Disagreements between partners, directors, and shareholders are an unavoidable part of doing business. The resolution of such conflicts is a common reason for requesting a business valuation; because many shareholder disputes include company or share value, dividend payouts, and remuneration, a thorough valuation is sometimes required to support or defend each side’s position. Of course, the ideal situation is to avoid all shareholder disagreements. Many businesses try to avoid conflicts by drafting shareholder agreements that spell out how differences among owners will be settled. Even if the dispute does not progress to litigation, a business evaluation may be required to resolve the conflict.. We’ll look at some of the most typical causes of shareholder conflicts and how to avoid them in this article, as well as what to look for in an independent valuation specialist if a valuation is required to address the issue.
Common Causes Of Shareholder Disputes
Shareholder disagreements can emerge for a variety of reasons. The most popular are as follows:
- Disagreements over business direction: This type of dispute is common in small, closely-held private businesses. Disagreements over the management or direction of the company; expenditures; or reorganization, sale, or closure of the business can give rise to disputes between shareholders.
- Violation of shareholder agreements: Breeches of shareholder agreements may occur when one shareholder seeks to terminate the agreement against the wishes of other shareholders, or sells their shares in violation of the agreement.
- Fiduciary mismanagement or malfeasance: In privately-held companies, shareholders have fiduciary responsibilities to other shareholders, even if they aren’t employed by the business. Shareholders are expected to be open and honest with one another about the financials of the business, especially in the case of majority shareholders dealing with minority shareholders. Disputes can arise when some shareholders withhold financial or other important information from others.
- Inequities in compensation or contributions: Employees who are shareholders should be compensated according to their training, education, experience, and the norms for the industry and job role. Particularly in family-owned businesses, when employees who are family members are paid at differing rates than other shareholder employees in comparable roles, disputes can arise. Another source of conflict can result from disparity in the financial or work contributions of shareholders, if one shareholder is perceived to be carrying a less-than-equitable share of the load.
- Minority shareholders disadvantaged by majority shareholder decisions: In private companies, minority shareholders start from a position of disadvantage because they have fewer shares than majority shareholders and may have little leverage in seeking changes in the business. Many states recognize this disadvantage and have laws that protect minority shareholders, who are vulnerable to being shut out of management and decision-making.
Minority shareholders may find their investment tied up as a result of the desires of majority owners, who may be looking out for their own interests without considering the interests of minority owners, because shares in a private company may not be easily marketable to others. Failure to pay dividends, the use of company funds for personal needs, or the refusal to enable minority owners to see financial records or other papers can all lead to disagreements.
Avoiding & Resolving Shareholder Disputes
Many firms incorporate shareholder agreements as part of their partnership agreements or articles of incorporation/association, as noted in the introduction, to specify how shareholder disputes would be settled.
While these agreements cannot ensure that conflicts will not arise, they do provide a roadmap for dispute resolution when they are well designed. Incorporating employment agreements (for shareholding employees) and buy/sell agreements within the shareholder agreement ensures that each stakeholder is aware of his or her rights and duties, potentially reducing the risk of disagreements.
If a conflict arises despite these measures, or if a shareholder dispute has reached a stalemate, mediation should be the first step in resolving the matter. All parties may participate in mediation to seek an equitable resolution. When mediation fails to resolve a dispute, arbitration is the next best option—but it puts the decision in the hands of a third party, who may or may not be acceptable to one or both parties. If neither mediation nor arbitration succeeds in resolving the conflict, lawsuit is the last resort. This is the least desirable method of resolving the disagreement because both parties are likely to pay significant legal costs, and a third party is involved once again (the judge) will be the one to determine the outcome.
The Role Of Valuation In Settling Disputes Between Shareholders
A company appraisal is likely to be required whether a shareholder disagreement is resolved by mediation, arbitration, or litigation.
Shareholder disagreements frequently have a financial motivation or component—one party believes they are being treated unfairly, either because their investment or work is not being adequately compensated, or because someone else is taking more than their fair share of the company’s profits or assets. When a disagreement emerges over the operation or direction of the firm, the objecting shareholder may opt to leave and sell his or her stake of the company.
Whatever the reason, the worth of the business and shares must be established before a settlement can be reached. As a result, most shareholder agreements incorporate an appraisal right in the event of a disagreement.
It’s critical to have an impartial, certified valuation specialist estimate the value of the business in cases of director, partnership, and shareholder disputes. Certified business appraisers must adhere to the uniform standards of professional appraisal practice (USPAP), which define the appraisal profession’s ethical and performance requirements in the United States. If you don’t follow these rules, you risk losing your certification.
Having a certified valuation professional evaluate the company assures both sides in the dispute that the valuation will be a fair assessment that does not give preference to the interests of either party. A valuation expert with ASA (American Society of Appraisers) credentials who has experience in valuing private businesses will probably be the best fit. This will assure all parties that the determination of value is both reasonable and defensible.
Need a valuation of your business to settle a shareholder dispute?
Taqeem has helped companies in a variety of industries to attain accurate enterprise and asset valuations. We have extensive experience in performing valuations to settle shareholder disputes, and our team includes ASA-certified valuation professionals. Our valuation and transfer pricing specialists have worked with some of the largest companies in the world.
Contact us to see how we can help your company with its valuation needs.