Gavin Poole looks at a way business owners and shareholders can prevent dilution of their shareholdings when a partner wants to exit.
Those fortunate enough to attend the 2016 Cornwall Business Awards at the St. Mellion International Resort will recall the speech of the charismatic sauce-man and entrepreneur Levi Roots, who charmed dragons – Peter Jones and Richard Farleigh – to invest in his tangy, homemade Reggae Reggae Sauce. On the night of the awards, and based on the experience Levi had had when Richard Farleigh wanted to exit from the Reggae Reggae business, he highly recommended pre-emption rights to the audience.
What are pre-emption rights?
In simple terms, pre-emption rights are rights of first refusal. They can arise on the allotment, transfer or transmission of shares and can be used to great effect to protect shareholders against dilution of their shareholdings. In the simplest form this would take the structure of: “If you want to sell your shares, you must first offer to sell them to me.”
In most cases a lot of time and care is spent by a business and business owner in developing and protecting an investment. A lack of pre-emption rights could allow some of that investment to dissipate to third parties and disrupt the best laid plans.
Typically (and in the context of shareholder agreements) pre-emption rights can be used to great effect by family businesses and small businesses. As was the case for Levi, if a shareholder (Richard Farleigh) wishes to leave the business, without a pre-emption right, that shareholder would be able to sell the shares on the open market (and introduce a new, and unknown, dynamic into the company).
Except in rare cases, pre-emption rights do not automatically arise and as such shareholders should draw up an agreement that makes very clear how the pre-emption rights arise, the procedures to be taken in order to obtain a proper valuation of the assets and time periods in which the beneficiary of the pre-emption rights should exercise that right. Failure to exercise the pre-emption right within the requisite timetable should usually allow the exiting shareholder to sell shares on the open market.
In the Reggae Reggae case, the pre-emption right meant that Levi had the opportunity to acquire the shares back from Richard Farleigh. With the growth of his business (now valued at £60 million), Levi now has a greater interest than he might otherwise have had were it not for those rights.
The evening was a great reminder of two things. Firstly, the fantastic and varied businesses we have in the region – it was a great celebration. Secondly, it was a pleasure to have such an advocate on the value of legal arrangements, how they can impact on business and the lives of business owners.
Gavin Poole is a partner in the corporate team at Stephens Scown who are ranked top in the South West for SME/Owner-managed Businesses by Chambers and Partners, UK guide to the legal profession. If you have any queries then please do contact Gavin on 01872 265100, by email firstname.lastname@example.org.