When a business owner has resolved to release shares in their business, a shareholder agreement can provide protection for all parties involved.

When drafting the agreement, entrepreneurs should include clauses that allow them to continue drawing money from the business in dividend form for tax purposes without being hamstrung by paying dividends to other shareholders under present legislation. This can usually be achieved quite easily by using different classes of shares.

Shareholder agreements will generally contain specific clauses to determine what happens upon exit and, perhaps more importantly, protect the majority and minority shareholders by barring one from selling their holding and leaving the other vulnerable. Imagine the consequences of a competitor gaining a shareholding in your business. 

For the entrepreneur, a ‘drag-along’ clause allows them to accept an attractive offer and stops the non-executive director frustrating the sale, whilst a ‘tag-along’ clause ensures that minority shareholders can share the spoils upon exit.

Good and bad lever mechanisms also help to provide structure when there is a parting of the ways. Where the split is amicable, the ‘good’ mechanism allows the other party to buy back shares, while in the event of a major disagreement there is provision to say what should happen.

For companies with valuable assets such as plant or property, it can make sense to set up a holding company positioned above the main trading company, separating those assets and protecting their equity value. Such protection is usually unnecessary for trading companies without significant assets.

In this scenario, the holding company structure needs to be implemented well in advance of any potential problems, ensuring that the measure is deemed a bonafide commercial step and not simply a knee-jerk evasion tactic if matters begin to turn sour.
 
Holding companies can also be used where a business is seeking to introduce new funds to the business or maybe release some of the value.  Depending on the source of the funds, the holding company structure assumes an equity release.   Venture capitalists may typically acquire a stake of, say 30 per cent, whereas a private investor/non-executive may settle for 10 per cent (introducing less cash but adding value through their experience and knowledge). 

Whichever route is taken, the remaining shareholding should be ultimately worth more than the whole before the transaction. In both scenarios, the investors may require fees in addition to their equity stake.

Creating an employee share option scheme can prove another useful route for many entrepreneurs. By offering their employees a share-based bonus, staff are incentivised to work towards the growth of the business and have their efforts rewarded either through a dividend or eventual sale.

All instances of releasing equity outside of family should be done with a view to increasing or protecting the value of the business.

Entrepreneurs may choose to place some shares in trust for the benefit of their family.  For children over 18, the trust can receive dividends, which can then be used to good effect, funding first home deposits, paying the grandchildren’s school fees and the like. This avoids the entrepreneur donating money from taxed income and allows the trust to pay less tax, perhaps at a basic rate compared to the 50 per cent tax charge it may otherwise attract for the entrepreneur.

Such measures hinge on the company’s present structure, the owner’s goals and whether there are children who would wish to take the business forward.

Transferring shares to spouses also allows entrepreneurs to allocate income and enjoy tax breaks.  The transfer of shares to a spouse is exempt from capital gains tax and the spouse can receive a dividend at a lower tax rate than the owner would attract. If the spouse takes some role within the business, and can prove to have worked there for the past 12 months, or take a directorship, they may also qualify for entrepreneur’s relief, meaning an effective rate of tax of 10 per cent on any gain in value on exit.  (Individual gains of more than £1m are currently taxed at 18 per cent).

As long as entrepreneurs remain focussed, plan effectively and seek professional advice, appropriate share issues and structures can provide a clear means of business enhancement and growth.
 
 

Andrew Moss, corporate finance partner at Duncan Sheard Glass chartered accountants, looks at the key shareholding concerns for small business owners.