Shareholder Disputes Are Almost Inevitable…Be Prepared!
We are continually surprised by the number of privately held companies that do not have a documented plan to avoid or reduce future disputes among shareholders. Whether your business is family owned or has a number of arms-length shareholders you need to consider implementing a Shareholders’ Agreement to address one of many triggering events that will almost surely affect your business at some point.
The answer to the question “Why doesn’t your business have a Shareholders’ Agreement?” is almost always something to the effect of “We get along and agree on everything”. The other reason often given is “We are all family members so we don’t need one”.
What people forget, or choose to ignore, is that during periods of time when the business is doing well and everyone is actively involved, major disputes rarely occur. However, what happens when one or more shareholders approach their retirement date? What if they start reducing their workload or effectiveness over time? Perhaps the business takes a downward turn. Invariably this causes internal soul searching within the business that may shed light on one or more shareholders no longer pulling their weight. These are only a few examples of issues that can give rise to disagreement among shareholders.
You also need to consider that triggering events are not always discretionary. The death or disability of a shareholder can be difficult to deal with as the person affected may no longer be capable of speaking for themselves and you are left dealing with an estate executor or power of attorney.
These examples can affect any business. It doesn’t really matter if the parties are family or deal at arms-length; if they all have equal ownership positions or there exists majority and minority shareholders; if they are all active in the business or some are passive. The answer is to plan ahead. Discuss the issues that you may face, determine how you wish to deal with them, and document that plan in a Shareholders’ Agreement.
What are some of the issues that you need to consider? Many come from the examples noted above:
If you have minority shareholders, how are they protected in terms of future dividends; share redemptions; or purchase and sale of the majority’s shares?
How are you going to deal with future shareholder retirements? Think of issues such as timing; purchase vs redemption of shares; pricing; terms and conditions for payout.
What do you do in the event of the death or disability of a shareholder? Once again you need to consider things such as purchase vs redemption of shares; pricing; terms and conditions for payout. The implementation of life insurance or disability coverage will certainly have an impact on the funding available and should be considered.
How are we going to value the shares in situations other than an outright purchase and sale? Potential solutions include the use of a formula approach; the appointment of a Chartered Business Valuator at the time of the event; or agreement among the shareholders as to the business value at some predetermined interval, generally coinciding with the annual meeting.
How do you provide liquidity for shareholders while restricting their ability to market their shares outside of the existing group of shareholders? Clauses governing this area are generally referred to using terms such as Right of First Refusal; Piggy-Back; and Drag-Along.
Since this is not something business owners do on a regular basis you are going to need professional assistance to guide you through the process. A business coach experienced in ownership transition issues can be invaluable. Other professional help you will need could come from your external accountant, a Chartered Business Valuator, or your Company’s legal counsel.
As is the case in virtually all areas of business, the answer to any issue is to plan ahead and prepare. Are you ready?
Contact one of our Business Valuation team members for assistance with a shareholder dispute.