Business Partner Exit: Three Routes to Divide a Company

At a glance

This is a general explanation. Shareholders’ rights involve legal judgement; for an actual case, consult a solicitor.

Step one: read the documents first

Most people start negotiating a price straight away. But before the price, you need to know where the rules are set.

The articles of association — usually setting out transfer restrictions: board approval for a transfer, or a right of first refusal for existing shareholders. These provisions directly affect whether the departing party can sell to an outsider at all.

The shareholders’ agreement (if one was signed) — this is the crucial document. A good one sets out the valuation method, the exit notice period, pre-emption rights, a deadlock mechanism, and sometimes a “one side names a price, the other chooses whether to buy or sell” clause.

No shareholders’ agreement? Then you are left with the general provisions of the Companies Ordinance and whatever the two sides can negotiate. This is the most common and the most difficult situation — because there is no valuation method agreed in advance, and each side thinks its own figure is the reasonable one.

Which is also why these things should be thought about when the company is set up; see how to divide the shareholding.

How do you choose between the three routes?

A share transfer is the most direct. The departing party sells to whoever is staying, or to a new investor. The company itself is unchanged and carries on trading.

To deal with: the sale documents, valuation, stamp duty, updating the register of members, and filing with the Registry. See share transfers and stamp duty.

A capital reduction has the company itself pay to buy back or cancel the shares. It suits the case where nobody can afford, or wants, to pay personally. But the company needs sufficient funds, and the statutory procedure has to be followed (including the solvency requirements).

Liquidation and distribution is the last resort — nobody wants to continue, or the relationship has reached the point where negotiation is impossible. Realise the assets, pay the debts, and divide what remains in proportion to the shareholdings. See liquidation or deregistration.

As a rule of thumb: if terms can be agreed, transfer; if they cannot but the company still has value, consider a reduction; only when neither works do you talk about liquidation.

How is the valuation done?

There is no single “correct” answer, but the common methods are:

• Net asset value — total assets less total liabilities. Simple, and suits asset-heavy companies
• Earnings multiple — past earnings times a multiple. Suits service companies with steady revenue
• Agreed price — if the two sides can agree, no formula is needed at all

The most useful practical move: produce a current set of accounts first. The root of most separation disputes is not a difference of method — it is that the two sides do not agree on what the company is actually worth and what it actually owes. With a clear set of accounts, a lot of the argument disappears on its own.

Most commonly missed: personal guarantees

This deserves special mention, because it can be very expensive.

If the departing party gave a personal guarantee for the company’s bank loan, lease or supplier credit, selling the shares does not automatically release it.

Which means: you are no longer a shareholder and no longer involved in running the business, but the creditor can still pursue you for what the company owes afterwards.

The right approach is to deal with it expressly in the separation arrangements: apply to the bank or landlord for a release, or substitute a new guarantor. That needs the other side’s (the bank’s, the landlord’s) agreement — it is not something the two of you can settle between yourselves.

The same goes for two related items: whether the departing party is still on record as a director (they have to resign formally and file it), and whether they remain a signatory on the company’s bank account.

When is a solicitor essential?

Negotiating between yourselves first is fine where the relationship is good, the sums are modest, both sides agree on the valuation, and there is a shareholders’ agreement to follow.

Consult a solicitor where:

• There is no shareholders’ agreement and the sums are significant
• The two sides disagree on valuation or on the exit terms
• Intellectual property, customer lists or non-compete restrictions are involved
• One side suspects the other of misconduct
• Negotiations have already broken down

This article sets out the common framework, not legal advice. Once shareholders’ rights are in dispute, consulting a solicitor early is generally cheaper than dragging it out to the end.

What we can help with

Part of a separation is company document work — share transfer documents, stamp duty, updating the register of members, filing the change of director, tidying up the accounts. That we can do.

Valuation negotiations, drafting a shareholders’ agreement, and contested cases belong with a solicitor or a valuation professional. We will not pretend otherwise.

Want someone to get the company’s documents and accounts straight before you decide how to negotiate? Talk to us.

This is general information and does not constitute legal advice. Shareholders’ rights, valuation and the terms of an agreement involve legal judgement; for individual situations, consult a solicitor.