Shareholder Agreements – ‘Good and Bad Leavers’
If you are a shareholder in a company, holding less than 100% of the entire issued share capital, and you haven’t yet considered shareholder agreements then you ought to. Actually putting one in place does depend on the nature of the company ownership, the relationship between the parties and a host of other factors. However, not considering implementing such an agreement could leave a shareholder and the company exposed, and generally at a time when they can ill afford to be.
There are a number of considerations when owning a company with others that ought to be thought through carefully. Namely, what rights do the shareholders actually have, what controls can they place on the company, what happens in the event that parties want to cease their involvement or disagree on decisions, and more pertinently than most, what if something happens that hadn’t been expected.
It is this last point that can lead to discussions around ‘good’ and ‘bad’ leavers. And for more complex arrangements further ‘intermediate leavers’ or ‘very bad’ leaver provisions can be introduced.
So what exactly are they and why are they important?
A ‘good and bad leaver’ clause in shareholder agreements seek to treat the valuation of a party’s shares differently depending on their circumstances of departure. They are therefore triggered by an event that compels the shareholder to offer their shares for sale in a company. This could be retirement, ill health, dismissal, etc.
In our experience, the offering of shares to key employees has become more common. The retention of talent is a key priority, and ever-increasing salaries are unaffordable. Offering incentives, through a variety of different schemes, such as shares in the company is one solution. As a result we have seen an increasing number of conversations in this area, and getting the structure right and protection in place is a key element to a successful transaction.
‘Good and bad leaver’ provisions incentivise key executives to stay with the company and, more accurately, act as a disincentive to key people from leaving.
Frequently, shareholder agreements will provide that a shareholder is required to offer their shares for sale in the event that they become a ‘Leaver’, that is, cease to be involved with the company. On such trigger event their shares are subject to compulsory transfer provisions and are capable of being bought out by either the company (subject to company law limitations) or the existing shareholders (as a whole or by reference to priority for founder members). In any case, the value of those shares is the key for the exiting shareholder.
A ‘Good Leaver’ is generally someone who has left but for reasons they are unable to control. For example illness, retirement, redundancy and unjustifiable dismissal by the company. In these instances the departing member would likely attract the full ‘Fair Value / Market Value’ of their shares, incentivising the shareholder to retain their shares so as long as they are able to do so. Inclusion of these provisions when governing the shareholders enhances their drive to act in the best interest of the Company. Ascertaining the financial gain that awaits a good leaver would further incentivise a steady and commercial relationship that they have with the business, creating positive results for all parties involved.
A ‘Bad Leaver’ is someone who has left the company, but for reasons within their control and on which it has previously been agreed that they are treated as a ‘Bad Leaver’. For example dismissal by the company, voluntary resignation, departure within an agreed minimum period, breach of any shareholders agreement, criminal conviction (save generally for minor offences), bankruptcy. In these cases the shareholder would likely suffer a discount on the valuation of their shares at an agreed rate. Getting the rate right is dependent on discussion at the time, and may vary – leading to the introduction of other ‘Leavers’, including the ‘Intermediate’ or the ‘Very Bad’. There is a necessity to have bad leaver events as well as good; having incentives to act in the best interest of the Company should be welcomed with a polarising position. Not only are members to be rewarded for their actions but shall be at a disadvantage if they do not look to promote the success of the Company.
We think there are three key things to consider.
1. Should there be a requirement for a departing shareholder to be subject to compulsory transfer provisions?
2. Should there be a distinction between the circumstances triggering the offer of shares?
3. What ‘penalties’ should be applied in respect of a transfer pursuant to unwanted behaviour?
As part of any shareholder discussion, we would engage with clients and explore the different options. Taking time at this stage can save further painful discussions. If a shareholder, who is also a key employee of the business, is dismissed with good cause, then one of the last things the company is going to want to do is make further payments in respect of his/her shareholding, especially where it could impact on the future performance of the company.
At Bright Solicitors we have extensive experience in advising companies and shareholders regarding the terms of shareholder agreements generally, and particularly around ‘Good and Bad Leaver’ provisions. If you have any questions then please contact us to find out more.