Buying out a shareholder

Hi,

I have a reallly tricky problem. I and a friend set up a business nearly a decade ago, and we both had 50% of shares. He left the company a year and a half in because it wasn't going well. We weren't making any money, and he needed a fresh start. Unfortunately we never sorted out the shareholding issue, and I ploughed on into the business, with three other colleagues. I was young, and hadn't a clue about business.

The company's fortunes improved immediately after he left, and it's been pottering along for years now. Turnover of circa 3 to 400,000, but not huge outgoings either, so that we've mostly been just about breaking even. We made net profits of circa 100k in 2007, circa 6k in 2008, and a loss of 33k in 2009. We expect a similar loss for 2010. However we didn't pull in a lot of our earlier profits - like a lot of businesses, a lot of our turnover turned into bad debts. I guess what's kept us going was eventually redeeming some of our 2007 profits.

Anyway, we're having real problems planning ahead because of this shareholder issue. I feel like my three colleagues, who've stuck with the business with me for the guts of a decade, should be entitled to shareholdings of 20% each - maybe even 25%. It's difficult to motivate us all, given this uncertainty. Why should they work to make the business a success, just to increase his (and my) 50% stakes when they have nothing other than a mediocre wage?

I think my original business partner will be reasonable about this - he may wish to retain a small shareholding, or to sell all of his shares to my colleagues, which I think would give us a fresh start. I've no idea what would be a fair amount to pay him. The company's got a good name, loyal clients, but virtually no fixed assets. A few 6k worth of computers etc, if that.

Has anyone any idea what we could do? Is it a question of valuing the company (and my other shareholder agreeing to the value) and my colleagues buying him out? Could this be done by the company paying what would be part of their wages to him?

Any idea what the company's worth as it stands?

Any advice would be greatly appreciated.

Cheers

little sme said:

Has anyone any idea what we could do? Is it a question of valuing the company (and my other shareholder agreeing to the value) and my colleagues buying him out?

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Yes. Though it might just as easy to liquidate and start again.

little sme said:

Could this be done by the company paying what would be part of their wages to him?

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If the company has cash it could loan the new shareholders funds to buy out the original shareholder and the new shareholders could repay that from their net income. The limit for a loan is 10% of share capital AFAIK so that may not be enough.

It may be possible to get seed capital tax relief on the investment so the new shareholders would get their tax back too. That would be easier if you form a new company.

little sme said:

Any idea what the company's worth as it stands?

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Very hard to put a value on it. Lots of questions have to answered like what are your net profits likely to be going forward, what is your growth rate, etc.

If you have averaged a 10K net profit over the last 4 years then a typical P/E of 15 would value it at 150K if that helps.

Key question for me is are the clients loyal to the company or to you? If you setup another operation tomorrow would they follow you? If so, maybe the value is zero?

Your colleagues certainly should not borrow from the company to buy shares. This is just way too messy from a tax point of view, and a cash flow point of view.

However we didn't pull in a lot of our earlier profits

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A profit on paper is not a profit if the customer does not pay.

It sounds to me as if the company has no value other than goodwill which attaches to you and your three colleagues. If your former partner is reasonable, he will recognize this and sell the shares at a nominal value.

I strongly recommend that you address this now. Business will pick up and it will be very difficult to deal with if the business is profitable.

Have a chat with your fellow shareholder. Ask him to transfer the shares free of charge. He may well agree. If he doesn't, then set up a new company and close down the old company.

Brendan

did ye have an original shareholders agreement?

Thanks for the replies.

I don't know about a shareholders agreement - whatever's in the standard incorporation for a limited company. We paid a company formation outfit to incorporate us. From memory I think myself and my former colleague have fifty shares each.

Suppose he was agreeable to diluting his shareholding, with shares being issued to my other colleagues and I. Is that doable?

Re profits, our accountants have always advised us to pay corporation tax based on orders in the return year, irrespective of whether they've been realised. I don't know. Maybe we get it back somehow the next year...

A shareholder's agreement is not required when setting up a company but is generally a good idea to get one drawn up and have all shareholders sign it. It is designed to cover scenarios like the one you are facing.

Yes the company can issue new shares and dilute the existing shareholding. You may need to increase your authorised share capital to do that but it would be straightforward for an account to do both for you.

Your accountant is correct, you must declare the income once it is billed even if you haven't received the cash yet. But it is prudent to include a provision for a doubtful debt if you are unsure of being paid and you should write it off as a bad debt if you are certain you won't ever be paid. You can accumulate losses and use them to reduce future CT liabilities but I don't think you can claim back previously paid CT just because you are now making a loss.