It is common to find joint shareholders in a company, at least two partners in a partnership, joint venture or other business arrangements. This article focusses on how to determine shareholding in the case of a private company or profit share in the case of other business arrangements. In companies shareholding proportions inform, inter alia, voting and dividend distribution. The determination of shareholding or profit share can easily be a deal breaker if the proportions are views as unfair, situations commonly referred to as “no deal”. Further, if the proportions are set without a meeting of the minds that can lead to future disgruntlement or even disputes.
In most cases such determination is through negotiation by the parties. Some of the factors considered during negotiations are explained hereunder.
Equal shareholding or profit share
It appears there is an explained presumption that parties should hold equal shareholding or profit share. It is about confusing equity (fairness) with equality (having the same)? Fairness does not necessarily mean equal. It depends with the circumstances of the business set up. Unfortunately, parties may simply agree to equal proportions simply for the deal to go ahead hoping to alter the situation later. It is advisable to have frank and constructive engagements in order to agree.
Influence decision making
Many shareholders prefer having control over the affairs of the company through for example voting at the company’s general meetings, appointing or removing directors, being part of the board of directors or management. For example a member may prefer holding at least 51% of the voting rights to influence ordinary resolutions or at least 75% where that threshold is required for special resolutions.
Shareholders prefer being able to appoint a certain number of directors of the company, for example at least 50% or the chairperson of the board to influence decision making.
Some shareholder may prefer holding 100% of a small business instead of a small percentage of a big one as they want it to be “their thing”.
Originator of the business idea
An originator of a business idea may want the scale tilted to his / her favour. Conversely, the one with the funding may prefer the higher scale due to the risk of losing finances in the event that failure visits.
Weaker versus stronger party
It also depends who the weaker or stronger party is in the circumstances. For example, where existing shareholders are desperate for funding they can be amenable to dilution of their effective shareholding through issue of new shares. Conversely, if a party is negotiating its way into a company or business arrangement it may be limited to what the stronger parties consider acceptable.
Better than nothing
A party to a deal may prefer having something than nothing.
Funding requirements
Shareholding may be determined after considering the following factors:
- Desired capital structure, as to debt-equity ratio,
- Amount of equity funding required,
- Capacity of the business partners to raise funding or bring capital in kind.
In most cases the one party with more financial resources usually gets the higher equity or profit share.
Non- cash contributions
Non-cash contributions considered usually include:
- Ability to attract business through networks, etc,
- Know how or specialist skill,
- Strategic partner,
- Management responsibilities though this may be compensated through salary for example.
Risk appetite
Risk appetite influences how far an investor can invest. Some investors may be averse to assuming significant risk in greenfield projects.
Investment policies
Where an investor is an institutional investor such as pension funds, insurance companies, private equity or venture capitalists, there may be desired investment thresholds as part of risk management.
Existing shareholders and goodwill
Normally existing shareholders want a business valuation to be carried out before a new investor comes on board. Such valuation may even include goodwill. The inclusion of goodwill is common in partnerships where existing partners claim credit for the brand. An incoming investor’s shareholding may therefore be limited by what he / she is able to pay to invest in the business.
Regulatory requirements
There may be regulatory limitations on the percentage shareholding an individual shareholder may hold, for example in the insurance business.
Results of rights issue
A rights issue is the issue of new shares to existing shareholders in the proportion of their current shareholding. A shareholder who fails to pay for his / her shares may be diluted.
Expected return on the investment
Naturally investors would like significant shareholding or profit share in high return businesses. Interestingly, an investor may also be willing to accept a smaller effective shareholding or profit share if the resulting dollar share of the return is meaningful.
Convertible debt
Some shareholders may lend the company and later convert debt into equity thereby increasing their shareholding.
Restricted share transfer or issue of new shares
A company’s Articles of Association, Companies and Other Entities Act (Chapter 24:31) or other applicable laws may restrict the transfer or issue of shares to third parties without the consent of the current shareholders.
Godknows Hofisi, LLB(UNISA), B.Acc(UZ), CA(Z), MBA(EBS,UK) is a legal practitioner / conveyancer, chartered accountant, corporate rescue practitioner, and consultant in deal structuring and tax. He has handled resolution of corporate disputes. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com
