Twitter Logo Youtube Circle Icon LinkedIn Icon

What are some of the risks inherent in making changes to the structure of share capital?

September 2019 - Corporate & Commercial. Legal Developments by IR Global.

More articles by this firm.

The following article discusses session two in the IR Global Virtual Series on ' Redistributing Share Capital - Considerations for family-owned enterprises

Brazil - LJ The legal puzzle around maintaining control may include the following considerations.

Should the company have only one class of shares or multiple classes, with different economic and/or voting rights, and should the controlling block be organised in one or more holdings through a shareholders’ agreement.

They must also consider the major economic and political powers that the shareholder(s) cannot compromise, plus the risks that they will not take, and the level of protection inherent in this structure.

Rules around conflict of interests, transactions with related parties and corporate governance in shareholders´ agreements or memorandum and articles should also be included.

In the latter situation there should be a thought about whether the management functions can be reinforced. The involvement of the shareholders in the management or board of directors should also be considered. The application of remedies and conflict resolution methods concerning these shareholders and the company, is important.

Poland - RL Most family members insist on keeping control over the enterprise after taking on a minor shareholder or a minor partner. They are interested in limiting the rights and powers of a new investor, however, there is always some risk of losing control, for instance in the case of the enterprise being indebted or via a hostile takeover through redemption of shares.

Control will be ensured through signing family favourable investment agreements (partner agreements or shareholder agreements in addition to their formation agreements) between family members. The new investor will be kept away from key issues involving the running and development of the enterprise.

This can be done by limiting casting votes attributed to shares/interests offered to a new investor and not allowing a new investor to be involved in decision making process.

In such circumstances the new investor is limited to a passive position. They are vested with rather poor rights and powers. This may be wish of family members, however, new investors usually try to gain more influence over business, leading to tensions and disputes within the negotiating process.

Mexico - JC While the steps required for a share reorganisation may seem simple, a great deal of effort is required to manage communications regarding governance changes. For family businesses, in particular, shareholder communication is critical to ensure that there is buy-in and everybody ends up where they intended. It is important that shareholders understand the impact in terms of board seats, voting rights, preference, subordination and dividends vs. interest payments.

For many family businesses, there is also an emotional aspect if the reorganisation results in ownership differences between various family members.

Those who pursue a share reorganisation must understand that if a company gives away stock, and the only difference in the stock is voting rights, all shareholders have the equal right to participate in the firm’s profits. Thus, owners must decide whether they are ready to give up a percentage of ownership in the company, even if through non-voting rights. In short, in most shareholder reorganisations, all shareholders have shared economic interests whether they hold voting or non-voting rights.

In family-owned companies, it is now more common for the family to be very involved in the board and committee meetings and to structure the family protocol to minimise the risk of a loss of control or a hostile takeover. They may also set up internal family rules to negotiate any dispute between Them.

England - AC Company law in England and Wales provides protections for minority shareholders who start to acquire rights once they own a least 5 per cent of the company’s shareholding.

However, in order to make meaningful changes to the structure of the company, you need to own at least 50 per cent of the shares. To force through some fundamental changes to the company’s constitution, you need to hold or control at least 75 per cent of the shares. The easiest way to ensure that the family retains control, is to make sure not to offer more than 24 per cent to minority shareholders. The family should also strongly consider putting in place a shareholders’ agreement governing rights that attach to the shareholdings. They should also consider whether they offer the minority shareholders a different class of share with different rights attached to them.

Hostile takeovers tend to be less of an issue for small private companies, as the minority shareholder would need to get enough of the other shareholders on side in order to force through changes to the structure of the company.

Disputes between family members, however, can be more common, and can cause major issues in running the business effectively. Most decisions of the company are made by the directors, and so if key family members also act as directors and fall out, this can prevent day-to-day decisions being made. In family companies, the shareholders and directors are often the same, and so if there is a dispute it is normally difficult to get agreement to remove a director.

There is no specific provision within company law in England to deal with a difference of opinion in relation to the strategy of a company. The running of the company is undertaken by the directors, and if the shareholders have a difference of opinion regarding strategy their most powerful remedy is to seek to remove the director. If the dispute is between directors, then they will need to reach a commercial conclusion.

UAE - TP In the UAE we have different kinds of companies. We have a company set up in the Free Zone and a company which is set up on the mainland. The difference is that Free Zone companies can be 100 per cent owned by foreigners, while mainland companies must be 51 per cent owned by a local Emirati entity or individual.

In the case of a mainland company the best thing in order to mitigate the risk is to have a shareholder agreement in place. Typically, the shareholder agreement takes care of the key governance issues and makes sure that the shares are pledged in favour of the investors and the local partner should release power of attorney. You should make sure that during the process of the incorporation of the company, the profits are distributed between the partners in a different proportion. For example, in Dubai the minimum that can be allocated to the local Emirati partner is 20 per cent of the profit.

A similar solution is suitable for the free zone companies. Since the free zone authorities are more or less like an administrative authority (i.e. they don't take any decisions with a direct impact on the company structure or business), any dispute between partners is to be prevented or solved in the articles of incorporation or with appropriate shareholder agreements.

Court proceedings should always be avoided and in our experience, we see that shareholders’ agreements are the proper tool to prevent and mitigate any risks during the life of the company. If you don't have unanimous consent, you will be forced to go to court and get an order from the court.

We had a case, where a client was holding 95 per cent of the shares in a company in a Free Zone of UAE. The other 5 per cent was in the name of an Indian individual who was also the manager of the company. The majority owner was not able to change the manager because unanimous consent was required.

