Guide:

Company Buy Backs & Minority

Shareholding Buy backs

Contents What happens when a shareholder wants to exit? How can a value be arrived at for a minority shareholding and what is the best way to structure a deal? If there is no shareholders agreement stating that shares should be valued pro-rata to 100% negotiations can become intense. Even if there is the 100% valuation, this may not suit the buying party who might struggle to match the open market rate, nor feel that this reflects the sweat equity that has led to the parties current position. Furthermore how can the buying party afford the shares? This guide looks at the following Exit Options Company Buy Backs Legal Requirements Tax and the Buy Back Employing an Adviser Minority Shareholder Valuations Introduction What happens when a shareholder wants to exit? How can a value be arrived at for a minority shareholding and what is the best way to structure a deal? If there is no shareholders agreement stating that shares should be valued pro-rata to 100% negotiations can become intense. Even if there is the 100% valuation, this may not suit the buying party who might struggle to match the open market rate, nor feel that this reflects the sweat equity that has led to the parties current position. Furthermore how can the buying party afford the shares? This situation can quickly lead to shareholder disputes. These are akin to the breakdown of a marriage in that no one sets out in a business venture or marriage hoping that it will fail. In some circumstances the breakdown of a marriage and a dispute between shareholders are one and the same. With blood, sweat and tears invested in both a business and marriage it is no surprise that emotive as well as financial concerns enter the fray making for what is often a testing process. But what solutions are there to enable shareholders to exit a business at the end of the working relationship that avoid the expensive vagaries of the court process? The sale of the business to an external buyer is certainly an option. Trade buyers can usually pay more than the incumbent parties can afford. Both parties gain from a tax beneficial position and non-instigating party may even be able to look at other ventures and continue trading in some way after a deal. Many of course are reluctant to do this and therefore a buyout may be the best option. See our guide to valuations and sales. Winding up the business is often an undesirable option as goodwill will not be realised benefiting neither party A company buy back may be the most attractive as in the best scenarios it allows one of the conflicting parties to exit whilst realising the true value of their stake in the business. See below. Employing an adviser to arbitrate valuation and negotiation between the parties. Company Buy Backs If an internal buy out is to be struck the company buy back is potentially an excellent prospect. The concept of a company buy back is not a difficult one: The company is simply buying back one of the parties' shares which are then cancelled, leaving the other party (or parties) as the only remaining shareholder(s). Of course it is dependent on one of the parties being prepared to allow the other to continue the business and benefit from the goodwill that the business may have built up over time (i.e. where one party is not intending to work in the particular industry of the company anymore and only wants to see a return on their investment of time or money, or where one of the parties does not believe there is much goodwill invested in the business itself).
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Guide: Company Buy Backs & Minority Shareholding Buy backs

