Shareholdings for Employees or Family Members
Posted: 19 February 2020
Bringing a key employee or a family member into your business by offering them a shareholding can be a powerful motivator and a significant indicator of how much you value their contributions to your success. However, the process should be done carefully with a robust shareholders’ agreement and company constitution, as there are many facets of the company-shareholder relationship that must be agreed upon to ensure a harmonious future between yourself and the new shareholders.
The circle of trust
First and foremost, your shareholders should be people whose values are aligned with those of your business. Even if they are minority shareholders, there are circumstances in which you will have to rely on their good judgement. The easiest way to prevent disagreements down the road is to carefully consider their business sense, character and propensity for confrontation before embarking on shareholder discussions.
The majority shareholder issue
There is a misconception among business owners that 51% or more share ownership is a ‘controlling stake’. While that is correct for general resolutions, if a special resolution of shareholders is required, anything less than a 75% ownership will put you at the mercy of your fellow shareholders. Given that a special resolution of the shareholders is required for any major transaction, this could cause significant difficulties for you if they do not agree with your proposed actions. There are also a few decisions that require the unanimous consent of the shareholders, such as changing the constitution.
Cashing in shares
There is always risk that new shareholders will ‘cash in’ their shares when it becomes profitable for them to do so, or they receive a better offer of employment elsewhere. To prevent your shares being used as a cash bonus, you can incorporate prohibitions on the sale of shares within defined timeframes, or place a cap on the increase in share value over time.
The solution to this problem will be specific to the operating model of your business and how comfortable you are with employees holding shares if they are no longer involved in your company.
Rights of first refusal
Your shareholders’ agreement should include the process to be followed if the new shareholders no longer want to be involved in your business. Often you will want to ensure that those shares do not get sold to a third party. Including a right of first refusal where you must be offered the shares back from your shareholder at a fair price is usually the most reasonable way to prevent this.
To retain key employees, it is also possible to include a prohibition on ownership of the shares if they cease to be an employee.
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