation of public share
offers has been surprising to many.
According
to the Commercial Code of Ethiopia issued in 1960, a
business organization is a company arising out of a
partnership agreement. The code further states that any
business organization other than a joint venture shall be
deemed to be a legal person. However, Ethiopian business is
dominated by private limited companies, often shortened as
PLCs, and sole proprietorships with no legal personalities
separate from the owners.
Many
businessmen and women claim that they prefer to establish
their business undertakings in the form of private limited
companies for reasons of veil of incorporation and ease of
formation and operation. The first is the legal protection
that one obtains to protect his personal assets in case of
bankruptcies and when trade creditors and other liabilities
are in excess of assets owned by the company.
Tax
deductions for allowable expenses and the relatively lower
tax rates for companies compared with sole proprietorships
are other advantages. With the second, two people can form
PLCs (It is not uncommon for one of them to be a silent
partner); paid-up capitals are not required to be
ascertained by regulatory bodies and contributions in kind
are a matter of agreement between the founding shareholders.
Moreover,
annual financial audits are not mandatory and formation is
possible with capital of 15,000 Br or more, as opposed to
formation of share companies, which is not possible with
less than five persons and 50,000 Br paid up capital.
With share
companies, at least one quarter of the capital has to be
paid upfront and contributions in kind have to be valued by
authorized professionals and approved by the Ministry of
Trade and Industry (MoTI). Annual financial audits by
authorized auditors are mandatory and the accounts have to
be submitted to the Ministry for publication in the
interests of third parties.
Going Public? What's Up!
Considering the advantages enjoyed by PLCs, one may wonder
why promoters are keen to set up share companies, and why
now?
It seems
that the era of easily obtained cheap bank credits is over.
After the global financial crisis [triggered by the
sub-prime mortgages], bricks and mortar are no longer enough
to convince bankers that they are adequate collateral to
secure credits in order to extend financing. With the
increasing regulatory restrictions by the Central Bank on
extending loans and advances, equity financing from
prospective shareholders has become a way out for
cash-starved upcoming projects.
We are
witnessing a continuously shrinking world where competition
is no more with just the neighbouring similar establishment.
With the increasing influence of globalization, a tiny
handcrafts shop next door is facing direct competition from
giant multinationals overseas. It is no more "Small is
beautiful".
Taking the
advantage of economies of scale from mass productions by
giant manufacturers, global commodity prices are being
pushed down making the price of products from small
enterprises unreasonable for the rational minded consumer.
Not to mention the image of small holders from quality
standards' perspectives. The bigger is becoming the safer
and the winner.
The local
and global realities of our time call for the emergence of
bigger and more reliable companies which can be made
possible through public offering of shares. While
potentially lucrative projects are lining prospective
shareholders up, too many gray areas in the current
practices are deterrent for many prospective investors from
wholeheartedly earmarking their monies to the proliferating
public share offerings.
The main
concerns of aspiring shareholders and the public can be
summarized as inadequate regulations by appropriate and
responsible state agencies, and limited awareness by
prospective shareholders of their rights and duties to
protect their resources as provided by the applicable laws
governing share companies and their operations.
One of the
luring factors for prospective investors to acquire the
publicly floated shares is the promised returns on
investment and the time period required for investments to
start providing dividends. It is not uncommon for the
promoters of share companies to promise annual returns to
the prospective shareholders, over 50pc of equity
contributed. The Ethiopian Commercial Code, in its Article
318/2, states that copies of the prospectus and expert
report be made available to all persons who may wish to
subscribe. Moreover, Article 309/1 indicates the liability
of founders of share companies on the accuracy of statements
made to the public in respect to the formation of the
company.
However, I
observed that most figures offered by promoters of companies
lack detailed studies and are not ascertained by independent
professional bodies. For instance, a promoter of a certain
company had promised, in the prospectus, close to 49pc rate
of return on investment a couple of years ago only to post
actual annual return on investment of about 11pc this year.
Should one
ask, "How come?" The scapegoat is the usual, "It is the
economy, stupid!"
The
Commercial Code, in its Article 310, limits the advantages
to founders of share companies to a share from annual
profits, not exceeding 20pc of the net profits in the
balance sheets for a maximum period of three years. The Code
explicitly states that there should not be any other
advantages to the founders.
This
protects the monies of shareholders from being used to the
advantages of the promoters before the value of their
efforts is clearly reflected on the bottom line of the
financial statements.
However,
many shareholders are concerned that monies collected to
finance the establishment process in form of service charges
may end up benefiting the promoters and founders. Some even
fear that the rush to establish new public offerings is
closely linked with the scramble to benefit from the service
charges collected on top of par values of shares which are
easily accessible to the promoters than the advantages from
profits from operations of the companies.
In line
with preoperational establishment expenses, Article 308 of
the Commercial Code indicates that all expenses incurred by
the founders for the formation of the company are to be
refunded to them upon approval by the general meeting of
subscribers. This implies that the preoperational expenses
are to be borne by promoters and to be refunded later.
It is
obvious that when a company is formed, it needs financing.
In the
developed world, there are sources for such financing. The
private equity market is known for its financing of
startups. It includes venture capitals and 'angel'
investors. For some startup companies, the founders would
have sufficient resources to get things launched. They
simply cover living costs, office space rentals, and other
things out of their savings while they formulate business
plans for the product or services they intend to launch.
When they have no resources or their resources dry up, they
may seek funding from one or more 'angel' investors -
wealthy individuals who are willing to fund what they regard
as good ideas.
Founders
and 'angel' capitals are necessary in order to get the idea
formulated and develop a business plan. The next step is to
approach venture capitalists for further funding. A venture
capital represents funds invested in an existing, relatively
new enterprise. Money from venture capitalists helps the
company grow.
However,
there is always high risk of failure for startup companies.
With failure, the venture capitalists lose their money. If
the companies become successful, the company will go public
for sale of its shares to the public enabling the venture
capitalists to obtain cash returns on their investment with
huge profits.
But there
are more in this whole scene, including institutional
investors such as investment banks.
Investment
banks play a very crucial role in the public share floating
process. Most of the IPOs elsewhere are done through
investment banks as underwriters. They are known for their
top notch investment analysts who can reasonably forecast
future cash flows arising out of projects, thereby
professionally determining the value of companies and their
shares. The investment banks have earned public trust and
this facilitates the public offering process.
What we
can learn from the practices of other countries is that the
risks associated with startup companies are primarily
assumed by a small number of sophisticated investors who can
reasonably calculate the associated risks and returns. Only
companies proven successful will go public through IPOs.
Still, successful private companies going public through
IPOs are subject to regulatory scrutiny and approval by
responsible bodies such as the Securities and Exchange
Commission (SEC) of the United States.
One of the
major concerns in public share offerings is the lack of a
specific regulatory agency that closely follows up the
activities of public share floating operations to ascertain
conformity with relevant laws and regulations, thereby
protecting other peoples' money (a.k.a. OPM) from being
swindled by irresponsible promoters.
While such
bodies protect public money from major potential
embezzlement, it facilitates the process of raising public
funds for worthy objectives as interested potential
shareholders would take lesser time to convince themselves
whether their money remains in good hands.
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