Valuation Issues In Shareholder Agreement
When a company has more than one owner, these owners are called ‘shareholders’, who will then be legally bound to a ‘shareholder agreement’.
A ‘shareholder agreement’ is a legal document stating the privileges and responsibilities of each shareholder. It aims to protect the interest of individual owners as well as the overall interest of the group. Hence a good shareholder agreement acts in consideration to all the shareholders regardless of their voting shares.
In truth, a shareholder agreement seems most useful for the minority shareholder, who usually carries 50% or less of the outstanding voting shares and hence not entitled to make unilateral decisions on the company’s fate.
However, shareholder agreements in reality often use inadequately structured valuation clauses, and hence lacking in terms of:
(1) achieving a mutual ground for determining the worth of equity – or ownership – interest in the company;
(2) setting the exact conditions for valuation; and
(3) defining the individual returns and benefits.
A Shareholder Agreement That Uses Adequately Structured Valuation Clauses Will Be Able To Achieve The Following:
- Identify and address the possible circumstances – or ‘triggering events’ – where a business valuation would be needed;
- Use proper methods to achieve a mutual ground for determining the worth of the company’s equity interest;
- Detail a fair compensation for the withdrawing shareholder while protecting the interests of the remaining shareholders and the company;
- Ensure that a shareholder withdraws from the partnership through proper procedures and does not cause any impending damage to the company;
- Protects the remaining shareholders when a third party buys the company’s shares.
Failing to do the above may spur debates and eventual conflicts amongst the shareholders, which will then lead to unpredictable aftermath like greater costs and a pending litigation. Hence it is vital to first address the common issues of valuation in a shareholder agreement before setting the main content of terms and conditions.
Common Triggering Events
One of the most common triggering events that requires a business valuation in a shareholder agreement is a shareholder’s death or disability. In such circumstances, the shareholder agreement can provide a provision for the surviving shareholders to purchase the deceased or disabled shareholder’s interest at a predetermined price, as determined by a business valuation.
Another triggering event that may require a business valuation in a shareholder agreement is a shareholder’s retirement or resignation from the company. In such cases, a shareholder agreement may also include a provision for the remaining shareholders to buy out the retiring or resigning shareholder’s interest at a fair market value, which is determined by a business valuation.
Additionally, a shareholder agreement may also include provisions for buy-sell agreements, which provide for the sale of a shareholder’s interest upon the occurrence of certain events, such as divorce or bankruptcy. In such cases, a business valuation can help establish a fair market value for the shareholder’s interest to ensure that the remaining shareholders are not unfairly impacted.
A shareholder agreement can also provide a provision for a forced buyout of a shareholder’s interest in the event of a shareholder’s breach of contract or violation of the company’s bylaws. In such cases, a business valuation can help determine a fair price for the shareholder’s interest in the company.
Read other triggering events here.
Conclusion
It is also essential to ensure that the valuation methods used in a shareholder agreement are appropriate and reliable. The valuation methods used should be consistent with the purpose of the valuation and the type of business being valued. For example, the asset-based approach may be more appropriate for a manufacturing business, while the income-based approach may be more appropriate for a service-based business.
It is also important to consider the timing of the valuation, as valuations may fluctuate over time due to changes in the business or economic conditions. Therefore, a shareholder agreement should outline the frequency of business valuations and the circumstances under which valuations may need to be updated.
In conclusion, a shareholder agreement is a vital legal document for a company with more than one owner, as it helps protect the interests of individual shareholders and the company as a whole. It is important to ensure that the shareholder agreement contains adequately structured valuation clauses to prevent valuation disputes and conflicts amongst the shareholders.
