Shareholders choose to end business relationships for any number of reasons. When a shareholder decides to leave, it’s important to ensure they’re fairly reimbursed for their stake in the company. Planning ahead and knowing how to determine a fair price are key elements of creating a smooth shareholder exit strategy.
Understanding Shareholder Fair Exit
Shareholders wishing to leave a company have the right to a “fair exit.” This concept refers to the shareholder’s right to be fairly reimbursed for their stakes in the company. Handling a shareholder exit should presuppose the shareholder ought to be treated fairly.
Paying out a shareholder is ultimately a business transaction. Avoiding emotion or attempts to undercut the shareholder’s financial best interests should be avoided. By beginning with the goal of a fair payout, many of the difficulties around paying out a shareholder can be avoided.
Planning Shareholder Exit Strategies in Advance
Ideally, the best way to handle a shareholder exit is by planning. At the time of the company’s creation, it’s best to put an exit strategy in place for how shares will be valued and the process and timeframe for doing so.
If your company did not put such a plan into place at the time of formation, it’s a good idea to contact a business attorney and discuss exit strategy creation.
A shareholder exit is often prompted by disagreement or interpersonal conflict. However, attempting to undervalue a shareholder’s stakes or trying to force them to remain vested in a company they wish to leave aren’t wise strategies. Planning helps reduce conflict and streamlines the shareholder exit process.
Determining a Fair Shareholder Exit
How a company determines fair exit can vary widely. Some of the most common strategies used for setting the terms of a shareholder’s exit include:
- Tag-along rights
- Drag-along rights
- Right of preference/first refusal/preemption
- Put options
- Redeemable shares
If the company does not already have a shareholder exit strategy in place, a business attorney can assist by walking you through these commonly used options, highlighting the benefits and downsides of each.
Identifying a fair share valuation is often a complex process. Methods used for assessing share value include asset evaluation, earnings valuation, market-based valuation, or a combination of the three.
Whether you’re a shareholder planning your exit strategy or you run a company that needs to identify how to fairly compensate an exiting shareholder, it’s essential to work with a skilled business attorney to avoid shareholder disputes and interruptions to business operations. I always put together a valuation team on day one with an expert who can put numbers together to determine valuation before even discussing this with other shareholders.
Consult a Business Lawyer for Help
Guaranteeing a fair shareholder exit is a complex process. A business attorney is indispensable for ensuring the transition is a fair one. A lawyer can assist with writing shareholder agreements, creating an exit strategy, identifying exit terms, and advising on valuation strategies.
Working with a lawyer from the start helps streamline the shareholder exit process, but it’s never too late to consult a business attorney on how to move forward with achieving a fair exit for a shareholder leaving your company.