Would you be happy for your co-directors to resign from work but still hold shares in your company?

If yes- don't read on…

In most small and medium businesses, some or all of the directors are also the shareholders of the company. A point that is often missed is that shareholding and directorship are two distinct legal capacities with different rights and obligations attached to each in law.

Think of this scenario

Two of you set up a company together and you work around the clock. You both own 50% of company and you are both directors of the company receiving an equal salary. Your co-shareholder (Gerard) is married to an American who just had a fantastic offer to be a Hedge Fund advisor in LA. After much deliberation they decided to take the opportunity and make the move. Gerard has therefore resigns from his director's role in the company, informing you he will be leaving in 60 days.

Clearly Gerard will not be entitled to receive his salary after resignation. Five years later you successfully manage to sell the company for £3m, a great reward for all your hard work.

During these five years, unless stipulated otherwise in the Articles or in the Shareholders Agreement, Gerard remains a 50% shareholder in the company: he is entitled to vote, receive dividends and 50% of the £3m sale proceeds!

Directors/shareholders of most small and medium businesses would not be happy to have their business partner resign from their job in the company but still be entitled to be a company shareholder.

How to avoid such a scenario

It is quite astonishing how so many shareholders agreements I see totally ignore this crucial point!

To avoid such position, it is important that your Shareholders Agreement clearly stipulates that termination of directorship triggers provisions dealing with the termination/ sale of the resigning director's shareholding. The provisions need to stipulate that if the relevant shareholder no longer operates as a director for any reason whatsoever, then the termination of the Shareholders Agreement will apply.

Good / Bad Leavers Provisions

You can also include "Bad Leaver"/"Good Leaver" provisions. In a nutshell, these provisions stipulate that, on departure, the shares of the departing shareholder will be bought by you/the company/ an agreed 3rd party at market value, unless the relevant person is a bad leaver. An extreme example would be, say, your co-shareholder got caught with "her hand in the till". In such a case she would be a bad leaver only entitled to the nominal value of her shares (e.g. £1 each).

It is VERY difficult to get all these provisions in place once the relevant shareholder decides to resign. Like always, there is no time like the present!