Saturday, April 14, 2012

BV Benefit #8 - Shareholder Disputes

Business owners typically do not require an independent business valuation every year.  Or do they?

In shareholder disputes there is often an immediate need for a business valuation.  However, being proactive and obtaining an annual valuation can help to avoid a potential shareholder dispute.

Business ownership can be complicated, particularly when there are a number of shareholders.  The odds of disagreement, conflict and dispute in these situations can be very high.  When shareholder relationships break down there should be a mechanism in place for dealing with the dispute or for enabling one or more of the shareholders to exit the business in a pre-determined manner.

Shareholder disputes are often grueling and devastating.  They can be costly and very time consuming.  The shareholders become distracted and ultimately exhausted from preparing for and attending discoveries, meetings with lawyers and experts, settlement negotiations and arbitration or court proceedings.  Relationships are destroyed and ultimately the business suffers because the shareholders are no longer devoting sufficient time and attention to managing the company’s operations.

The importance of a unanimous shareholder agreement ("USA") to privately held businesses cannot be over emphasized. An effective USA should address the following areas: i) compensation; ii) decision making; iii) entrance; iv) exit; and v) return on investment.

Having a business valuation is critical for new shareholders to buy-in and for existing shareholders to measure their return on investment or to exit the business.  Privately held company shares are illiquid assets.  The USA should provide a shareholder, under certain situations or triggering events, with the means to liquidate an otherwise illiquid asset.  For example, a buy-sell provision (or "shotgun" clause) allows for one shareholder to offer to buy the shares of another shareholder subject to the right of the other shareholder either: i) accepting that offer; or ii) buying the shares of the offering shareholder at the same price offered by that shareholder.

With respect to valuation, the USA should provide the definition of value (e.g. fair market value or fair value) and set out the process and timing for obtaining a valuation.  Many USAs stipulate that an annual or biennial valuation of the business should be prepared by an independent Chartered Business Valuator.

Committing to this process allows the shareholders to discuss and agree to the current value of the business before any potential disagreements arise.  In the event of a dispute, the valuation issue will have already been dealt with.  The return on investment of an independent and annual valuation can be tremendous if it means avoiding a costly, time-consuming and perhaps devastating shareholder dispute down the road.

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