Director & 50% shareholder exits business & creates deadlock

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Director & 50% shareholder exits business & creates deadlock

A dissenting director who holds shares can cause issues. If you do not address the issues, the company will be deadlocked. Here, the dissenting director wanted to leave.

How we negotiated a deal

We were instructed by the remaining director, on behalf of the company, and:

  • Valued the departing shareholder’s shares.
  • Put forward a reasonable settlement offer with a view to concluding a deal.
  • Drafted the buyback documentation for the company’s purchase of shares.
  • Ensured the payment qualified as a capital payment, making the deal attractive to the departing shareholder.

Dissent between SME shareholders

For SMEs, in our experience, the most difficult problems arise when directors, who are also shareholders, depart. Such directors often intertwine their personal and company positions. This means the legal and private aspects are difficult to separate. Our advice is based on understanding this dynamic.

Small business directors and shareholders

The smaller the business, the closer the ties between shareholders. Rarely when creating a business are the following issues formally agreed:

  • How the business is managed,
  • What happens if the shareholders fall out,
  • What happens when a director & shareholder departs.

When these issues emerge, the result is deadlock. Legislation doesn’t cover the following issues:

  • Being forced to sell shares,
  • How the departing director and shareholder exits the business,
  • Timing,
  • The basis of a share valuation in a private company.

Our client understood the share valuation and the director/shareholder’s departure was worth a lot of money. He sought our advice and guidance.

Articles of association and/or shareholders agreement

Our client’s articles of association, which were standard, did not cover a director/shareholder leaving the business. Nor was there a shareholders agreement. So the departing director could leave the business, and keep his 50% shareholding.

For our client, this was disastrous. He could not make a shareholder decision without the departing director’s agreement. Such decisions typically require over 50% of the shareholders to agree, and sometimes 75% or even 100% agreement. Without the other shareholder’s agreement, the articles of association could not be amended.

Offer to buy/sell shares

We advised our client to purchase the departing director’s shareholding. We prepared a valuation of the shares which reflected fair market value. We offered a reasonable sum because:

  • Our client had already offered the departing director/shareholder a lower sum prior to instructing us.
  • The departing director had refused this offer.
  • A reasonable offer reduced the chances of the departing director obtaining an independent valuation.
  • The company would probably pay for the independent valuation, as the company wanted the share sale and purchase.
  • Our client wanted a quick resolution.

We prepared advice for the departing shareholder that explained the tax implications of selling his shares. We assured the departing shareholder that we would structure the deal to treat the proceeds as capital rather than income. He could then claim entrepreneurs relief that reduced the rate of CGT payable to 10%.

Completing the sale/purchase

For the departing shareholder, the capital treatment of the transaction was important. We obtained clearance from HMRC that the transaction would qualify for entrepreneurs’ relief.

In addition, the departing director was concerned that the company might be sold at a higher valuation in the near future, and he would miss out on the increased valuation. To close the deal, we drafted provisions which enabled him to receive a proportion of the proceeds if the company was sold in the near future. These are called “anti-embarrassment” clauses.

These provisions clinched the deal. The departing shareholder agreed, and our client gained complete control. Our client then instructed us to draft bespoke articles of association to better protect the company should new shareholders join.

Helen Curtis heads the corporate team at Gannons. Helen handles share sales and purchases for buyers and sellers. The expertise encompasses tax advice, and consideration of overlapping employment issues that will likely arise.