Sale of Shares to Third Party Buyers – Shareholders Agreement
Shareholder agreements should include clauses for the selling of the company’s shares to third party buyers to protect the interests of the remaining shareholders and the company. These clauses should be able to manage situations involving a mandatory sale, ‘tag along’ rights and participation in a subsequent sale. These points are very important in the process of a company valuation.
A Clause For The Mandatory Sales – Or The ‘Drag Along’ Clause – Safeguards The Liquidity Of The Controlling Interest Of The Company:
When buying the shares of a private firm, most third party buyers would only confirm their purchase when they can get all of the company’s voting shares. To facilitate a smooth transaction in such cases, it is normal for the shareholder agreement to include a clause for all shareholders to sell their ownership interests when there is a third party offer for all of the outstanding shares acceptable to the indicated majority of shareholders. All the shares will be sold according to the terms of the said offer.
A ‘Tag along’ Clause – Or The ‘Coat tail’ – Safeguards The Liquidity Of All The Shareholders During A Third Party Buyer Offer:
Based on the above third party buyer offer, minority shareholders should also receive the same offer as the majority ownership holders, for their shares. Hence the shareholder agreement would also include a clause – the ‘tag along’ or ‘coattail’ clause – to ensure this.
A ‘Participation In A Subsequent Sale’ Clause Disallow Any Particular Shareholder From Spontaneous Acquisition Of The Voting Shares Of Other Shareholders To Sell The Company As En Bloc To A Third Party Buyer, And Earn Profits From The Sale:
There are situations when a withdrawing shareholder sells his/her voting shares back to the remaining shareholders; and these shares together with the rest are then sold to a third party buyer, who offers an exorbitant amount (a significant premium) on a per share basis.
Naturally, the shareholders involved in the subsequent en bloc sale of the company’s share would receive enormous returns since they held ‘the most amount of shares’ at that point in time. This means that the shareholders who had sold their ownership of the company prior to the en bloc sale, would receive lower returns.
To ensure fair and equal returns for all the shareholders, and in accordance to the ‘tag along’ clause, the shareholder agreement would include a clause that allows withdrawn shareholders to participate in any en bloc sale of the company’s voting shares or net assets to a third party buyer, within the designated time frame after the sale of their own shares. This clause is then known as the ‘participation in a subsequent sale’ clause.
It is the responsibility of all shareholders to make sure that the shareholder agreement sufficiently records the interests of the group and individual shareholders; and explicitly defines the terms and conditions of future transactions according to those interests.
As situations are volatile, it is vital to regularly revise and update the mutually agreed clauses earlier set in the shareholder agreement, as they are the foundation for future transactions.
Internal accountants and a company valuer can add value to shareholders of private companies, through collaborating with company valuers and shareholder agreements. Read here on more issues concerning shareholder agreements.
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