Buying a share of a veterinary business

Buying into a company as a shareholder is exciting….. you have a stake in the business you work for! But what kind of stake? Will you be permitted to place a hand on the wheel, or be confined to the back seat?

Here are six questions to help you establish what influence you will have on the direction of the journey and what will happen if the road gets bumpy.

1. Does the business have a shareholder agreement in place?

If you are buying into business run through a limited company, find out of there is a shareholder agreement that you can review before committing to buy into the business.

A shareholder agreement a private contract between the owners of a company that sets out the ‘rules of the game’. It is a method of agreeing in advance what will happen in various scenarios that may occur in the life of the business. For that reason it is sometimes called a ‘business Will’.

Like a Will, there is no legal requirement for the owners of a company to make a shareholder agreement. But in the absence of a shareholder agreement the business owners will need to consult the Companies Act 2006 to determine their rights – which inevitably means having to consult a lawyer. A shareholder agreement will put in place rules to address the other questions set out below.

2. How are key decisions of the business made?

Some key decisions in a small business have a big impact on all shareholders. The shareholder agreement can set out which of these ‘big’ decisions need the unanimous consent of all business owners and which ones simply require the majority to consent. Some examples:

a) Should a shareholder be allowed to be have a stake in a competing business? Or in any other business, competing or not?
b) How many directors should be required to authorise large payments on behalf of the company (e.g.) greater than £10,000?
c) What level of approval should be required to engage or dismiss a senior employee?
d) What level of approval is needed to change the nature or direction of the business?
e) What level of approval is needed to invite a new shareholder into the company?

There is no standard answer for deciding the level of consent needed for these big questions. But it is worth knowing in advance what level of involvement you might be allowed and whether your voice will be heard.

3. How will the shareholders share the profits?

The net profits of a company (i.e. what is left after overheads, salaries and other expenses have been paid) are split between the shareholders in proportion to the shares that they hold. These payments are called ‘dividends’. The directors decide each year by a simple majority vote on how much of the profit will be paid to shareholders and how much will be retained for investment in the business.

Some businesses will retain all of their profit for reinvestment. Others will distribute it all to shareholders. A shareholder agreement can establish a set of rules for determining when dividends will be paid. This can ensure that a fair distribution of net profit is made to each shareholder.

4. What happens if a shareholder dies?

Shares are a personal asset and as such they pass under your Will to your next of kin. They do not automatically pass back to the company upon the death of a shareholder. This can lead to some potentially some undesirable outcomes: either, the surviving shareholders may wish to buy back the shares from the next of kin, but they may not wish to sell them, in which case they can hang on to those shares. Or, the next of kin may wish to sell those shares back to the company to realise some cash for the shareholding of the deceased shareholder, but the surviving shareholders may refuse to buy those shares, which leaves the next of kin with a paper asset that they cannot convert into cash.

The answer is to have a clause in a shareholder agreement that gives the next of kin a right to sell the shares back to the company and gives the surviving shareholders a right to buy the shares back from the next of kin.

5. What happens if a shareholder wants to leave the business in future?

Sometimes a shareholder needs to voluntarily leave the business (e.g. due to a new job, relocation or personal circumstances). Shareholdings are not automatically connected to your employment, which means that they do not automatically pass back to the company upon you leaving your employment. This is potentially detrimental for both the company and the shareholder.

The company might be left with a shareholder who doesn’t work in the business anymore but still hangs on to shares in the business. Meanwhile, the shareholder retains a minority shareholding that is impossible to sell and cannot be converted not cash.

The solution is to have a set of rules in place that give the leaving shareholder a right to sell his or her shares back and give the continuing shareholders a right to buy the shares back from the ex-employee.

6. How are shares valued?

There are as many different ways of valuing shares in a private company as there are companies, but ultimately the price paid for shares will be a compromise between what a buyer is prepared to pay and what a seller is prepared to accept. However, disagreement is achieved as commonly as a compromise.

There are different measures that can be used to place a value on shares: a) the company’s total asset value; b) its net profit; c) its future potential. For reasons of convenience, a shareholder agreement will often state that, in the absence of a compromise agreement, the question of share valuation will usually be referred to the company’s accountant or an independent accountant to determine. Much like a Will this can provide a method of avoiding bitter disputes after the event.

As anyone who has attempted to play monopoly with their family members will know, not all business ventures end amicably. Sometimes, building an empire doesn’t bring people together. Establishing a clear set of rules at the beginning is like putting in place a fence at the top of a cliff, which stops company owners from falling over the edge and into the hands of lawyers who wait in the ambulance parked beside the rocks below!