By Christine Nicholson and Andrew Cassin
When a business first starts out all the activity is usually focused on getting some money in the bank and getting a steady flow of customers. Having a Shareholder Agreement is recommended at the start when you are all getting along, especially when the dust starts to settle and you start thinking about your long term plans. Shareholders often have very different ideas of what next year or ten years time looks like for them personally and its worth getting this all out in the open sooner rather than later. A Shareholder Agreement documents this so that everyone is protected.
Over 50% of businesses find they have to respond to a crisis in a shareholders life – divorce, death, disease, disability to name just a few. This frequently has a devastating effect on the business. Shareholder Agreements help manage those situations more easily and with a lower impact on the business, especially its value. Here’s 3 reasons to get a Shareholder Agreement in place AND regularly review it:
#1: Review your Shareholder Agreement
Businesses with multiple shareholders more often than not have in place a formal shareholder agreement (SHA). When prepared well, allowance for the inevitable departure of some or all shareholders is made. Those that are a little less comprehensive sometimes overlook this eventuality. Irrespective of when your SHA was prepared or by whom, take the time to review it to ensure that provision is made for:
- Tag along, where all shareholders have the right, and can elect, to sell their shares in accordance with the same conditions to a buyer who has made an offer to purchase another shareholder’s shares;
- Drag along, where once a proportion of the total shareholding is to be sold, all remaining shareholders are required to sell their shareholdings in accordance with the same conditions and consideration;
- Buy/sell, where remaining shareholders have first right to purchase a departing shareholder’s shares and under what conditions;
Other considerations relating to the eventual sale of the business. It might be prudent to seek professional legal advice at this point if you are unsure about your existing SHA.
#2: Get commitment from all shareholders
Nothing will doom a planned business sale like a split in the ranks. In fact, it is often a split in the ranks that precipitates the decision to exit a business, however this is not usually an optimal outcome. In businesses with multiple shareholders, be they external investors, silent partners, active partners or staff, the decision by the principal to exit has implications for all and requires their commitment to ensure the most desirable result. This is particularly true when other shareholders are required to invest time, money and/or effort into preparing the business for the principal’s exit.
So, be open and honest with other shareholders and get them on board. Communicate how the decision to exit will have positive implications for them and how you intend to move forward. A united group will stand a far better chance of achieving the desired, mutually beneficial result.
If, however, other shareholders cannot see a personal benefit from supporting the effort, you may need to consider all alternative strategies to ensure your efforts are not doomed to fail before you even begin.
#3: Think: is your potential buyer already a shareholder?
Speaking of the need for a mutually beneficial outcome for all shareholders, consider the extent to which your equity partners could be the perfect buyer for your stake in the business. For instance, in larger organisations, external investors, such as private equity firms, often seek the opportunity to increase their stake, whilst, in smaller partnerships, remaining partners welcome opportunities to increase their equity.
Conversely, consider the implications of your desire to build value in the business to achieve your own exit objectives, when the likely buyer is an existing shareholder. If they support your efforts, they will likely have to fork out more to purchase your stake than were they to buy you out at current value.
Either way, if the likely buyer is an existing equitable partner, consider carefully how to put the most supportive structures (e.g., buy/sell provisions in the Shareholder Agreement) in place, how and when to communicate your plans and what their likely reactions would be.
