Why successful partnerships also need an exit plan

Many entrepreneurs implicitly assume that a shareholder who wishes to exit will simply be able to sell their shares. In practice, things are often less straightforward. Imagine, for example, three entrepreneurs who founded a company together. After ten years, one of them decides to pursue a new venture. Or consider a brother and sister who own shares in a family business, where one of them wishes to invest their wealth elsewhere. In such situations, who will buy the shares?

A pre-emption right does not necessarily solve this problem. It merely gives existing shareholders the first opportunity to acquire the shares if a buyer has been found. It does not create a buyer.

Particularly in the case of minority shareholdings, family businesses, or privately held companies, finding an external party willing to acquire shares can be challenging.

That is precisely why it makes sense to think about shareholder exit mechanisms from the very beginning.

When entrepreneurs hear the term “exit arrangement”, they often immediately think of shareholders disputes. While these mechanisms can certainly be useful when relationships become strained, they are just as relevant in many other situations.

A shareholder reaches retirement age. An entrepreneur wants to scale back their activities. A family member no longer wishes to remain involved in the family business. Or a shareholder wants to realise part of their investment in order to finance another project.

In all these cases, a well-designed exit mechanism can prevent uncertainty, lengthy discussions, and unnecessary tensions.

A call option gives a shareholder the right to purchase another shareholder’s shares when a pre-agreed event occurs.

A put option works in the opposite direction. It gives a shareholder the right to sell their shares to one or more other shareholders who have previously agreed to purchase them under certain circumstances. A simple example illustrates how this works.

Assume two entrepreneurs, who each own 50% of the shares and are both actively involved in the business. They may agree that if one of them steps down from their operational role, the other shareholder has the right to acquire their shares through a call option. Conversely, they may agree that a shareholder who retires has the right to require the other shareholder to purchase their shares through a put option. Such arrangements create clarity in advance and reduce the need to search for an external buyer when a shareholder wishes to leave.

These mechanisms are often combined with so-called good leaver / bad leaver provisions.

A shareholder who leaves due to circumstances such as retirement or permanent disability will generally be considered a good leaver and will receive the full economic value of their shares. By contrast, a bad leaver, for example a shareholder who commits fraud or seriously breaches their contractual obligations, may be required to sell their shares at a discounted value.

This allows the company to discourage undesirable behaviour while ensuring that loyal shareholders are treated fairly.

A less widely known, but often very interesting, solution is the creation of an internal market for shares. The concept is straightforward.

At predetermined intervals, for example annually or every three years, shareholders are given the opportunity to indicate whether they wish to sell part of their shareholding. The remaining shareholders are then given the opportunity to acquire those shares. If there is insufficient demand, the company itself may be allowed to repurchase the shares, subject of course to the limitations imposed by applicable law. An internal market effectively creates a periodic liquidity event for shareholders.

Consider a family business owned by four siblings. Two of them work actively in the business, while the other two do not. After several years, one of the non-active shareholders wishes to sell part of their stake. An internal market allows this to happen in a structured and controlled manner, without the immediate need to find an external purchaser.

Particularly for larger family businesses or companies with a broad shareholder base, this can be an extremely valuable mechanism.

An exit mechanism is only as effective as its practical implementation. Several questions therefore deserve particular attention.

When can the mechanism be uses?

Can a shareholder exit at any time? Or is this only possible in specific circumstances, such as retirement, death, disability, or after a minimum holding period?

Who must or may purchase the shares?

Do the remaining shareholders merely have a right to purchase the shares, or are they under an obligation to do so? Can the company intervene if no shareholder is interested?

How will the price be determined?

In practice, the biggest disputes rarely concern whether a shareholder may exit, but rather at what price.

It is therefore crucial to agree in advance on a valuation methodology. This may include:

• A predetermined valuation formula;
• An EBITDA-multiple;
• A valuation by an independent expert; or
• A combintation of different valuation methods.

How will the purchase be financed?

Even if a pricing mechanism exists, or the parties agree on a value, the acquisition still needs to be financed. A deferred payment arrangement, often referred to as a vendor loan, may provide part of the solution. In practice, however, parties frequently examine to what extent the transaction can be financed through the underlying business itself.

Does the arrangement fit the company?

What works well for a fast-growing company backed by external investors may not be appropriate for a third-generation family business.

A good exit mechanism should reflect the company’s shareholder structure, its financial capacity, the financial position of the shareholders involved, and their long-term objectives. It should also create certainty not only for the shareholder wishing to leave, but equally for the shareholders who remain and for the company itself.

Entrepreneurs rightly devote significant attention to how they will work together. Equally important, however, is considering how a shareholder can exit that relationship in the future.

A carefully designed exit arrangement not only provides a solution when shareholders grow apart, but also creates clarity when someone retires, wishes to pursue new opportunities, or simply decides to take a different path.

That is precisely why the question “How can a shareholder eventually exit?” deserves the same attention as the question “How will we work together?”

Because good governance is not only about the start of a business relationship. It is also about having a clear and fair framework for bringing that relationship to an end when the time comes.

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