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Shareholder Disputes: Common Causes & Solutions

Shareholder Disputes: Common Causes & Solutions

Partnership, director, and shareholder disputes are an unpleasant fact of life in business. Resolution of such disputes is a common motive for seeking a business valuation; since many shareholder disputes involve company or share value, dividend distributions, and compensation, a comprehensive valuation is often necessary to support or defend the positions of each side.

The ideal, of course, is to avoid disputes between shareholders altogether. Many companies attempt to avoid disputes with well-crafted shareholder agreements, which stipulate how disagreements among shareholders will be resolved. But even if the dispute doesn’t escalate to litigation, a business appraisal may be necessary to settle the disagreement.

In this article, we’ll examine some of the common reasons for shareholder disputes and how they can be avoided; we’ll also discuss what to look for in an independent valuation specialist should a valuation be needed to resolve the issue.

Common Causes Of Shareholder Disputes

Disputes between shareholders can arise for a variety of reasons. The following are the most common:

  1. Disagreements over business direction: This type of dispute is common in small, closely-held private businesses. Disagreements over the management or direction of the company; expenditures; or reorganization, sale, or closure of the business can give rise to disputes between shareholders.
  2. Violation of shareholder agreements: Breeches of shareholder agreements may occur when one shareholder seeks to terminate the agreement against the wishes of other shareholders, or sells their shares in violation of the agreement.
  3. Fiduciary mismanagement or malfeasance: In privately-held companies, shareholders have fiduciary responsibilities to other shareholders, even if they aren’t employed by the business. Shareholders are expected to be open and honest with one another about the financials of the business, especially in the case of majority shareholders dealing with minority shareholders. Disputes can arise when some shareholders withhold financial or other important information from others.
  4. Inequities in compensation or contributions: Employees who are shareholders should be compensated according to their training, education, experience, and the norms for the industry and job role. Particularly in family-owned businesses, when employees who are family members are paid at differing rates than other shareholder employees in comparable roles, disputes can arise. Another source of conflict can result from disparity in the financial or work contributions of shareholders, if one shareholder is perceived to be carrying a less-than-equitable share of the load.
  5. Minority shareholders disadvantaged by majority shareholder decisions: In private companies, minority shareholders start from a position of disadvantage because they have fewer shares than majority shareholders and may have little leverage in seeking changes in the business. Many states recognize this disadvantage and have laws that protect minority shareholders, who are vulnerable to being shut out of management and decision-making.

Because shares in a private company may not be easily marketable to others, minority shareholders might find their investment tied up as a result of the desires of majority owners, who may be looking out for their own interests without considering the interests of minority owners. Disputes can arise over a failure to issue dividends, the use of company money for family expenses, or failure to allow minority stockholders to inspect financial records or other documents.

Need a business valuation to settle a shareholder dispute? Download our free Business Valuation Checklist to learn what information is required to calculate an accurate value.

Avoiding & Resolving Shareholder Disputes

As mentioned in the introduction, many companies include shareholder agreements as part of their partnership agreements or articles of incorporation/association, to stipulate how shareholder disputes will be resolved.

While these agreements cannot guarantee that issues will not arise, when carefully drafted, they present a road map for dispute resolution. Including employment agreements (for shareholding employees) and buy/sell agreements in the shareholder agreement ensures that each shareholder understands his or her rights and responsibilities, which can further reduce the likelihood of disputes.

If a dispute does arise in spite of these precautions, or there is a shareholder dispute deadlock, mediation should be the first route attempted to resolve the issue. In mediation, all parties may participate in reaching an amicable resolution. When the dispute cannot be settled through mediation, arbitration is the second best option—but this puts the outcome in the hands of a third party, which may not be acceptable to one or both of the parties. If neither mediation or arbitration settles the dispute, litigation is the final option. This is the least favorable way to settle the dispute, since both sides are likely to incur large legal bills, and again, a third party (the judge) will be the one to determine the outcome.

The Role Of Valuation In Settling Disputes Between Shareholders

Whether a shareholder dispute is settled via mediation, arbitration, or litigation, a business appraisal is likely to be necessary.

Disagreements among shareholders often have a financial motivation or component—one party perceives they are being treated unfairly, either because their investment or work is not being properly compensated, or because someone else is taking more than their fair share of the profits or assets of the business. In cases where a dispute arises over a difference of opinion in company operation or direction, the objecting shareholder may choose to leave and sell his or her share of the business.

Regardless of the reason, before there can be a settlement, the value of the business and shares must be determined. For this reason, most shareholder agreements include a right of appraisal in the event of a dispute.

In cases of director, partnership, and shareholder disputes, it’s important to have an independent, credentialed valuation expert assess the value of the business. Certified business appraisers are required to follow the uniform standards of professional appraisal practice (USPAP), which stipulate the ethical and performance standards for the appraisal profession in the United States. Failure to abide by these guidelines can result in the loss of certification.

Having a certified valuation professional evaluate the company assures both sides in the dispute that the valuation will be a fair assessment that does not give preference to the interests of either party. A valuation expert with ASA (American Society of Appraisers) credentials who has experience in valuing private businesses will probably be the best fit. This will assure all parties that the determination of value is both reasonable and defensible.

Need a valuation of your business to settle a shareholder dispute?

Valentiam has helped companies in a variety of industries to attain accurate enterprise and asset valuations. We have extensive experience in performing valuations to settle shareholder disputes, and our team includes ASA-certified valuation professionals. Our valuation and transfer pricing specialists have worked with some of the largest companies in the world.

Contact us to see how we can help your company with its valuation needs.

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Topics: Business valuation