Shareholder Agreement
Why have a shareholder agreement and what is its impact on valuation?
One of the standard questions we will ask when instructed to value a shareholding for litigation or commercial purpose is whether there is a shareholder agreement.
In this article I explain the importance of a shareholder agreement and the impact on the valuation of a shareholding.
What is a shareholder agreement?
A shareholder agreement sits alongside the company’s articles of association. It can govern all shareholders or possibly a certain class of shareholders.
The company’s articles are publicly available. The shareholder agreement is not publicly available yet is still legally binding. It is not mandatory to have a shareholder agreement but for a company with more than one shareholder it is advisable to have one in place. I would recommend that even where the shares are held by family members, an agreement should be prepared.
What is typically included in a shareholder agreement?
Shareholder agreements typically include the following:
- The types of shares
- Rights and obligations of shares or share classes
- How votes will be decided
- How shares can be sold or transferred, drag and tag-along provisions.
- Dividend policy
- Capital rights
- Non solicitation or anti-competition clauses
- How shares will be valued on an exit including any fair value provisions.
What might be included in a shareholder agreement to determine the price at which shares are sold?
Various mechanisms could be included such as:
- A pre-determined fixed price which will not vary in the future
- A price based on a formula which could consider growth in profits, length of ownership and market conditions
- A price based only on the company’s net assets at book value and thus without any value attributed to goodwill
- A value assessed by an independent valuation expert. The identity of the expert may be included or, alternatively, just the expert’s qualifications and the process of appointment may be set out. The valuation by the independent expert may be a formal expert determination and, in this case, it is binding on the parties.
How is shareholder value defined?
The shareholder agreement should include a clear definition of value. The absence of a clear definition can lead to costly litigation.
Fair value and minority discounts in relation to valuation of a shareholding
A key issue in defining the value is whether it is anticipated that a minority discount should be applied to the valuation of a shareholding to reflect lack of control and non-marketability. In other words, 25% of the cake is not valued at 25% of the value of the whole cake.
The term “fair value” is adopted for valuations where no minority discount is applied. Fair value is distinct from “market value”. Fair value is normally adopted by courts when assessing the value of a minority shareholding in cases of unfair prejudice. In such matters the minority shareholder is not a willing shareholder so fair value safeguards their position in valuing their shares without a minority discount.
The assessment of the amount of a minority discount is complex but the impact can be significant. For example, if the whole company is valued at £10 million and the shareholding is, say, 25% then the valuation pro-rata without a minority discount is £2.5 million. However, if a minority discount is applied this might reduce the value by perhaps 50% to give a value of £1.25 million. The exact percentage discount depends on several factors and in litigation is ultimately decided by the court.
Shareholder agreements and share valuations
When instructed to value a shareholding of less than 100% we will ask if there is a shareholder agreement. This will be relevant not only when valuing shares in a divorce or shareholder dispute but also in commercial valuations. The clauses in a shareholder agreement may impact the capital value of the shares and also the ability of a shareholder to extract value.
As valuer we consider if there are any restrictions on the sale or transfer of shares. We will review any agreed mechanism to value the shares and, critically, whether a minority discount should apply. We will also consider if the shareholder agreement can be varied.
Conclusion
A shareholder agreement is an important document for shareholders and should be drafted with your legal advisers at the outset of the business and revisited regularly. The small investment of time and legal fees could save a lot of money and stress in the future.
As a business valuer I will issue a long information request at the start of my engagement and the shareholder agreement will be one of the questions. As I have explained, the existence or absence of a shareholder agreement can have a significant impact on my valuation of shareholdings of less than 100%.
Getting in Touch
Fee estimates and CVs are readily available. Quotes can typically be provided within two working days.
Email: fiona@fhmforensic.co.uk
Telephone +44 (0)7770 642491
