Company Buy-Back of a Minority Shareholding

Work: Share buy-back / shareholder exit / corporate restructuring

I regularly advise private companies and their shareholders where a minority shareholder is leaving the business and the company itself is to buy back and cancel their shares.

A company buy-back can provide a practical way of dealing with a shareholder exit without requiring the remaining shareholders personally to fund the purchase. It can also simplify the ownership of the business by cancelling the departing shareholder’s shares, with the remaining shareholders’ percentage interests increasing accordingly.

However, a buy-back is not simply an ordinary transfer of shares. There are specific Companies Act procedures, funding requirements and shareholder approvals which have to be followed for the buy-back to be valid.

Agreeing the shareholder’s exit

I have advised on buy-backs arising from a variety of circumstances, including the retirement or departure of a shareholder and the restructuring of ownership between the continuing shareholders.

The starting point is usually agreeing the commercial terms: which shares are being purchased, their valuation, when the shareholder will leave and how the purchase price will be funded and paid.

I can become involved at the heads of terms stage so that the proposed structure is workable before the parties commit themselves to detailed documentation.

Structuring the buy-back correctly

Unlike an ordinary share sale, the purchaser is the company whose shares are being acquired.

This means the transaction has to comply with the statutory rules governing a company’s purchase of its own shares. The company’s articles, available distributable profits and the source from which the purchase price will be funded therefore need to be considered at an early stage.

The corporate approvals are equally important. In one transaction I advised on, the board minutes specifically addressed the statutory requirements for a purchase of the company’s own shares, the use of distributable profits and the requirement for shareholder approval of the buy-back contract.

I prepare the necessary buy-back agreement, board minutes and shareholder resolutions, as well as dealing with the corporate formalities required to implement the transaction.

Directors’ interests and shareholder approvals

Buy-backs frequently involve directors who are also shareholders, so conflicts and declarations of interest need to be dealt with properly.

This is particularly important where one shareholder is exiting and the economic interests of the remaining shareholders will increase when the purchased shares are cancelled.

For example, the board documentation on one transaction expressly recorded the directors’ interests under section 177 of the Companies Act 2006 and the fact that the continuing shareholders’ percentage interests would increase following cancellation of the bought-back shares.

My role is to ensure that the correct sequence of board and shareholder approvals is followed rather than treating the buy-back as a simple bilateral agreement between the shareholders.

Funding the purchase price

A major practical issue is often how the company can afford to fund the departing shareholder’s exit without placing excessive pressure on its cash flow.

Depending upon the circumstances, the price may be paid entirely on completion or the transaction may need a more sophisticated structure.

I have advised on arrangements involving an initial cash payment combined with deferred consideration and loan notes, allowing the shareholder to exit while the balance of the price is paid over an agreed period. In one such transaction, part of the consideration was satisfied by secured loan notes, with repayment taking place over a number of years.

Where payment is deferred, the drafting needs to address what happens if instalments are late, whether interest applies and whether early repayment is permitted.

Protecting the departing shareholder

If a shareholder gives up their shares before receiving all of the purchase price, they move from being an owner of the company to effectively becoming its creditor. That creates an obvious commercial risk.

I therefore advise on appropriate protections for the outstanding consideration. Depending upon the transaction these can include loan notes, security over the company’s assets, personal guarantees, restrictions on dividends and controls over significant transactions while money remains outstanding.

For example, one transaction included restrictions on dividends while repayments were outstanding, access to the company’s accounting records, limitations on disposals of business assets and security for the deferred consideration.

Another transaction used staged purchases of the departing shareholder’s shares, together with rights to financial information and restrictions on significant corporate transactions while the exit arrangements remained incomplete.

The objective is to find a sensible balance: protecting the departing shareholder’s entitlement to be paid without preventing the continuing owners from running the company normally.

What happens to the shares?

The documentation also needs to deal correctly with the shares themselves.

On completion, the relevant shares are transferred back to the company and, in the usual private-company buy-back structure, cancelled. The company’s issued share capital and the percentage holdings of the continuing shareholders consequently change.

This needs to be reflected in the company’s statutory books and the appropriate Companies House filings made following completion.

Coordinating the whole transaction

A successful buy-back therefore involves considerably more than drafting an agreement for one shareholder to sell their shares.

I normally coordinate the transaction from the initial commercial agreement through to completion, including:

• reviewing the company’s articles and existing shareholder arrangements;
• advising on the proposed structure and funding of the buy-back;
• preparing or reviewing heads of terms;
• drafting the share buy-back agreement;
• structuring deferred consideration, loan notes, guarantees or security where required;
• preparing board minutes and shareholder resolutions and dealing with directors’ interests;
• coordinating the shareholder’s resignation as a director where appropriate; and
• dealing with the post-completion corporate records and Companies House requirements.

The result is a clean exit for the departing shareholder and a simplified ownership structure for those continuing with the business, while ensuring that the buy-back is implemented using the correct company law procedure.

Key areas advised on: company share buy-backs • minority shareholder exits • shareholder restructuring • purchase of own shares • deferred consideration • loan notes • security and guarantees • distributable profits • directors’ conflicts • board minutes • shareholder resolutions • director resignations • share cancellation • Companies House filings.