Shareholder Agreements and their impact on value

Shareholders Agreement - Virtus Group LLP

Once a buy-sell provision is triggered in a unanimous shareholders agreement (USA), the valuation clauses in that agreement (which have usually been ignored for years) may lead to unintended financial outcomes for all parties.

Careful consideration when preparing (or revising) the shareholder agreement can better reflect the shareholders’ intentions as well as provide useful instruction and guidance to the valuator to avoid misinterpretation.

How will price/value be determined?

There are a few valuation mechanisms commonly seen in shareholder agreements to determine the value of the subject shares. While they each have their limitations, three widely used valuation mechanisms for determining the value of shares are the fixed price method, a shotgun clause, and a predetermined valuation formula.   

Fixed price method

A fixed price method is where price is agreed on or negotiated in advance by the shareholders and is intended to be updated regularly, usually on an annual basis. This method is simple, easy to understand and inexpensive to adopt.

Unfortunately, this method is usually impractical due to the difficulty in getting the shareholders to agree and update the share price each year. It must be updated frequently to be useful, otherwise it will not reflect the actual value of the shares at the time of a shareholder exit.

Shotgun clause

A shotgun clause is where one shareholder of the corporation offers to purchase the shares from another shareholder, and the shareholder receiving the offer must either accept the offer or alternatively acquire the shares from the offering shareholder at the same terms and price as those offered.

This can result in inequities where one shareholder has access to significantly greater financial resources or is more actively involved with the business and thus has better insight into the operations and future prospects.

Valuation formulas

A third mechanism is the use of predetermined valuation formulas based on a multiple of historical reported earnings, sales or book value. The difficulty with this approach is that business values are influenced by both internal and external factors and a formula cannot reflect all the variables necessary to be considered for an accurate result.

Formulas are backwards facing, are based on historical figures, and a static multiple may not be reflective of future profits and growth, competitive pressures and the overall economic conditions facing the company at the transaction date. For example, one may not want to be stuck buying out a partner’s interest in a travel agency or cruise line during the COVID-19 pandemic in May 2020 based on the 2019 year end results and a multiple agreed on in 1998.

A more accurate alternative to choosing between imperfect options discussed above is to require that a valuation report be completed by a Chartered Business Valuator that can resolve the above challenges and provide an impartial assessment of value that takes into account all the relevant factors. The shareholder agreement can further stipulate the agreed-on firm who will complete the valuation where a triggering event occurs.

Which definition of value to use?

Fair Value vs. Fair Market Value

The terms “Fair Value” and “Fair Market Value” almost appear to be interchangeable, but can have significantly different value implications.

The value standard most frequently applied in notional market valuations is Fair Market Value (FMV), defined by the CBV Institute as follows:

The highest price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

“Fair Value”, while not specifically defined in any of the corporation acts, has generally been interpreted by the Canadian Courts to mean fair market value without the application of a discount that would otherwise be applied to a minority shareholding.

Fair Value is more commonly used in the context of family law or in shareholder dispute cases involving minority shareholder oppression remedies.

Fair Market Value - man holding FAIR blocks with money

Dealing with Life Insurance proceeds

In the event of a death of a shareholder, life insurance proceeds are commonly used to fund an acquisition of the deceased’s interest. The question arises – Should these proceeds also be considered part of the company’s value?

The amounts are often very significant and if excluded, can result in a considerable benefit to a surviving shareholder. The shareholder agreement should clarify the shareholders’ intent with respect to how these proceeds are to be accounted for when determining business value.

Another consideration is whether the proper amount of insurance is put in place. Too much insurance relative to the business value means over-spending on premiums. More commonly seen insurance coverage issues arise as the business has continued to increase in value and the current coverage may no longer be sufficient to finance an acquisition of the deceased’s interest.

Impact of a Departing Shareholder

Not everyone contributes equally to the business. And in many cases, one shareholder’s involvement is largely tied to the business’ success. So what happens when “Rainmaker Roger” retires – do I have to buy out his shares based on the level of profits generated by the business while he’s still here? Or should the business valuator instead consider the negative impact of Roger’s departure to the business when determining the fair market value of his shares?

As you can imagine, this is much easier to agree on in advance when forming the agreement, instead of at the timing of the departure.

Minority Discounts

A partial ownership interest may be worth less than its proportional ownership in the entire business. This is due to the fact that a minority shareholder does not have the same rights and privileges as a majority shareholder.

A minority shareholder is disadvantaged in that they may have little to no influence on the direction of the company, nor on the return on their investment (i.e. dividends, wages) and may be restricted in their ability to sell their shares as they wish. Due to these restrictions a theoretical investor is generally only willing to purchase these minority shares at a discount from pro-rata value, often referred to as a “minority discount”.

Depending on the circumstances, a minority discount may range anywhere from 10% – 50% (or more). Determining the appropriate discount to apply is based on a large number of factors and can be a fairly subjective exercise.

The terms of the shareholder agreement should be explicit as to whether this discount should be considered, and in what circumstances.


In conclusion, contemplating many of the above issues when drafting a USA can assist in better reflecting the intentions of the shareholders and also help avoid unintended financial outcomes. Certain simplified or mechanical approaches in setting value such as a formula may initially be appealing but as business and economic circumstances change over time, they can quickly become irrelevant and not reflective of the current market realities.

The value implications of the provisions within a shareholder agreement can be significant, and a Chartered Business Valuator can be useful in providing assistance with these issues.

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