When you start up in business with a friend or business partner then you may never consider that your relationship could sour in the future. Unfortunately, without giving consideration to that possibility you may face difficulties if things do not work out the way you had planned.
In principle the shareholders are the owners of the business and they appoint the directors to run the Company on their behalf but, in practice, each business partner in a new small business venture is likely to act as both director and shareholder.
Somewhere down the line there could be disagreements between business partners that cannot be resolved, breakdowns in relationships or one of the business partners may simply walk away from the Company, but in each case the parties may retain their shares.
In these circumstances the remaining shareholder(s) may not want the problematic shareholder to be able to participate in the Company’s value, but it is important to remember that the shareholders are the owners of the company and in normal circumstances you cannot simply take away, or stop someone from owning or benefiting from, their own property.
If you find yourself in this situation then there is no sure-fire way to remove the shareholder but, depending on the circumstances, there are options available:
- Amicable Agreement
The first port of call is to try and reach an agreement where the problematic shareholder sells his shares at fair market value either to the other shareholder(s), or back to the Company. Only if an amicable agreement cannot be reached would you consider the other options listed.
- Call & Forfeiture
If the shares have not yet been paid for, and if the Company’s Articles allow for partly paid shares and include clauses on Call & Forfeiture (our articles include these clauses as standard), then you may be able to cause the shares to be forfeited. There is a procedure to follow, and the shareholder must be given the opportunity to pay for his shares, but if payment is not forthcoming (usually after around four weeks and two calls for payment) then their shares may be forfeited and reissued to someone else.
Dilution is where you issue more shares to one or more shareholders, reducing the proportion of ownership of the other shareholder(s). It is almost certain that the Company’s Articles of Association will guard against dilution of share capital by including pre-emption rights on allotment. Even if silent (as in the case of the Model Articles) the provisions of the Companies Act will apply giving much the same effect. This means that any new shares must be offered to the existing shareholders in proportion to their shareholdings. Whether this option may work is usually a gamble on whether the problematic shareholder would take up the right and invest further money in the company. You would also want to be able to back up the ‘Rights Issue’ with a genuine business decision to raise further capital, in case the problematic shareholder opposes the allotment arguing that the sole purpose was to dilute his holding.
- Wind-up and Dissolution
If none of the above work and you feel that the Company cannot continue in business with all parties on board, then as a last resort it may be in the best interests of the Company to wind it up and go your separate ways. This is clearly not a decision to be taken lightly and we would recommend reattempting to reach an amicable agreement before giving this option consideration.
Ultimately, the wisest thing to do is to be prepared for the worst from the outset and ensure that agreed procedures exist, either in the Articles of Association or in a separate Shareholders Agreement, so that all parties know where they stand. In these agreements you can dictate how shares are to be dealt with in specific situations. For example you could include clauses stating that a shareholder may only remain a shareholder for as long as he is employed by the company and should he leave employment then he must give up his shares, authorising the directors to act as attorney on his behalf should he refuse.
No one wants to believe that a relationship may not work out, but addressing the possibility and appropriately planning while the parties are friendly can save a lot of heartache should animosity emerge in the future.