Summary
- When a shareholder exits a company, the process must follow the company’s constitution or a shareholders’ agreement, which typically governs how shares are valued and transferred.
- Departing shareholders may be required to offer their shares to existing shareholders first, under what are known as pre-emption rights.
- Disputes can arise if exit mechanisms are not clearly documented, making well-drafted agreements essential for protecting all parties.
- This is a plain-English guide to shareholder exit processes for Australian business owners, covering key legal considerations under Australian law.
- The content has been prepared by LegalVision, a commercial law firm that specialises in advising clients on shareholder agreements and corporate governance.
Tips for Businesses
Review your shareholders’ agreement before any exit occurs. Ensure share valuation methods are clearly defined to avoid disputes. Confirm whether pre-emption rights apply and follow the correct transfer process. Keep company records updated when ownership changes. Address exit provisions early, ideally when the company is first established.
Shareholders do not always stay with a company forever. Circumstances change, and when a shareholder decides or is required to leave, the process of exiting must be handled carefully to protect everyone involved. A shareholder exit can happen voluntarily or involuntarily, and the rules governing it will usually depend on your shareholders’ agreement and company constitution. This article explores the key considerations for exiting shareholders in Australia.
Making a Voluntary Exit
Private companies do not have an easily accessible market to sell their shares, unlike public companies, which list and trade their shares openly. Private companies possess unlisted shares, making them more challenging to sell. Occasionally, the board of directors might reject a third party’s bid to purchase shares from an existing shareholder and join the company as a shareholder.
If there is no third-party purchaser available, you, as the exiting shareholder, have two voluntary exit methods:
- you can sell your shares to one or more fellow shareholders; or
- the company can conduct a selective share buy-back of your shares.
A combination of both may be possible.
Option 1: Share Sale to Remaining Shareholders
When you, as the exiting shareholder, sell your shares to other shareholders, you engage in a share sale transaction. It involves the transfer of shares from one shareholder to another for payment. This action increases the overall shareholding of the buying shareholder(s) according to the number of shares they acquire. Consequently, your number of shares decreases (in the case of a sell-down), or you cease to be a shareholder altogether (in the case of a total sell-off).
Price, Purchase and Market Value
Both the buyer and seller must agree on the purchase price. The sale should occur at a value at least equal to the total market value of the shares at the time of the sale.
Determining the value of a privately owned company may require assistance from the company accountant or a business valuer. If the sale price is lower than the market value, tax implications may arise for all parties involved in the sale, including other shareholders not part of the sale.
Additionally, performing a share transfer involves critical legal documents, such as:
- resolutions from the company to approve the share sale, and note that all requirements under the company’s constitution (if one exists) and shareholders’ agreement/deed (if one exists) have been complied with;
- a share transfer form to legally transfer the shares; and
- a share sale agreement, negotiated between the buyer and seller, which outlines aspects of the sale such as:
- the purchase price to be paid for the shares;
- when the purchase price will be paid (i.e. will it all be paid on completion of the share sale, will half be paid upfront and half in 6 months, etc.); and (amongst other aspects)
- warranties in relation to the shares, such as the seller warranting to the buyer that the shares are free of any registered security interests the seller may have granted to another party to secure a loan it took out.
Key Documents
Additionally, performing a share transfer involves critical legal documents, such as:
- resolutions from the company to approve the share sale, and note that all requirements under the company’s constitution (if one exists) and shareholders’ agreement/deed (if one exists) have been complied with;
- a share transfer form to legally transfer the shares; and
- a share sale agreement, negotiated between the buyer and seller, which outlines aspects of the sale such as:
- the purchase price to be paid for the shares;
- when the purchase price will be paid (i.e. will it all be paid on completion of the share sale, will half be paid upfront and half in 6 months, etc.); and
- warranties in relation to the shares, such as the seller warranting to the buyer that the shares are free of any registered security interests the seller may have granted to another party to secure a loan it took out.
After a Sale
After completing any sale:
- the company will need to update the member’s register;
- the company must cancel the seller’s share certificate;
- you will need to issue new share certificate(s) to the purchaser(s); and
- the company must notify the Australian Securities and Investments Commission (ASIC) of the changes to the shareholdings.
Sometimes, the company must update the directors’ register and notify ASIC if a share transfer changes the directors.
Pre-emptive Rights
Under the Corporations Act, shareholders have pre-emptive rights. This means existing shareholders must be given the first opportunity to purchase shares before they are sold to third parties. These rights ensure that existing shareholders maintain their proportional ownership in the company and prevent unwanted parties from becoming shareholders.
However, pre-emptive rights are a replaceable rule under the Corporations Act. Companies can modify or exclude them through their constitution or shareholders’ agreement. Most private companies establish their own pre-emptive rights regime in governing documents. These often include more detailed procedures and timeframes than the statutory provisions. You must comply with the applicable pre-emptive rights regime, whether under the Corporations Act or your company’s documents. This applies unless you obtain shareholder waivers.
