Share buybacks: helping majority shareholders manage a shareholder exit

In many owner-managed businesses, shareholders are often closely involved in the day-to-day running of the company. It is not unusual for senior employees, founders or directors to hold shares in the business. However, circumstances can change. Relationships may break down, individuals may want to move on, or an employee-shareholder may leave the business entirely.

In these situations, a share buyback can provide a practical and controlled way to facilitate an exit.

A share buyback allows the company – or sometimes the remaining shareholders – to purchase shares from a departing shareholder. For majority shareholders, this can be an effective way to regain control of shares and ensure they remain within the existing ownership group.

When a share buyback may be appropriate

Share buybacks commonly arise when an employee who also holds shares leaves the business, particularly where the departure is not entirely amicable. In these circumstances, both the departing shareholder and the remaining owners usually share a common goal: achieving a clean break that allows the business to move forward.

Negotiating the terms of the exit is therefore an important step.  This often includes agreeing the price for the shares and the terms under which the shareholder will leave the business.

Legal advisers can help guide this process, ensuring the negotiations remain structured and that the agreed outcome protects the interests of the company and the remaining shareholders.

Establishing a fair valuation

One of the most sensitive issues in any share buyback is the valuation of the shares.

In many cases, both parties will want reassurance that the agreed price is fair.  A common approach is to appoint an independent valuer jointly, who can provide an objective valuation of the shares.  Alternatively, each party may obtain their own valuation and agree to take the midpoint between the two figures.

If the company already has a shareholders’ agreement, the process is often simpler. Many agreements include provisions that set out how shares should be valued and transferred if a shareholder leaves the business. Having these mechanisms in place can significantly reduce the scope for dispute.

The importance of a settlement agreement

Where the exiting shareholder is also an employee, a settlement agreement will usually form an essential part of the process.

A settlement agreement provides legal certainty for both sides. It confirms the terms of the departure and, importantly, prevents future employment claims being brought against the company.

The agreement will typically record the financial terms of the exit and may also address additional matters such as:

•   tax treatment of payments

•   continued use of company assets for a limited period (for example, a company car)

•   confidentiality obligations

•   restrictive covenants to protect the business

By clearly setting out the agreed terms, the settlement agreement ensures there is no misunderstanding about what has been agreed between the parties.

Structuring the buyback properly

Share buybacks are subject to specific legal and procedural requirements under company law.  These include formal approvals by shareholders, documentation of the transaction and ensuring the company has the appropriate funds available to complete the purchase.

Professional advice is therefore essential to ensure the process is
carried out correctly and that the necessary filings and documentation are completed.

Preventing disputes in the future

Situations involving departing shareholders can be complex, particularly where expectations differ about how an exit should be handled. One of the best ways to avoid disputes is to ensure that the company has a well-drafted shareholders’ agreement in place.

A shareholders’ agreement can include provisions dealing with:

•   how shares should be valued if a shareholder leaves

•   whether the company or other shareholders have the right to buy those shares

•   restrictions on selling shares to external parties

Having these mechanisms agreed in advance can make future transitions far smoother and reduce the risk of disagreements.

Taking advice early

Share buybacks can be an effective way to manage changes in ownership while maintaining stability within the business. However, because they involve both corporate and employment law considerations, it is important to take legal advice early in the process.

With the right structure and guidance, a share buyback can help facilitate a smooth exit for the departing shareholder while protecting the long-term interests of the company and its remaining owners.

Sarah Astley can be contacted at s.astley@gullands.com