A key advantage to structuring a deal in such a way is that because the company is purchasing the shares, a larger sum for the shares is often more achievable than if an individual were to purchase the shares. Secondly, the remaining shareholder(s) do not have to extract the available funds from the business (thereby incurring tax charges) in order to pay the outgoing shareholder(s) as they may have to if they were to purchase the shares personally. Logic may indicate that a company buy back is the best solution but bringing both parties to the table to begin reasoned negotiations can be difficult. With so much of the individual poured into the business, emotive and personal issues may prevent the parties being able to resolve the issue themselves. At this point skilled advisers may often be introduced to break the deadlock. A key part of the advisers role at this stage is to highlight the potential problems that will arise if the parties fail to reach an agreement. Compromise may be unpalatable to the parties but it may be the only way to salvage value from a mutually destructive situation. Of course, a shareholders agreement at the birth of the business might well have resolved at least some of the potential areas for dispute. But this is not often high on the list of priorities of new business partners, particularly if they are (or perhaps the word "were" is more appropriate by this stage) married as well. Legal Requirements Assuming the parties are able to broker some form of broad agreement through their advisers, the adviser will need to ensure that the structure of the deal meets the requirements of company law. There are some important procedural formalities to follow when affecting a buy back. The Companies Act 1985 lays down a specific procedure of a company buy back of shares in section 164. Key points to be aware of are: the company's articles of association must give it the authority to affect the purchase. If they do not then the shareholders will have to pass an appropriate special resolution enabling it to do so; a special (and preferably written) resolution must be prepared confirming the company's authority to effect the buy back; where an extraordinary resolution is used, the company's proposed buy back 'contract' must be filed at its registered office for 15 days prior to the resolution being passed/contract being entered into (using a written resolution makes this unnecessary). the shares must be fully paid up; payment for the shares should be made out of distributable profits. The purchase may also be made out of capital (but it requires still more stringent formalities). Failure to observe the Companies Act requirements may make the buyback void and legally unenforceable. Additionally the company could find itself liable to a fine and the company's officers liable to both a fine and imprisonment. Another issue that must be carefully considered is whether there are in fact sufficient distributable profits from which to affect a buy back. This must be clearly established before the transaction proceeds. Often the business owners or their accountants suggest that the company pays the outgoing shareholder money over a period of time. Although in fact there is nothing in the legislation to prevent staged payments for the company's shares, it is usually the case that the consideration will have to be paid in full and at the point of sale. If there is any suggestion that the parties want to pay in stages, a company buy back may well be inappropriate. The outgoing shareholder would have to be asked to take a probably unacceptable risk that if the company does not have distributable profits at the time a payment is due they could be left without a legal remedy to insist on the company making the payment. Tax and the buy back

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Guide: Company Buy Backs & Minority Shareholding Buy backs

Tax concerns are also often the biggest factor in the decision to use a company buy back of the outgoing partners' shares. Providing certain conditions are met the proceeds received from the buyback may be treated as a capital transaction (liable to capital gains tax, which can be useful if the parties qualify for Capital Gains tax relief). However, clients are well advised to take specialist tax advice on the precise tax implications of a buy back and to do so in good time before the transaction is too far advanced. It is usually also advisable to seek revenue clearance on this type of transaction and this must be factored in to the planning of the timing of a deal. The Revenue can take up to 28 days to reply to a request for clearance. Employing an adviser Understanding the issues, which may be broad and complex, commercial or personal, is essential to handling a successful share buyback. Avondale can assist both with valuations and negotiations. Utilising expert advice usually avoids disputes escalating. Skilled arbitrators create a buffer between the parties to enable a commercial reality to set in. Through their expertise in this area Avondale have a history of resolving potential disputes and delivering successful transactions through practised and sensitive share buyback negotiations. Fees vary from project to project so please contact us for a full understanding of how Avondale can assist in adding value in this area. Financial advice regarding the specifics of a company buy back should be taken from your usual regulated advisors. Minority Shareholder valuations If a minority Shareholder in a private limited company wishes to sell his shares he may well find that it is impossible to sell them on the open market and he may be as a result at the mercy of the continuing Shareholders who may or may not be prepared to pay a "fair price". It is often not appreciated how little a minority shareholding may be worth in the absence of an arrangement (in the Articles of Association or by way of Shareholders Agreement) that such shareholding shall be valued at a pro rata fraction of the value of the Company as a whole. For majority stakeholders seeking a transaction, minority shareholders can form a major barrier and it is well to examine their position early on. Whilst every valuation must depend on its own factors so that it is impossible to generalise nevertheless case law suggests minority shareholders not valued pro-rata in a shareholders agreement be valued at:- A 25% shareholding in a Company may be valued at 5% of the value of the Company as a whole. A 49% shareholding in a Company may be valued at 20% of the value of the Company as a whole. A 55% shareholding in a Company may be valued at 44% of the value of the Company as a whole. A 75% shareholding in a Company may be valued at 75% of the value of the Company as a whole. We suggest that anyone who is considering becoming a minority shareholder in a private limited company should consider the following questions:- 1. Do the majority of the Shareholders agree that each of you will exercise your voting power in the Company to ensure that certain named individuals will be the directors of the Company? 2. Is it agreed that the appointment of any new Director will require the approval of all of you? 3. Is it agreed that every Director of the Company shall be a Shareholder? 4. Is it agreed that any Director who ceases to be a Shareholder shall forthwith cease to be a Director? 5. Should any Director who resigns his directorship or who becomes disqualified from being a Director be forced to sell his shares to the other Shareholders? 6. Should all Directors be paid the same and if not should the Directors by majority vote be able to decide upon the remuneration to be received by each Director?

