We regularly meet with minority shareholders because they feel blocked within their own company: they want to sell their shares, but without an external buyer they cannot exit at a price they consider right. Regularly, the feeling of “stuckness” turns into resentment, which gradually evolves into an open conflict of shareholders. This usually causes the conflict to escalate, frustrations mount and sometimes this will also damage the company.
In order to avoid such situations, the possibility of setting up a micro-liquidity mechanism should be examined. This mechanism should be compared to a kind of ‘internal’ stock exchange, which allows shares to be exchanged for short periods of time and under conditions that are determined in a similar manner from year to year. This is to ensure the continuity and longer-term commitment of the remaining shareholders.
In concrete terms, such a mechanism implies that a valuation of the company is carried out on a regular basis (annually or every two years) after the financial statements have been recorded and approved by the management board and the general meeting. The outcome of the valuation is determined under the supervision of the board and then transparently communicated to the shareholders. The value may serve as the basis for a transaction between shareholders during a predetermined period and according to a predetermined procedure. If no shareholder is willing to accept an offer of shares, a mechanism can be envisaged whereby it will ultimately be the company (i.e. all remaining shareholders) that acquires the shares by means of a buyback program.
This usually involves applying a limited illiquidity discount to compensate the remaining shareholders.
A micro-liquidity mechanism should be compared to a kind of internal exchange, which allows shares to be exchanged for short periods of time and under pre-determined conditions.
Then the company can decide what to do with these shares: keep them, put them up for sale to other shareholders in the following financial years, work out a share plan for the management or staff, or destroy them.
When the company buys its own shares, the other shareholders’ share in the capital is increased. It is therefore also a good deal for the other shareholders.
Microliquidity mechanisms are not suitable for every type of enterprise and certain conditions must be met.
In order to set up such a mechanism, however, it is required to simultaneously impose the necessary restrictions (e.g. a maximum percentage of shares) because this can only work in practice if the company also has the necessary liquidity or means of financing to buy back the shares. Delayed payments can also be provided for, so that the exiting shareholder also indirectly provides a solution for financing.
If several shareholders choose to sell their shares and the predetermined limit is exceeded, they may only sell their shares up to their respective pro rata share of the limit.
A liquidity mechanism can only function properly if there is sufficient liquidity or the necessary means of financing.
Furthermore, to set up a micro-liquidity mechanism, it is preferable that the company already has excess liquidity so that it can buy back its shares without restricting its growth and further plans.
It is also easier to set up such a mechanism in a business with substantial and predictable cash flows. In this context, real estate companies often provide the perfect framework for the introduction of such mechanisms.
We notice that in companies that have set up a micro liquidity mechanism, shareholders are happier and ultimately less inclined to leave. After all, they receive regular valuations and can therefore measure whether there is value creation. It is a paradox: because one knows one can exit, one is less inclined to do so because there is more transparency about the evolution of the underlying value.
The regular valuation exercises also enable the management to better explain the value creation of investments to shareholders.
Would you like more information on setting up a micro-liquidity mechanism? Feel free to contact Bernard Thuyasbaert.