Tuomo Kauttu participates in the IR Global Commercial Virtual Series – Redistributing Share Capital: Considerations for family-owned enterprises
Foreward
According to the World Bank, there are more than 160 million privately-owned small and medium-sized enterprises in the world employing more than 500 million people.
Many of these businesses are family-owned, with tightly held shareholdings. They are very often well-established companies where control has been maintained by a small of group of individuals since inception.
In an increasingly demanding economic environment there are a myriad of new challenges facing family-owned business models, ranging from the threat of advancing technology to succession planning for younger generations with different aspirations than their parents.
Opening up share capital to third parties is often a difficult, but necessary step to free up capital for investment, or to offer incentives to existing employees. It may also be done in order to attract talented individuals as part of a succession plan, or to lock in reliable suppliers or customers. Releasing value for owners, or generational estate and tax planning are other reasons.
According to a 2019 survey of US family businesses, conducted by an international consultancy firm; 47 per cent of firms surveyed are planning to bring in outside expertise to help them run their company, while 39 per cent expect to merge with another company within the next two years. More than a third of firm’s said they were open to bringing in private equity (PE) to help fund their business and the report noted that PE houses are renewing their focus on the family-business sector, carving out specialist teams to do this.
What are some of the common reasons that private enterprises might take on minority shareholders?
Minority owners realising value, is not one of the most common reasons to open the share capital of a company in my experience. Realising the value of whole stock is much more common.
It’s difficult to find buyers who are prepared to pay the real price of the real value of a minority share of the company. Family companies are operated differently than public companies or private companies that are not family owned.
Generally, buyers don’t think that owning minority shares has a real value. If the firm is operated by the majority shareholders, it means you really don’t need such shares. In most cases buyers gain higher profit by investing in other kinds of companies.
There are many cases just around shareholder agreements. It is not common for owners to realise the value of their shares by selling shares to outsiders, if that is a minority share of the company.
It is a totally different situation when we are discussing financing the growth or expansion of the company. It’s much more common to distribute shares to outsiders to get capital or equity in the company. In many cases, those outsiders who are intending to contribute equity to the company attribute a different value to such shares than the owner.
There are many tools, investors can use to protect their ownership in the case that the shares are distributed by the company in exchange for equity, in comparison to the situation in which the shareholder is realising his or her minority shares’ value.
Generally, owners can protect their ownership and power by shareholder agreement, class of stock, and redemption and consent clauses in by-laws/articles of the company in addition to similar conditions in shareholder agreement. Naturally, an investor has much more influence to all of such tools when the shares are distributed by the company due to need of capital rather than sold directly by minority shareholder. Similarly, the existing shareholders can improve their rights against new shareholders, depending on the negotiation power on both sides.
There are also some other relevant reasons for opening share capital, including tax planning. In some case in this is why the family owners are obtaining minority shareholders. Generational shift or transition to immediate family or a third-party due to retirement is also a reason, as is expansion into foreign countries.
What are some of the risks inherent in making changes to the structure of share capital? How can clients legally ensure they retain control within the family? Any examples?
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.
How can professional advisors smooth the process and ensure the redistribution happens efficiently and achieves its goals? Any examples?
Shareholder agreements are always relevant, as are articles/bylaws of the company. In that sense, it’s possible to have a redemption condition in articles or bylaws that can be used in the same way as share classes, for instance voting rights.