Usually the shareholder agreement has to take into account different aspects of the business. What we need specifically is that the local partner is holding the shares on behalf and in trust for the investor. This should ensure correct profit distribution and make sure that there's a proper governance structure in place.

These are the elements that we will usually take into account when we have to deal with this kind of situation.

Finland - TK I would say that in all cases shareholders’ agreements are relevant. Beyond this, according to Finnish law it is possible that the bylaws/articles of the company contain conditions, especially redemption and consent clauses, that can help to manage these things. Also, class of stock may affect to proceeding when making changes to capital structure.

France - BP If a family-owned company opens its share capital, the new shareholders will ask for some rights. This might include asking to participate on the board of directors, or access to specific information on the management of the company, or its turnover.

There are some risks for the company in these requests. The first one is that there will be new directors within the company as well as new shareholders. It means that the management of the company may become more complicated, so it has to be a serious consideration.

The second point is that if there are people who are investing in the family-owned company, there is a risk of indiscretion as regards the information disclosed by the company to the new shareholders or to the new directors.

The members of the family will lose a part of the control of their company and they have to accept this. People are not going to invest in the company without getting some rights and control of its management. This is true even if they do not want to be involved directly in the management of the company.

Sometimes in France, it happens that new investors take advantage of some dispute which may exist between family members. They might side with one group of family members against the other group, just to get a majority control of the French company together with the first group. At the end of the day, they are able to take over the whole company because all the members of the family prefer to sell their shares to these new investors, rather than to keep on fighting each other.

If the dispute doesn't go as far as the sale of the company, there can be a dispute regarding the strategy of the company.

This may happen between the members of the family and the new investors who may have different point of views. It is necessary to take into consideration this possible dispute and how it would be solved.

It can be possible to mitigate the risk by using different types of shares. Investors can then invest in the share capital of the company, but their voting rights can be reduced, so they will not be proportional to their shareholding. This may also be done through a shareholders’ agreement, where the members of the family may have some priority rights.

We also need to consider the needs of the members of the family, not only from a business perspective, but also their private needs. If, for instance, we realise that one minority shareholder member of the family needs cash to buy a flat, or to help his children, this shareholder will look to find a solution. This might include selling shares to a new investor.

U.S - California - JF We have seen clients who have started up new businesses and had some success. When they are ready for the next stage, they will come to us and ask about taking on investors.

At that point we have a very serious talk with them about what the implications of that are. They've been running that business as their own private business, but now they're going to have minority owners. There's a huge risk to them if they don't understand the implications of bringing on investors. The investors will want things from them, such as information, control and accountability.

In the transactions in which we are involved, there is very significant risk of serious regulatory liability when investors are taken on. If they don't follow all of the requirements for disclosure under securities law, for example, the original owners could face serious liabilities.

U.S - California - SG If you discussing a family group, versus unrelated parties, the analysis is different, but even within a family group, the older generation often wants to retain control. A fairly common strategy for us is to use voting and non-voting interests. This is fairly easy to do and very often the tax consequences are relatively benign.

U.S - Texas - DL In a capital transaction, you've usually got a minority shareholder with leverage. You would be specifically negotiating voting rights and voting control over certain issues.

I would list that in three different ways. Voting control over certain issues, securing the investment by terms of the contract and then mandatory distribution, so that the majority can't prevent the distribution of profits.

When Marcus raised the issue of employees being given interest, it would be exactly the opposite here. The majority are trying to make sure that those employees do not have the right to control decisions.

Germany - MS It’s also important to define what a minority shareholder is. I would say it's a shareholder with less than 25 per cent of the voting rights. In Germany, this individual would not have a veto right, and they could not oppose a shareholders’ resolution. The majority, holding 75 per cent or more, has the control regarding resolutions in the shareholders’ meetings.

We do, however, quite often have a problem with minority shareholders regarding controlling rights and we see minority shareholders making things hard for the managing director and majority shareholder. They can ask thousands of questions regarding the management decisions, or why resolutions were made in a certain way. We also have a lot of problems with the invitation to a shareholders’ meeting. A minority shareholder can say that he has not received the letter of invitation and that there is a material mistake. You cannot avoid these risks.

U.S - Texas - DL In Germany you can contract that right though I believe. A new investor can contract the right to veto a decision?

Germany - MS Yes, that's possible.

U.S - California - JF In the US, there are ways for sellers to deal with it limiting interference from the investors, if you have the leverage.

One way is to sell a different class of shares limiting the minority owner’s ability to interfere with the ongoing operation.

That's one mechanism that can be used if the original owner of the company has all the power and leverage.

If they don't have that kind of leverage, then it's absolutely true that the investor is going to dictate terms that will give them the power to create trouble, because they want to protect their minority investment.


John R. Colter-Carswell (JC) Colter Carswell & Asociados, S.C. – Mexico

Lavinia Junqueira (LJ) Tudisco, Rodrigues & Junqueira – Brazil

Markus Steinmetz (MS) Endemann Schmidt – Germany

Alex Canham (AC) Herrington Carmichael – England

Bruno Pichard (BP) Pichard & Associés – France

John Friedemann (JF) Friedemann Goldberg LLP – U.S – California

Steven M. Goldberg (SG) Friedemann Goldberg LLP – U.S – California

Tuomo Kauttu (TK) Aliant - Finland – Finland

Thomas Paoletti (TP) Paoletti Legal Consultant – UAE

Donald R. Looper (DL) Looper Goodwine P.C. – U.S – Texas

Robert Lewandowski (RL) DLP Dr Lewandowski & Partners. – Poland