In SME’s, it is often the case that directors are also shareholders. If a director is removed from office, this will not generally affect their position as a shareholder and it will usually be the case that it is preferable to deal with the shareholding at the same time.
It is sometime the case that the company’s Articles or a Shareholders’ Agreement state that, if someone ceases to be a director, they must also sell their shares. If so, the procedure for selling the shares is set out. However, for most companies, this is not the case.
The next things to consider are the consequences of leaving their shareholding intact. How damaging this could be to the company or the remaining shareholders will depend to a large extent on the number of shares they have. A shareholder with more than 50% of the shares has ultimate power of the company and, in particular, can remove and appoint directors as they see fit (as long as correct procedures are followed).
Usually for SME’s, the following things are upmost in the minds of the other directors and shareholders:
- Dividends – the shareholder will be entitled to receive dividends, even when they are no longer a director. This can be a particular issue with companies who ‘pay’ their director-shareholders mainly through dividends rather than salaries. Changing things so that salaries are increased and dividends reduced can have adverse tax consequences and may mean the leaving director is entitled to apply to the court claiming unfair prejudice.
- A shareholder is entitled to receive a copy of the full accounts of the company and not just the abbreviated accounts filed at Companies House. If they have more than 10% of the shares, they are also entitled to ask for the accounts to be audited at the company’s expense.
- It is sometimes the case that proper procedures have not been followed by the Board or by individual directors. If this is the case, the shareholders can ratify the decisions made. A shareholder with less than 50% of the shares cannot prevent the ratification but the directors will need to disclose what has happened and he will be entitled to vote at the general meeting. In addition, a substantial property transaction with a connected person will need to be ratified by the shareholders and a director’s service contract with a term exceeding two years must first be approved by the shareholders.
- A minority shareholder also has the right to apply to the court if the company is being run in a way that is unfairly prejudicial to them. Therefore the directors must always consider how their actions will affect the minority shareholder.
For the above reasons, it is usually better to negotiate a sale of the leaving director’s shares at the same time as they leave. Most businesses are expected to grow in the future so the later it is left before the shares are sold, the more they are likely to be worth (although this will of course depend on the particular company).
The company’s Articles or Shareholders’ Agreement will often set out procedures for the sale of shares. These are known as ‘pre-emption’ rights. They usually say that the remaining shares must first be offered to existing shareholders and set a procedure for determining the price. Sometimes, they state that the company’s directors can refuse to register any share transfer at their discretion, which puts them in a powerful position. If the Articles or Shareholders’ Agreement do not contain these provisions, then a shareholder is free to sell their shares to anyone who will buy them.
Usually, the sale of shares, the price and how that is to be paid (straight away or by instalments) is a matter of negotiation. If paid by instalments, it is usual for the shareholder who is selling his shares to demand personal guarantees from the buying shareholders.
If the company has claims against the director, then generally the company would want to bring these into the same negotiation so that the ultimate price paid to the outgoing director can be reduced. Another factor that can be used by the company during negotiations is whether in practice, there would be willing buyers for the shares.
Whether you are the director-shareholder who is leaving, or the remaining directors-shareholders, it is important that you get a strategy in place for the negotiations and structure any share transfer in the best way possible. The leaving shareholder-director will also want to ensure that they have as much protection as possible especially if they are being paid by instalments.
There are many more things to consider by both sides than are set out in this piece. It is always advisable for both parties to obtain legal advice on their position, relative strengths and weaknesses, and a strategy to follow as soon as possible. If you think you could benefit from such advice, please do not hesitate to get in touch.