Exit mechanisms and options in Shareholders’ Agreements
Exit mechanisms and options refer to the provisions and processes included in shareholders’ agreements which enable shareholders to exit a company and/or dispose of their shares. Exit mechanisms and options are crucial components of shareholders’ agreements because they provide shareholders with a means of realising the value of their investment in the company and provide a mechanism for transferring ownership of the company to new investors and shareholders.
Thus, shareholders’ agreements should set out a general exit strategy including how shareholders are to be bought-out, the method and process of listing the business or shares for sale, and how value is attributable to each share. There are various different types of valuation methods which can be utilised for a successful exit. Commonly used methods include a predetermined formula, an agreed value or a determination by an independent expert.
Important issues which should be considered when drafting an exit strategy include:
Should the parties have a right to sell their shares and/or exit the company at will?
Should there a minimum period of time that the parties are required to hold their shares before sale is permitted? This may be particularly relevant in circumstances where two businesses are merging, and it is the interest of the companies to ensure that the value of the combination is realised before anyone is able to exit.
How should the assets of the company be dealt with upon a winding up?
Are there any assets which one party contributed to and will seek to retain after winding up?
How should the value be determined in circumstances where one party is seeking to buy another party out?
Some of the most commonly used exit mechanism for shareholders of companies include initial public offerings, mergers and acquisitions, and management buyouts.
Initial public offerings (IPO)
IPO is a process by which the shares of a privately owned company are listed on a stock exchange and made available for purchase to the general public. This means that existing shareholders may exit the company by selling their shares to the public through a new stock listing. IPOs allow a company to raise capital, fuel growth and pay down debt. It is often referred to a “going public” and is typically utilised by companies that have established a strong market position and are looking to expand their operations.
Mergers and acquisitions (M&A)
M&A are transactions in which the ownership of a company, its assets and its liabilities are transferred or ‘acquired’ by another entity. A merger is the consolidation of two entities into one, whereas an acquisition occurs when one existing company takes over another. The process is typically used by companies looking to enter new markets, acquire new technologies or intellectual property or consolidate their operations. In the context of shareholders agreements, M&A can provide a mechanism for shareholders to exit the company by selling their shares to the acquiring company.
Management buyouts (MBO)
MBO is a transaction where the management team of a company purchases the assets and operations of the company from its existing shareholdings. Often, this will occur by a leveraged buyout, where the management team uses borrowed funds to buy out all or part of the company. MBOs allow existing shareholders to exit the company whilst preserving the company’s future growth and prospects.
Without a properly contemplated exit mechanism, parties can find themselves “locked in” to the business without a clear way out. Though the oppression remedy in the Corporations Act 2001 is available to shareholders who have been unfairly treated, prejudiced, discriminated against or oppressed, the process of seeking a court order to wind up and/or exit a company is costly and time consuming. Thus, comprehensive exist mechanisms and options are an important aspect of any shareholders agreement because they allow parties to make informed decisions about their investment.
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