Shareholders’ agreements often seek to address the imbalance between shareholders holding a majority of shares, and those with a minority. But what about where two shareholders each hold 50% of the shares?

Whilst day-to-day decision making of a company is handled by its board of directors, certain matters need to be considered by shareholders. If there are only two shareholders, and each of them hold 50% of the shares, the key question that shareholders should consider when drafting a shareholders’ agreement is what happens if there is deadlock between them.

There are various ways to deal with a deadlock which will see the company continuing or will provide a way for an exit or termination. Below are some typical mechanisms used to address this issue (and sometimes we see combinations of these mechanisms in the one agreement).

• Controlling vote:  One shareholder has a controlling vote in a deadlock. Often this is done by allowing that shareholder to have a casting vote or being allowed to appoint two directors. But this is not ideal for the other shareholder, and possibly defeats the whole purpose of a 50-50 arrangement. Therefore, this mechanism is less likely to be seen.

• Independent third party:  Any deadlock could be referred to an independent third expert to review – acting as mediator (trying to facilitate an agreed resolution) or arbitrator (who determines the outcome). Whilst this can ensure the dispute is resolved, the expert may not have specific knowledge of the business so the final decision may not be in the interests of either party.

• A shoot-out:  Under this process, one shareholder notifies the other that it wishes to sell its shares to the other at a certain price. The other shareholder must then elect to accept that offer or to sell its own shares to the shareholder who sent the notice at the same given price. This mechanism provides an opportunity for the business to continue by forcing an exit of one shareholder. It also has the advantage that the buy-out price is determined by the ultimate buyer, rather than by way of an independent valuation.

• Sealed bids:  Each shareholder submits to an independent person a price which it is prepared to pay to buy the other’s shares. The independent person then reviews the sealed bids and decides which of them represents the best offer. One of the shareholders is required to accept the best offer. Again, the upside to this method is that the price is within the control of the bidders as opposed to being independently valued. But this can also favour one party over the other, e.g. if one of them has greater financial resources. Further, given the element of chance involved, it may be not attractive to shareholders.

• Buy-out:  One shareholder is obliged to buy-out the other in the event of a deadlock. This requires agreement up front as to the price, or the formula to calculate that price, based on the company’s valuation. This requires one shareholder to agree up front to buy-out the other . Most shareholders will be reluctant to commit to this based on a future unknown valuation. The upside is there is a guaranteed buy-out by a shareholder, even if the price is unknown at the point of signing up. That gives assurance that the business can proceed without being wound up.

• Winding up:   Sometimes shareholders’ agreements include a mechanism that ultimately provides for the company to be wound up if a shareholder dispute cannot be resolved and it affects the company’s ability to continue operating as a going concern. This is the nuclear option which can act as a commercial incentive to bring disputing parties to the table.

• Go silent:  Finally, it is an option to simply remain silent on the matter of deadlock. None of the above options represents a silver bullet and can lead to outcomes that neither is happy with. The alternative is always to negotiate at the time or wind up the company even where no specific wind-up provision applies.

Round up

Having a deadlock-resolution mechanism in the shareholders’ agreement ensures shareholders are more likely to avoid a scenario where one shareholder effectively holds the other to ransom using the threat of winding up – and that mechanism can always be overridden if the parties agree.

Shareholders also need to decide when the mechanism is triggered. It is usual that shareholders and directors don’t always reach unanimity on key decisions, but disagreements may not be so significant that it impacts the future relationship and/or the viability of the business. The agreement should be clear when a deadlock is so material that the mechanism should be used.

Finally, you may need to consider how the company’s governance could change in the future, e.g. if further shares are issued or a new director appointed.  This may mean the potential deadlock disappears overnight – even a small shareholder or a single new director may be able to swing the balance of power in a way which may not be intended.  So, before you agree to a new shareholder or director, think about whether you need to revisit the shareholders’ agreement.

Give us a bell if you are setting up a 50-50 owned company.  Our corporate team can chat through your options to work out what is the best fit for you.