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What do I need to consider if I bring in another shareholder?

April 12, 2012

Many businesses start out as owner managed operations with one person owning all of the shares as well as being the managing director. However, as businesses grow, they often want to bring in other people as shareholders; maybe in return for an investment or possibly to a manager that they want to incentivise.

This is a natural part of growing as a business but there are some important things that need to be considered when sharing the ownership of your company. Firstly you need to consider how you are going to bring in the new shareholder. Are you going to sell some of your shares, allot new shares or grant some form of share option?

Secondly you need to consider what rights and obligations you and the new shareholder will have. General company law deals with some of these points but it is a ‘one size fits all’ approach so you may often find that the minority shareholder has gained rights that you didn’t want them to have or, indeed, not receive all the rights they were expecting.

You should always have a professionally drafted set of articles of association and, preferably, a shareholders’ agreement as well which sets out your respective rights and obligations. These can vary hugely depending on the circumstances of the shareholders however, for this article we will look at one of the more common scenarios:

A 100% shareholder wants to bring in a minority shareholder who will be employed by the company and hold less than 25% of the shares. This simplifies the issues faced by the majority shareholder slightly because, as they hold at least 75% of the shares, they can pass any ordinary or special resolution and, as the minority shareholder is an employee of the company, many of their obligations to the company come through their employment contract.

However, some of the provisions you still need think about are:

Leaver provisions: If the manager shareholder leaves the company then you will probably want to get their shares back from them when they do leave. Without leaver provisions in the articles or another document, you will not be able to force them to sell their shares back to you. The leaver provisions should also specify what price the shares are to be sold for (a nominal amount or market value).

Drag provisions: If you get an offer from someone to buy 100% of the company then you are going to want to be able to force the manager shareholder to sell as well. Otherwise they could try and hold out for a higher price, potentially scuppering the deal you’ve been working towards for so long. Drag rights can force the manager shareholder to sell at the same price that you are selling.

Tag provisions: These are similar to drag rights, but allow the manager shareholder to forcibly sell their shares when the majority shareholder sells their shares making sure they aren’t left behind. These are for the benefit of the manager shareholder but ensure that they have an ‘exit’ route.

Non-compete provisions: If the manager shareholder is important enough that you have given them some of the shares in your company, then you presumably don’t want them to go off and work for a competitor or set up their own business doing the same thing. Well drafted non-compete provisions can attempt to stop them doing this.

Pre-emption provisions: Unless the articles specify otherwise, any new issue of shares must be offered to all of the shareholders equally before they are offered to any third party. If you want to issue shares to another shareholder in the future (say an investor) then you may want to exclude these pre-emption rights otherwise the minority shareholder will have to be offered the shares first.

Transfer Provisions: Should there be any restriction on when and how you and the manager shareholder can transfer their shares? These can be set out in the articles.

The above are the most common legal issues you need to consider, but depending on the exact circumstances there may well be other concerns, including tax.

Further Information

This article has been written for ByteStart by Elemental CoSec who are experts in this field.