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7. 8. 9. 10. 11.

Guide: Company Buy Backs & Minority Shareholding Buy backs

Should each of the Directors devote his full time and attention to the business of the Company? Will the Directors all have Service Contracts with the Company? Will any Managing Director or Chairman have a casting vote at Directors meetings? How many Directors will need to be present at a Directors meeting to constitute a quorum? Will the Directors agree not to compete with the Company nor poach its customers nor divulge its trade secrets both during the time that they remain Directors and during a period of say one or two years thereafter? 12. If any Director has to give personal guarantees to the Company's Bankers or Landlords do the other Directors agree that any liability will be shared by them all equally? 13. Is it agreed that no party will seek to quit as a Director/Shareholder for a minimum specified period? 14. Is it agreed that the consent of all will be required before the Company can launch into any new business venture which is substantially different from that presently proposed or before Company can increase its share capital or borrowing in excess of a specified sum? 15. On the occasion of any future allotment of new shares in the Company should each existing Shareholder have the Option to subscribe for shares pro-rata to preserve his relative voting power? 16. Should any Shareholder be free to transfer his shares to whom so ever he pleases or should the continuing Shareholders have the option to buy the shares of any Shareholder wishing to sell? 17. Bearing in mind that a Shareholder may find it impossible to sell a minority shareholding on the open market should the continuing Shareholders be obliged to purchase the shares of any Shareholder wishing to sell his shares subject to the proviso that if the continuing Shareholders cannot afford the shares themselves or cannot find Purchasers for the shares they will concur in a sale of the Company as a whole or the liquidation of the Company if necessary? 18. On what basis should the price to be paid for a shareholding be calculated? Should a 25% shareholding for example be valued at 25% of the value of the Company as a whole? If shareholdings are to be valued by reference to the value of the Company as a whole should the value of the Company as a whole be determined by the Company's Auditors as experts or by a more specific formula related to the profits and/or assets of the Company? 19. If the price to be paid for a shareholding is likely to be substantial should the purchasing Solicitors be allowed to pay the price with interest by way of instalments over a specified period? 20. A transmission of shares occurs when a Shareholder dies or becomes insane or bankrupt. On the occasion of a transmission should the continuing Shareholders have the option or the obligation to buy the shares in question? The same considerations as are mentioned in paragraph 17 above with regard to Share Transfers are relevant to the question of transmissions. 21. Do you agree that the consent of all of you should be required for any alteration of the rules of the Company i.e. the Articles of Association? 22. Can you agree now on a dividend Policy for the Company or are you happy for the Directors to decide the matter from time to time? You could decide now that a specific Percentage at least of the Company's profits after tax shall be distributed each year by way of dividend to the Shareholders. 23. It is agreed that all Contracts to be entered into by the Company will be negotiated on an arms length basis and at competitive prices? Having considered the above questions, one needs to look at the existing Articles of Association of the Company to check the present provisions with regard to such matters as Share Transfers, pre-emption rights, transmissions and allotments of new shares. The security of a minority Shareholder will depend on a satisfactory interplay between the provisions of the Company's Articles of Association and the provisions of a Shareholders Agreement.

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This guide is not definitive. Accuracy is not guaranteed and it does not replace professional advice.