- For whatever reason, many businesses have to cut ties with shareholders.
- The steps to removing a shareholder are referring to the original agreement, consulting professionals, claiming majority, negotiating and creating a non-compete agreement.
- Although removing a majority shareholder can be difficult, it is possible.
Shareholders don't always work out. Whatever the reason, there sometimes comes a point where one shareholder wants to cut ties with another in their company. While it's a complicated process, it's not impossible – especially if you take precautions.
1. Refer to the shareholders' agreement.
A shareholders' agreement outlines the rights and obligations of each shareholder in an organization. Typically, it is created and agreed on by all shareholders to ensure everyone is fairly represented. That way, if you want to cut ties with a shareholder down the line, you can refer to this document for guidance.
"The shareholders' agreement is a contract between all the shareholders that they will not do certain things," said Nate Masterson, marketing manager for Maple Holistics. "If the conduct rules are specific enough, getting rid of a shareholder for misconduct becomes much simpler."
This is especially useful when removing a majority shareholder – someone who owns more than 50% of the company's outstanding shares. If they violate anything explicitly stated in the agreement, you can remove them solely based on that offense. To avoid this issue, you can also make a provision in the agreement to elect a director annually, said Masterson.
Make sure to be specific with the agreement, including details like date, number of issued shares, capitalization table, restrictions on transferring shares, preemptive rights for current shareholders to purchase shares, and payment details in case of a company sale, according to Investopedia.
2. Consult professionals.
Before acting, especially without a shareholders' agreement in place, you need to reach out for professional insight to avoid any legal issues. While you might think the process is simple, it requires much thought and attention.
"In short, removing a shareholder is not something for amateurs," said Stanley P. Jaskiewicz, esquire at Spector Gadon Rosen Vinci P.C. "You should consult with counsel, under attorney-client privilege, as early as possible. An agreed-upon voluntary buyout between the company and the targeted will almost certainly cost far less than the expense of a contested removal."
Professionals can help you approach the matter in an objective, negotiable manner, while ensuring you meet any regional requirements in your area. This is crucial in any business decision, particularly ones that might cause tension among business partners. You don't want to skip this step in the interest of time or money.
"In some cases, the expense of an independent attorney may even be necessary, if the company's counsel has ethical or legal obligations to the target of the removal," said Jaskiewicz.
3. Claim majority.
Without an agreement or a violation of it, you'll need at least 75% majority to remove a shareholder, and said shareholder must have less than a 25% majority. The removal is accomplished through votes, and the shareholder is then compensated upon elimination, according to Masterson.
While claiming majority might work in some cases, it doesn't against majority shareholders who already acquire more than 50% majority alone, or even majority shareholders with more than 25% majority.
4. Negotiate.
If all else fails and you find yourself with no legal reason to remove the individual, you should sit down and negotiate with them, discussing a fair value of their shares.
"Although the shareholder may not be able to keep his shares, he almost certainly can dispute the value of what will be paid for the shares, and whether his removal occurred for an improper purpose," said Jaskiewicz.
Once you reach an agreement, you can buy back and distribute their shares to individuals in the company.
"If during negotiations you succeed in ousting a shareholder, you must ensure that no shares remain unallocated," said Anthi Pesmazoglou, legal specialist at Linkilaw. "All shares will have to be either gifted or transferred to another shareholder by using a stock transfer form."
5. Create a non-compete agreement.
If you're successful in removing your shareholder, proceed with caution. Because the process is often rocky, you want to impose a non-compete agreement on your departing shareholder. This will ensure they do not start or enter a business that directly competes with your organization for a set number of days after leaving.
Additional FAQs about removing a shareholder
Can the majority shareholder be removed?
According to Lankford Law Firm, although it may be somewhat difficult, removing a majority shareholder is possible – for instance, if they have violated the original terms of the shareholders' agreement of the company's bylaws.
What are the rights of a shareholder?
Most shareholders are bestowed with the following rights:
- The right to vote on major issues
- Ownership of a portion of the company
- The right to transfer ownership
- Entitlement to dividends
- Opportunity to inspect books and records
- The right to sue for wrongful acts
What happens when a shareholder leaves a company?
According to Corporate Resource Guide, when a shareholder leaves a company, the remaining members of the company must determine the value of the interest of the shareholder leaving. If there is no plan in place, the company must negotiate in order to buy the leaving member out of the company.