In many businesses including start-ups, the directors and shareholders are the same people. The directors will work hard to get the business going, whilst the same people as shareholders should get the benefits of their work in the form of dividends and increasing value of the company.
This doesn’t always happen. A director may not play his or her part in building up the business. The director may leave. In those circumstances, the company may be pulled in different directions and it may become difficult to keep the business going in a productive direction. Could the director be removed and could you force a sale of the director’s shares?
How can we remove a director?
If the continuing shareholders are the majority, a director can be removed by passing an ordinary resolution (51% majority) after giving special notice. You will need to be careful if the director is also an employee to make sure there is no claim for unfair dismissal. The director will, however, continue to own the shares and remain entitled to receive dividends.
How can we remove a minority shareholder?
Most shareholders disputes are eventually resolved by having the majority buy out the minority shares for fair value. We can help you prepare a letter making an offer to purchase the shares on terms which would most likely be awarded by a court. This should put pressure on the minority shareholder to negotiate sensibly.
You will first need to consider a valuation of the shares working with your accountant. A valuation of a minority shareholding will usually be at a discount to the proportional value of the whole company since a minority shareholder cannot control the company.
You should start negotiations with a view to reaching agreement for the purchase of the shares for fair value. If the minority shareholder agrees, the shares can be bought by either the company or the continuing shareholders.
If the continuing shareholders hold at least 75 per cent of the shares, you have a number of alternatives to reduce the dividends paid on the existing shares. You could consider a further class of shares which pay dividends ahead of the ordinary shares (known as ‘preference shares’) being issued just to the remaining shareholders. You could also consider increasing the remuneration of the remaining directors - but note that this may not be tax efficient, but may still be preferable to paying dividends to a shareholder who no longer participates.
Alternatively, the majority holding 75% of the shares has the option of winding up the company. If a solvent company is wound up through a members voluntary liquidation, the company’s assets can be transferred into a new company owned by the continuing shareholders.
The continuing shareholders could also set up a new company (Newco) to buy the existing company’s assets. This will require the continuing shareholders to be at least the majority to be able to remove the director and pass certain ordinary resolutions. In such case:
the continuing shareholders could provide funding to Newco by using loan notes;
Newco pays for the company’s assets with the loan notes;
the company declares a dividend consisting of loan notes;
the majority shareholders cancel the loan notes (because the loan notes are debt that are owed to themselves) and the minority shareholder can redeem the loan notes for cash at a value which is equal to the fair value of the shares.
You will need to be careful during the process of removing the minority shareholder since the holder has a right to apply to the court to claim that the company’s affairs are conducted in a manner that is ‘unfairly prejudicial’ to the holder.
How can I make sure this doesn’t happen to my business?
No one ever wants to talk about this one, but it is extremely important to discuss this at the beginning of the business relationship. To avoid these situations arising in the first place, you should be thinking about a suitable shareholders’ agreement and articles of association. There is something known as a ‘bad leaver’ provision which allows shares to be bought back from a shareholder leaving the company.