Sometimes personal or financial circumstances can affect a company’s shareholders. A shareholder may wish to voluntarily make an exit from the company and sell some or all of their shares. So what can exiting shareholders do to leave a company and dispose of shares? This article will explain two options for shareholders in this situation.
How to Make a Voluntary Exit
Private companies are not liquid. Because of this, there is no readily accessible market to sell shares. In contrast, public companies list on a stock exchange and can sell shares readily. Sometimes, companies may know a third party purchaser who would like to purchase shares in that company, but often there is no obvious buyer.
If there is no ready third party purchaser, the shareholder can make a voluntary exit in two ways:
- the shareholder sells its shares to one or more existing shareholders in the company; or
- the company undertakes a selective buy back of the exiting shareholder’s shares.
A combination of both may also be possible.
Option 1: Share Sale to One or More Remaining Shareholders
A share sale is where other shareholders in the company buy the shares from the exiting shareholder. The buying shareholders’ shareholding increases by the number of shares purchased. The seller either holds less shares going forward (where there is a sell-down) or is no longer a shareholder (where there is a total sell-off).
The seller is selling an asset, so needs to consider any tax consequences. Where the shares are capital assets, capital gains tax exemptions or reductions may be available, so the seller needs to obtain tax advice before the sale.
Price, Purchase and Market Value
The parties need to agree on the share price. Shares are usually sold at market value. As private companies are not marketed on a stock exchange, the buyer and seller will often need assistance to determine the company value. The company accountant may know how to value the company. Alternatively, the parties can seek an independent valuation by a valuation expert.
The incoming shareholders usually buy the shares with their own funds, However, a purchaser may acquire their shares with loan funds, whether from an external lender or under a vendor-financing arrangement.
Any share sale below market value may have tax implications for the exiting shareholder.
There are two key legal documents to effect the share transfer:
- a share transfer form to legally transfer the shares; and
- a share sale and purchase agreement, negotiated between the parties, to address issues such as:
(i) confirming the seller has no inside or special knowledge about the company which has prompted the sale;
(ii) protecting confidential information;
(iii) protecting intellectual property; and
(iv) non-compete, non-disparagement and non-poaching clauses.
After a Sale
Following the completion of any sale:
- the company will need to update the member’s register;
- the company must cancel the seller’s share certificate;
- new share certificate(s) will need to be issued to the purchaser(s); and
- the company must notify the Australian Securities and Investments Commission (ASIC) of the changes to the shareholdings.
Sometimes, changes to the officers occur as part of the share transfer. For instance, the existing shareholder will also be vacating an officer position, such as secretary or director. In this case, the relevant officer will need to officially resign. The company must update the directors’ register. Then, the company must notify ASIC of the change.
It is important that any share sale to a remaining shareholder is permitted by, and undertaken in accordance with, the company’s constitution and shareholders agreement, if they exist.
This can be solved by a waiver from any shareholders who are not a party to the share transfer (non-buying shareholders), in writing, to confirm that they are happy for the requirements under the constitution and shareholder’s agreement to be deviated from.
They can, for example, waive preemptive rights. It is standard for a shareholders agreement to include a preemptive rights procedure. This requires an existing shareholder who wishes to sell their shares to offer their shares to sale to all of the shareholders of the company (in accordance with a prescribed timetable).
If the intention is to not follow this process, then the non-buying shareholders must provide a waiver. If the non-buying shareholders do not agree to waive their preemptive rights, then the company must follow the preemptive rights process. Several shareholders may seek to purchase the shares for sale. The company is usually required to inform all shareholders of a potential sale of shares. If non-buying shareholders will waive their preemptive rights, this can help to speed up the sales process, for efficiency.
Option 2: Share Buy-Back by the Company
This option is where the company buys back the shares held by the exiting (selling) shareholder.
This type of buy-back is a selective buy-back; the company is not making an offer to purchase the shares of all shareholders. The transaction results in a transfer of shares from the exiting shareholder to the company.
The company must then cancel the shares. Any rights attached to the shares are suspended after the company buys back the shares. This has the effect of reducing the number of shares issued by the company. In turn, this means that the relative ownership stake of each shareholder increases equally in proportion to their existing shareholding.
A company may buy back its shares only if the:
- share buy-back does not have a materially adverse effect on the company’s ability to pay its creditors; and
- company follows the procedure set out in Part 2J.1 Division 1 of the Corporations Act 2001 which, among other things, includes the approval of the shareholders.
The company also needs to make sure it complies with any further requirements set out in the company’s constitution and shareholders agreement.
Usually, a company will buy back the shares from a shareholder for market value, unless its shareholders agreement or constitution provides otherwise. In some cases, a share buy-back may need to happen for nominal consideration. For example, where it relates to the buy back of unvested shares.
Where there is no third party purchaser, exiting shareholders who have decided to voluntarily leave the company can seek to depart by either a share sale to the other shareholders or via a share buy-back. This needs to be a voluntary purchase or buy-back; usually exiting shareholders cannot force a purchase. However, there are circumstances where the company or other shareholders can force an exiting shareholder to sell, for example, if the company has a shareholders agreement with ‘bad leaver’ provisions and the shareholder breaches these.
Both the exiting shareholders and the company should obtain tax advice on the sale and purchase.
If you require further assistance with a share sale or share buy-back, call LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
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