The Pre-emptive Rights Process
When pre-emptive rights apply, you must follow a specific procedure before selling to third parties. The process starts with serving a formal transfer notice on existing shareholders. This notice details the sale price, payment terms, and key conditions. Existing shareholders have a specified period, usually 30 to 60 days, to decide whether to purchase the shares. They typically purchase in proportion to their existing shareholdings.
If shareholders decline or fail to respond within the timeframe, you may sell to the third party on the specified terms. If the third party’s terms change, you must re-offer the shares to existing shareholders, who can match the revised terms.
Waivers
You must follow the procedures and rules in the company’s constitution and shareholders’ agreement or deed, if they exist. Before selling shares to another shareholder, ensure that you have permission to do so.
If you wish, you can deviate from the requirements of your company’s constitution, shareholders’ agreement or deed. In that case, you need a waiver from shareholders who are not a party to the share transfer (non-buying shareholders). Likewise, non-buying shareholders can confirm in writing that they are happy to deviate from specific requirements.
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Option 2: Share Buy-Back by the Company
In this option, the company buys back your shares as an exiting shareholder. This type of share buy-back typically involves a selective purchase. The company is not offering to buy all shareholders’ shares. It is only repurchasing the ones you own.
Once the company completes the share buy-back process and cancels the shares, it nullifies any associated rights. This decreases the total number of company shares issued. Consequently, each shareholder’s ownership stake increases proportionally to their existing shareholding.
Before a selective share buy-back, the company must ensure it can pay the exiting shareholder without risking insolvency.
Notably, ASIC also imposes strict requirements for a company to carry out a share buy-back of a shareholder’s shares. The process involves:
- a board resolution, the explanatory memorandum to the shareholders (explaining the arrangement, reasons and key details of the share buy-back (such as the number of shares being bought-back, purchase price, etc.) and share buy-back agreement being prepared;
- the directors signing the board resolution and submitting the board resolution (along with the explanatory memorandum and share buy-back agreement) to ASIC (via mail), along with an ASIC Form 280;
- once ASIC receives the ASIC Form 280 and its attachments, the company and the selling shareholder must wait at least 14 days after lodgement of the ASIC Form 280 until the share buy-back agreements and members’ resolution (approving the share buy-back) can be signed; and
- the company must update ASIC and cancel the shares.
When the shares are cancelled and bought back, the company will then proceed to cancel the share certificates, update the members register, and pay the buy-back amount to the exiting shareholder.
The above provides a general overview of the required process for a share buy-back. You need to carefully complete the required documents and make sure you follow the process correctly. Otherwise, you might consider the share buy-back invalid.
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Compulsory Exit Situations
While this article focuses on voluntary exits, shareholders should be aware that certain circumstances may trigger compulsory share transfers. These typically include death or incapacity of a shareholder, termination of employment or directorship, insolvency or bankruptcy, or breach of the shareholders’ agreement. The company’s constitution and shareholders’ agreement will usually specify these trigger events and the process for compulsory transfers. Understanding these provisions is crucial as they may override your ability to choose your exit method.
Restraint of Trade and Post-Exit Obligations
Exiting shareholders, particularly those who are also employees or directors, may be subject to restraint-of-trade clauses that restrict their ability to compete with the company or to solicit customers and employees after exit. These restraints must be reasonable in scope, duration, and geographic area to be enforceable. The shareholders’ agreement may also impose ongoing confidentiality obligations regarding company information. Review these provisions carefully as they may affect your future business activities and should be considered when negotiating your exit terms.
Key Takeaways
Exiting shareholders who have chosen to leave the company voluntarily can either sell their shares to other shareholders or participate in a share buy-back if there is no third-party buyer available. You cannot force other shareholders to buy your shares, nor can the company or other shareholders compel you to sell unless specified in the company’s shareholders’ agreement.
Completing a share buy-back involves detailed requirements, which your company must strictly follow. Both you, as the exiting shareholder and the company should seek legal, tax, and financial advice before proceeding with the sale and purchase.
If you have any questions regarding the sale or buy-back of shares as an exiting shareholder, LegalVision provides ongoing legal support for businesses through our fixed-fee legal membership. Our experienced corporate lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.
Frequently Asked Questions
As an existing shareholder, you can either sell your shares to the remaining shareholders or take part in a share buy-back. The price must be agreed upon by both parties, and capital gains tax may apply.
The company must follow a process that includes board resolutions and the submission of documents to ASIC. Once approved, the shares are cancelled, the register is updated, and the exiting shareholder receives payment.
You need company resolutions approving the sale, a share transfer form, and a share sale agreement outlining the purchase price, payment terms, and warranties confirming the shares are free of security interests.
Compulsory transfers can occur due to a shareholder’s death, insolvency, termination of employment, or breach of the shareholders’ agreement. Your company’s constitution and shareholders’ agreement will specify these trigger events and the transfer process.
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