Becoming a shareholder in a company is easy enough to do — removing yourself (or someone else) is a complex and legal process. This is because a shareholder of a privately held company has no right to sell his or her shares for the purpose of liquidity without the consent of the board and/or 51% of the shareholders. That is, unless the terms and conditions of such a sale are outlined in a shareholders’ agreement.
A shareholders’ agreement is a contract between all shareholders in a business. It is designed to, among other things, protect investments, establish fair relationships, govern operations generally and regulate departures. So while many friends or family members go into business together with the assumption that nothing will ever go wrong in the future, even the best of friends can fall out. Should that happen, a shareholders’ agreement determines what happens next and can save the shareholders from a costly and potentially bitter legal battle.
In a shareholders’ agreement, lawyers generally include the terms “right of first refusal” or “first right of refusal” when detailing the conditions in which one or more shareholder may sell shares to exit the company. With this clause, a shareholder who wishes to sell his or her shares must give the other shareholder(s) the option of purchasing those shares at the asking price before considering a third party buyer. (A simple addition of a clause stating that shares cannot be sold to a competitor ensures the integrity of any third party buyers.)
However, such a clause doesn’t always make for a fair divorce in a company with just a handful of shareholders. If, for example, you own 10% of the shares in a company with 20 shareholders, it’s not difficult to sell your small stake to the other shareholders or to a third party. Nor is it likely an excessive burden for the other shareholders to purchase your shares (should they so choose). But if you hold 1/3 of the shares in a company with just three shareholders, you’re putting the other two in a bind — either come up with the capital to purchase all of your shares or face having an unknown third party hold a hefty stake in the business.
A better and fairer clause to include in the shareholders’ agreement of a business with just a few shareholders is a shotgun clause. When invoked, this exit provision (often referred to as a buy-sell agreement) allows a shareholder to offer a specific price per share to purchase the shares of the other shareholder(s). The other shareholder(s) are then required to either accept the buy-out offer or purchase the shareholder’s shares at that price per share.
In simple terms, if you want to divorce your business partner(s) and an amicable separation agreement cannot be reached, triggering the clause becomes a buy-or-get-bought-out situation. Undervalue the other shareholder(s)’ shares and you may find yourself being bought out at that price instead; overvalue the shares and you may find yourself having to pay that price. Instead, this clause forces the invoker to determine a price that would be acceptable in either outcome.