You are a private company seller looking to exit your business after years of building up value. Your sale process is going well, and you have identified a preferred buyer that wants to pay a premium for your company. The only issue is that the buyer doesn’t want to buy 100% of the company. Instead, the buyer wants you to remain invested and “roll over” some of your equity at closing into a minority ownership position and enter into a shareholders’ agreement governing the target company after closing. You have never been a minority investor before, nor have you ever entered into a shareholders’ agreement. What should you do?
Potential Advantages of a Partial Exit
It is not uncommon for buyers in private company sale transactions (especially private equity funds) to want or require a seller to remain invested in the target business after closing.
There are many reasons for this, including:
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Wanting the seller to continue to operate the business (whether permanently or for a transition period) after closing
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Making sure that the seller remains invested in the post-closing success of the business
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Having the seller remain as a resource to the buyer after closing to make customer introductions, transition vendor relationships and generally act as a “bridge” to the buyer’s operation of the company
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Reducing the cash portion of the purchase price payable by the buyer at closing (an especially important consideration where the purchase price is being financed by debt)
Sometimes, a “partial exit” transaction may be the better choice for both parties than a “full exit.” Under the “partial exit,” the buyer benefits from the seller’s continued involvement in the target company, while the seller benefits from the additional resources, growth capital and general operational expertise that an experienced buyer brings to the table. If the target company increases in value and is sold in the future, the seller can capitalize on that increase in value when it sells its remaining equity stake. The seller may also benefit from continued distributions from the target company while it remains a shareholder.
Tips for Sellers
If a seller is going to consider keeping a minority position in the target company, it is imperative that it understands what its post-closing rights and obligations are with respect to its investment. However, many sellers have never entered into a shareholders’ agreement before and don’t know what issues to consider and how to properly protect themselves. Below are five tips for sellers to consider when negotiating a shareholders’ agreement for a minority investment.
1. Classes of Shares. You and the buyer may have different classes of shares in the company. It’s important to understand the differences and why each type is proposed. For example, one class may have enhanced voting or economic rights, or entitle the holder to transfer their shares more freely in certain situations.
2. Electing Directors. Generally, directors are responsible for supervising and overseeing the management of a company’s operations. They also ensure that the company acts in compliance with its governing documents and applicable law. As a minority investor, you may negotiate with the buyer for the right to nominate board members. If so, the number of board members you are entitled to nominate will depend on how many board members there are and the overall percentage of your equity in the company. Board participation can help ensure you receive enhanced information, reporting rights and voting rights on key decisions.
3. Voting on Key Decisions. A shareholders’ agreement usually removes the directors’ powers to vote on certain fundamental decisions and vests those decisions with the shareholders. You’ll want to review what decisions you can vote on, including decisions where you effectively have the right to “veto” because unanimous approval is required.
4. Liquidity Rights. Although described as “minority,” your equity in the company can often be a significant investment on your part. At the same time, you may be investing with a buyer with whom you have little experience outside the sale transaction. The relationship may not work out as hoped. If it doesn’t, you will need to know what rights you have to exit your investment.
If you choose to exit your investment, you may have the right to transfer your shares to related parties for tax or succession purposes. You may also be able to negotiate the right to sell (“put”) your shares to the buyer after a defined period of time under a set formula. If the buyer sells their shares, you may be able to sell yours in the same transaction. There are myriad liquidity options to consider for inclusion in a shareholders’ agreement.
5. Forced Sale of Your Shares. Given the possible upside when making a minority investment, you will also want to focus on the situations where you might be forced to sell your shares. For example, is your right to own shares tied to your continuing employment with the company? Can you be forced to sell your shares when the buyer is selling their shares to a third party? If so, it will be important to know what the sale process is, what price you’re entitled to and how that price will be paid.
Your legal advisors can assist you with understanding your rights and obligations as a shareholder and negotiating a shareholders’ agreement with the rights and protections that you require.
For further information, please contact:
Mike Stevenson +1-416-863-2458
Michael Elder +1-416-863-2242
or any member of our Private M&A group.
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