Avoiding Costly Shareholder Disputes

Business ownership can be complicated, particularly when there are multiple shareholders.  The odds of disagreement and conflict among shareholders over various issues can be very high.  When shareholder relationships break down there must 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. 

 

A shareholder buyout can quickly turn into a costly dispute if the value of the business has never been discussed and agreed to among the shareholders.  Different shareholders likely have different expectations regarding the value of the business.  Having an effective Shareholder Agreement and obtaining an independent business valuation can help avoid a very costly, time consuming and emotionally draining shareholder dispute.

 

I have been retained in many shareholder disputes to provide an independent expert business valuation for purposes of determining a price at which the departing shareholder’s shares should be acquired by the remaining shareholder(s) or redeemed by the company.

 

In my experience, these disputes can be devastating to the business as well as the individuals involved.  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 Shareholder Agreement to privately held business owners cannot be over emphasized.  An effective Shareholder Agreement should address the following areas: i) compensation; ii) decision making; iii) entrance; iv) exit; and v) return on investment.  Privately held company shares are illiquid assets and the Shareholder Agreement should provide the shareholders with the means to liquidate an otherwise illiquid asset under certain triggering events.  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 the valuation of the business and the individual shareholdings, the Shareholders Agreement should provide a definition of value (e.g. fair market value or fair value) and set out the process and timing for obtaining an independent valuation.  Many Shareholder Agreements stipulate that an annual or biennial valuation of the business should be prepared by an independent Chartered Business Valuator (CBV).  This independent valuation forms the basis for new shareholders to buy-in and for existing shareholders to exit or measure their return on investment. 

 

Committing to a formal business valuation allows the shareholders to discuss and agree to the value of the business before any potential disagreements arise.  In the event of a shareholder buyout, the valuation issue will have already been addressed.  The return on investment to the shareholders will be substantial if it means avoiding a costly, time-consuming, emotionally draining and perhaps devastating shareholder dispute down the road.

 

Contact us at jason@vspltd.ca or www.vspltd.ca to find out more about the valuation process and the types of valuation reports that CBVs provide.