How do shares transfer under a shareholder agreement?

Voluntary transfer of shares

Usually shareholders will not be able to simply transfer their shares to someone else without the permission of the other shareholders. A Shareholder Agreement can list exceptions to this rule, such as a transfer from individual ownership into a family trust. Otherwise, a shareholder will need permission to transfer and the other shareholders are likely to get first option.

The reasons for this are understandable. If you set up your company with a business partner you would not want to find yourself suddenly in business with his best friend in the event that your former business partner suddenly decided to leave the company and move to France, in the process selling his shares to his friend, whom he may trust, but you don’t know.

A Shareholder Agreement can deal with what happens to that business partner’s shares if he does decide to leave. For example, maybe:

1. the remaining shareholders get an option of first refusal to buy the shares

2. the remaining shareholders must buy the shares from the departing shareholder

3. the shares can be made available to outside investors

Compulsory transfer of shares

The first thing to make clear is that there are no circumstances in company law where a shareholder must sell his shares back to the company or to the other shareholders – even if he is squarely in the sin bin.

Imagine you have given a star employee 15 per cent of the shares in your company as an incentive to stay or as a reward for good work. What happens if he later wants to leave the company or, even, is sacked? What happens to the shares? Can he keep them?

The answer is yes – he can, unless he has signed a legal agreement promising to hand back those shares when he leaves the company.

A Shareholder Agreement can cover this, saying what will happen to the shares after a shareholder leaves the company.

However, Shareholder Agreements can also set out a wider list of events which might trigger a compulsory sale. For example:

1. the death or critical illness of a shareholder

2. the bankruptcy of a shareholder

3. a shareholder is absent for an extended period or abandons the company

4. a shareholder commits an act which is akin to gross misconduct under an employment contract

The Shareholder Agreement can also set out what price should be paid for the shares if any of these events happen. Many companies decide that the price should be less than full market value if the transfer of shares is triggered by one of these ‘compulsory’ and unwelcome events.

Valuation of shares

The valuation of shares is another area where formerly cordial relationships between business partners can become awkward, so it pays to have an agreed mechanism for the valuation of shares prepared in advance of any difficulties. The Shareholder Agreement is a good place to detail who will carry out the valuation and what method they will use.

There are as many different ways of valuing a private company as there are companies (about 4 million in the UK alone), but ultimately the price paid will be what it is worth to the buyer to acquire the shares. This can be influenced by many different factors: the company’s asset value; its revenues; the proportion of the company’s share capital up for sale (a minority share will have minimal influence, so may be less appealing); and even the actions of the seller – if they agree not to compete with the company in the future they can help to increase the share value.

For reasons of convenience, share valuation will usually be handled by the company’s accountant, although if the company accountant happens to be the close friend of one of the shareholders then for reasons of perceived independence the business partners may prefer to bring in an outsider to carry out share valuation. Many accountants specialise in the valuations of private company shares, so it shouldn’t be too hard to find an affordable option.

It is a very good idea to provide a formula in the Shareholder Agreement to help the person valuing the shares. This can create an internal market valuation mechanism for the shares and may avoid lengthy disputes about whether the valuation obtained from the company accountant is fair or accurate.