“Should I stay or should I go now?” – Dealing with the Clash in Shareholder Disputes

06 / 12 / 2017

You have sweated blood and tears to build a business from nothing.  You have made huge financial and emotional sacrifices to get the business to where it is now.  The business is your baby.

And then the divisions start to appear.  You want the business to go in different directions. You question your business partner’s judgment and morals. You argue. You fall out.  The trust is gone.

This is a common scenario.  Often it is further complicated by the fact that the business partner is a friend or member of the family.  A shareholder dispute becomes like a divorce and emotions run high.  It needn’t be, but the reality is there is no easy, one size fits all solution.

There are two broad ways to resolve the issues:

  1. You come to an agreement; or
  2. You are forced to go to court to get a resolution.

Court proceedings are expensive and time consuming and where the parties have a level of interaction, it is always worthwhile exploring a settlement. Sometimes this could be effected through a formal mediation or indeed facilitated discussions.  Other times it requires a more formal process to bring the parties to a resolution. The issues below are just some that you should consider when trying to resolve a shareholders dispute where it has reached the stage where the status quo cannot continue.

The Worst Case

If Court proceedings are unavoidable then there are few ways to resolve / determine the issues in court (depending on the circumstances):

  1. A claim for a breach of the shareholder agreement (if there is one) or the Company’s constitution (although this will not necessarily address the deadlock or future issues);
  2. An action to assert that a minority shareholder has been prejudiced by the running of the business by a majority shareholder and an order for purchase/sale of one party’s shares; or
  3. The company will be wound up by the court – because a deadlock has occurred and there is no other way to resolve the issues and extricate the parties. This is the last resort.

What to think about

The decision making process of how to proceed should involve legal and tax advisors.  The approach to the dispute and the resolution to the dispute must be joined up to avoid unintended consequences (and to maximise the efficiency or benefit from the separation). A few key things to consider:

  1. What do you want from the situation? Detaching from the emotion, really think about what you want the outcome to be – do you want to try to work it out, do you want to move on, do you want to remain involved, could you have a different but ongoing role, who is actually best to take the business forward?
  1. Is the relationship between shareholders sufficient to enable one partner to become a silent or sleeping partner? This would involve one party taking a back seat in the business.  It would be prudent to enter a specific shareholders’ agreement in order to formalise the relationship and also to ensure the shareholder who remains in the business on a day to day basis is incentivised. A further option may be to consider changing the shareholder rights or classes of shares given to the remaining or leaving  / sleeping shareholder – that usually addresses voting and dividend rights.
  1. Could the shareholders bringing in new investors dilute the disputes between the existing shareholders? This may be an attractive way for the shareholders to remain but with third party involvement in the decision making and division of power.  However, this may not be appropriate if the underlying issues are only being postponed as opposed to successfully resolved.
  1. Where one shareholder is buying out the other, a valuation of the business and shares will need to be agreed. There are a number of ways to value a company and shares so care needs to be taken to try to agree a framework for the valuation. The leaving shareholder may also consider requesting an anti-embarrassment clause to address the risk of the remaining shareholder selling on the shares at a premium shortly after acquisition – these issues should to some extent be addressed in the valuation exercise and in the structure of the consideration (such as deferred consideration / performance related consideration) but this remains very fact specific. The remaining shareholder/company may require restrictive covenants from the leaver not to compete or solicit staff or clients.
  1. Is it possible for the company itself to buy back the shares of a leaving shareholder? This may not circumvent some of the relationship issues in the short term but can be perceived a less emotional or personal approach. The same issues of valuation of the shares apply and care needs to be taken by the shareholders (and as directors) to ensure they comply with their obligations in terms of the use of company cash for the purchase and indeed how the use of that cash impacts on future growth plans of the business.  This may develop into a more long term purchase plan where the consideration is staggered over a number of years.
  1. Tax advice. One of the primary considerations for any exit is tax.  Tax advice must be taken to ensure the most tax efficient structure is effected for both the remaining shareholder and the leaver. This may include utilisation of tax exemptions on exit / termination payments, eligibility for entrepreneurs relief and any impact on EIS relief.

It must be remembered that you are discussing a business.  The impact on the business of a dispute between its shareholders can itself be catastrophic.  There is a real danger that if a commercial attitude (so far as possible in such an emotionally charged situation) is not adopted, the financial implication on the business and the individual shareholders can be very significant.  Expectations need to be carefully managed in a situation where, in all likelihood, it will result in neither party being “happy” with the outcome but where a resolution has been found to crystallise the issues and move forward. Save in cases of fraud or blatant wrongdoing by only one party, there will have to be an element of compromise.

….and if you are starting out, enter into a shareholders agreement.  It may be a cost to incur at a stage when there is little cash, but it really could save you thousands (and significant management time) further down the line.