Mergers & Acquisitions: Retain shares after selling up
This article considers the circumstances in which shareholders may be asked to retain shares in the target company they are selling (‘stub shares’) and some of the issues to consider. It is the third article in our series around the means of payment used in mergers and acquisitions.
Typically, on a merger or acquisition, all the shares in the target company are transferred cleanly on completion and with the shares are transferred all the rights that go with those shares, voting rights, rights to dividends (including accruing but unpaid dividends), capital returns in the future and any redemption rights. This keeps ownership and control together in the hands of the buyer and if there are reasons for deferring payment for the shares that can be dealt with separately (read more about Deferred Consideration and Consideration Shares).
Retain shares but split control and ownership
Having said that, there is a commercial logic in transferring the shares as they are paid for so let us consider some of the difficulties that creates. First, a seller:
- may be caught mid-stream with no way to complete the crossing. For instance, say your holding starts out at 100%, after the first installment it reduces to 60% (still a majority) and then reduces with the second installment to 40% (now a minority) at which point the buyer declines to complete any further installments. In this situation you have received 60% of the value of the company but transferred closer to 100% in value when you transferred voting control.
- may have created tax issues without meaning to. Shareholders will look to obtain Business Asset Disposal Relief (Entrepreneur’s Relief before 6 April 2020) but to be eligible they must be an office holder or employee (amongst other conditions) and therefore where the sale is associated with retirement, the Relief will only be available on the first installment sale. In each case specialist tax advice should be obtained.
The buyer also has a risk in being caught in mid-stream. The Companies Act contains a ‘squeeze out’ procedure which applies where a takeover is made to all the shareholders (of each class) in the target company. It can be used where the buyer already holds shares in the target company, but the qualifying condition requires 90% acceptance from the shareholders holding shares subject to the offer. In other words, even if the buyer held 90% of the shares at the time of the offer, it would need 90% acceptance from the remaining 10% shareholders to avail itself of the squeeze out mechanism. In the absence of a watertight agreement, the buyer cannot compel the stub shareholders to sell their remaining shares and even as minority shareholders they have rights to be treated fairly as between all the shareholders.
Retain shares with ‘stub share’ arrangements
So, are there any circumstances where stub shares are an appropriate part of the deal structure? It is a common structure in a number of European countries for whom a part and part buy out is a pre-requisite to doing the deal, the logic being that the stub shareholders leave their shares at risk in case there are any issues that emerge post completion (of the first part deal). It may also be appropriate where there is a genuine joint venture aspect to the arrangement and in effect the buyer is an investor with the investment taking (in part) the form in part purchase of shares.
In every case, the parties will need a shareholders agreement or carefully created articles to recognise their joint shareholding and the same sorts of issues as arise on shareholders such as management arrangements and controls, share issues, share transfers (see separate articles for more detail) will need to be considered. In addition, specific consideration will be needed to avoid the risks of being caught in mid-stream including a right for the seller and the buyer to complete the buy out process.
Specialist merger & acquisition legal advice
If you are looking to find out more about stub share arrangements including the process and implications, we have the technical expertise and breadth of experience to help. To discuss your situation with a specialist mergers & acquisitions team please call 0117 906 9400 or email firstname.lastname@example.org