Parting Ways with an existing shareholder is a gust post by Christopher Jenkins of Ecovis Wingrave Yeats on a business theme.
Parting ways with an existing shareholder
Nine essential things to remember
The Partners you start your business with and the shareholders you take on in the early days aren’t necessarily the right people for the business once it really starts to take off. People whom you were pleased to be able to recruit in year one often start to disappoint as the business develops over time.
Maybe they are no longer adding value, or maybe your visions for the business are no longer aligned. Whatever the reason, the easiest solution (live with it and keep the peace!) is never the best. So what are the key things you will need to consider when getting rid of an unwanted shareholder?
1. Choose your shareholders carefully
Shares are easy to give away and difficult to get back and EMI Schemes are the easiest way to accumulate unwanted shareholders. Installing a Scheme makes you feel good at the time but rush into one for the wrong reasons and then try unwinding it. The key is to understand what the recipient really wants, what will really tie them in and improve their performance. It may not be shares at all but rather cash now to pay off their mortgage or perhaps just respect, inclusion and purpose in their work would do the trick far better. Try ‘shadow’ shares that pay ‘shadow’ dividends for example.
2. Beware of NED’s as Shareholders
Equally, be wary of giving Non-execs a shareholding in your business. Yes they may be able to pull a spectacular rabbit out of a hat in the first year but they often lose their use quickly or stop trying once they’ve got hold of the equity that they wanted. Much better to pay them whatever it takes, and then be able to cut them as soon as they stop being useful.
3. Pre plan the exit route
If you take on an investor at an early stage try to agree with them a price at which you can buy back their shares over, say, the next 4 years. Offer them 5 times their money back. Most experienced investors would be delighted to make even 3 times their stake. If your business does take off then those shares could be worth more than 20 times their cost and it could end up being the best deal you ever did.
In sensitive situations, where the key issue is determining the value of their shareholding, try to mediate as far as you can. Introduce someone new into the negotiations, someone whom both parties respect and who is impartial, and ask for their help in negotiating a fair deal. However wary be of resorting to the long established route of asking the President of the Institute of Chartered Accountants to name a Firm to value the shareholding. Whatever their decision is, it will be binding on both parties and we have seen ludicrously high valuations forced on the Buyer which nearly bankrupted them.
5. Try the gradual buy-out
Remember that exits can be achieved gradually. The main problem is usually that the incumbent shareholder never has sufficient funds to buy out their exiting partner but the solution can often be found in a buy-out over time where future profits can be used to fun a pre-agreed price over say 5 years. Even if you have to pay more as a result, you do have the advantage of using the share of profits that the seller would have got anyway, to fund the payments to them.
6. Be careful of remuneration by Dividends
This is where so many shareholders fall out. The problem comes when your accountant tells you that the most tax-efficient way of paying yourselves is to take dividends. You own the business equally with another and in the first years you both contribute equally to the business in terms of hours worked, capital injected etc. But what happens when one of you decides that they only want to work 3 days a week, or not at all? Sharing profits equally doesn’t work any more and it is at this point that you need to be able to distinguish between remuneration due to you as a “Manager” (for the work you do) and the share of profits due to each of you as shareholders in the business, after Management (ie you!)has been paid at a commercial rate>
7. Make sure you have the right Paperwork in place
This does not have to involve a 30 page £15k Shareholder Agreement. The most important sheet of paper can be one just signed by all concerned that lays out exactly what you agreed originally – ie a paper for the avoidance of doubt’. Start arguing about what was originally agreed between you in the first flushes of enthusiasm and you will end up in a fight. So, in the nicest possible way, get your pre-nups in place early
8. Battling it out with a resistant shareholder
If you decide to go head-to-head to get rid of someone, then be prepared to lose a few Battles in order to win the War. In sensitive situations such as these, offence can be caused easily and ego’s can get in the way. Don’t try to win every point and always allow the person on the other side of the negotiating table their small victories if that enables them to accept your proposals more easily
9. Understand what is meant by ‘Oppression of a Minority’
Everyone has heard of this concept but few really understand its implications. What do you do with a 15% shareholder who started off as a Founder, put no real money in and then gradually ended up contributing nothing, but still expects a dividend each year?
The easy way, if they won’t sell is to dilute them by raising the share capital 10 fold, hoping they won’t accept the call and then –hey presto – their 15% reduces to 1.5% which you can live with. Or why not pay yourself a commercial salary and not pay dividends to starve out the other investors?
But then their lawyer cries “Oppression!” The key thing here is to make sure that you have played fair all along. Did you make them a fair offer? Is there a commercial reason why you might need to raise the Share Capital? If there is then claims of Oppression can be brushed aside.
Christopher Jenkins is Senior Partner at Ecovis Wingrave Yeats, an Award winning Firm of Accountants and Business Advisers based in London W1 that he founded. He has been Voted Best Business Adviser by the CBI in their Awards for Excellence. Contact him at www.wingrave.co.uk
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