Corporate Law

Owning a majority of the shares in a company may appear to give you control, but the Articles of Association can tell a very different story when a sale or exit is being considered.

A client of ours recently discovered something that unsettled her. She held 61% of the shares in her business and had done for years. She assumed that gave her control. It was only when she started thinking seriously about a sale that she asked us to check the Articles of Association properly, and the answer was not what she expected.

The Gap Between Shareholding and Control

Her Articles dated back almost a decade, to when the company was first set up. On paper, her majority stake looked simple. In practice, several provisions quietly took the decision out of her hands.

A minority matching offer clause gave the other shareholders a twenty-business-day window to put forward a rival buyer. This could have forced her to abandon the purchaser she had actually chosen and negotiated with.

A separate clause meant that any approved sale required prior board approval. With more than one director on the board, a majority of directors who were not her could, in theory, block the deal entirely.

Even if a sale did go ahead, the exit waterfall paid other investors their original capital plus a premium before anyone received a pro rata share. Her 61% of the shares therefore did not translate into 61% of the proceeds.

Why This Is More Common Than Owners Think

Articles of Association are usually adopted early, often from a generic template, at a point when a sale feels theoretical and years away.

Founders understandably focus on getting the company started rather than modelling what will happen when they eventually leave. Investors, by contrast, often consider their exit from the outset, and standard templates frequently include protections that favour minority shareholders and early investors.

The result can be a constitutional document that nobody revisits until it actually matters. By that stage, a buyer’s due diligence process is likely to identify each of these issues.

Instead of being treated as a technical footnote, problematic provisions can become leverage for a lower purchase price, create delays or provide a prospective buyer with a reason to walk away.

What We Did

We carried out a full review of the existing Articles and drafted a complete replacement set, updated to reflect how the company and its shareholders actually wanted control and proceeds to work.

This included correcting defective drafting that had developed over the years and restoring lapsed authority to allot new shares.

We also introduced a proper mechanism for a sole director, as the original Articles had assumed there would always be at least two directors in office.

Most importantly, the exit provisions were rewritten so that sale proceeds would be distributed strictly in proportion to shareholding. The minority matching offer right was removed entirely.

Securing Shareholder Approval

Changes to a company’s Articles generally require approval by at least 75% of the shareholders entitled to vote.

Our client therefore needed the support of other shareholders before the replacement Articles could be adopted.

We helped her prepare a clear explanation setting out what the other shareholders were being asked to give up, why the changes were needed and how the revised provisions would operate.

This was more effective than simply presenting shareholders with a dense legal document and expecting the drafting to speak for itself.

The Lesson for Other Owners

If you hold a majority stake in a private company and have not reviewed the Articles of Association since they were first adopted, there are three areas worth checking carefully.

• Does your shareholding percentage actually match your share of the exit proceeds, or does a waterfall provision pay another shareholder or investor first?
• Can a sale that you have negotiated be blocked by other shareholders or directors?
• Does the drag-along mechanism that is intended to allow a majority shareholder to force a sale actually work as drafted, or does it refer to provisions that have been amended or no longer exist?

These are not questions worth waiting for a prospective buyer to raise. They are usually much cheaper and easier to address before negotiations begin than they are to resolve in the middle of a transaction.