Overview of Common Issues Of Valuation In Shareholder Agreement
When a company has more than one owner, these owners are called ‘shareholders’, who will then be legally bound to a ‘shareholder agreement’.
A ‘shareholder agreement’ is a legal document stating the privileges and responsibilities of each shareholder. It aims to protect the interest of individual owners as well as the overall interest of the group. Hence a good shareholder agreement acts in consideration to all the shareholders regardless of their voting shares.
In truth, a shareholder agreement seems most useful for the minority shareholder, who usually carries 50% or less of the outstanding voting shares and hence not entitled to make unilateral decisions on the company’s fate.
However, shareholder agreements in reality often use inadequately structured valuation clauses, and hence lacking in terms of:
(1) achieving a mutual ground for determining the worth of equity - or ownership - interest in the company;
(2) setting the exact conditions for valuation; and (3) defining the individual returns and benefits.
A Shareholder Agreement That Uses Adequately Structured Valuation Clauses Will Be Able To Achieve The Following:
Identify and address the possible circumstances - or ‘triggering events’ - where a business valuation would be needed;
Use proper methods to achieve a mutual ground for determining the worth of the company’s equity interest;
Detail a fair compensation for the withdrawing shareholder while protecting the interests of the remaining shareholders and the company;
Ensure that a shareholder withdraws from the partnership through proper procedures and does not cause any impending damage to the company;
Protects the remaining shareholders when a third party buys the company’s shares.
Failing to do the above may spur debates and eventual conflicts amongst the shareholders, which will then lead to unpredictable aftermath like greater costs and a pending litigation.
Hence it is vital to first address the common issues of valuation in a shareholder agreement before setting the main content of terms and conditions.
Let's explore the first common issue of 'triggering events'.