Case Study - preference shares in a family business

In this case study, we look at a simple but effective way to use preference shares to reward key employees and family members.

Our client sought our advice on how to achieve the goal of using the company’s excess profits to reward the managing director and the company’s owner’s three grown children. He had taken tax advice and discussed the tax situation of his children with them, as well as taking into account various other factors. He decided that each of the holders of the preference shares would receive a monthly preferential dividend at a level that suited their personal tax situation.

Challenges

The challenges to be addressed included:

• Shareholder Rights - the intention was to get a dividend to certain key people, however, by giving out shares, the sole shareholder/director needed to put in place certain safeguards to protect his control of the company, keep the administration of the company simple, and to ensure that in the event of, say, a sale, that he could control the transaction. The solution was to create preferential shares as a new class of shares that had the following rights:

a. non-voting;

b. no rights on winding up;

c. the payment of a fixed amount as a dividend payable from the profits of the company.

• Shareholders Agreement versus Call Options over the Preferential Shares - we discussed with the client whether there should be a Shareholders Agreement or a Call Option over the preference shares. The client decided that a Call Option would be more appropriate given that he wanted a simple structure in place that could be removed relatively easily if, for example, the company no longer had the profits to support the preferential dividend. In addition, as the preference shares didn’t have any voting rights then a Shareholders Agreement was not appropriate.

• Trigger Events for the Call Options - we discussed whether the trigger event for the exercise of the Call Option for the managing director should be good/bad leaver provisions to determine the value of the shares on departure, and we also discussed how to treat the shares in the event of a sale of the company. The client decided that if the managing director left the company (for whatever reason), or there was a sale of the company, then the Call Option could be triggered. The rational for this was that the sole purpose of the preference shares was to give the managing director a monthly dividend while active in the company. Equally, there wouldn’t be a trigger event for the children’s Call Option such that the company could exercise it at any time and buy their shares for £1.00.

• Documentation for the Preference Shares - in order to implement the proposed structure, we prepared the following:

a. Board minute – issue of preference shares;

b. Shareholders resolution – issue of preference shares and pre-emption rights;

c. Call Option for the preference shares held by the managing director;

d. Call Option for the preference shares held by each of the children;

e. Amend the company’s Articles to set out the rights of the preference shares.

Impact

The use of preference shares was the right solution to the circumstances of the company owner. The solution was simple and effective, and cost effective in terms of professional fees.

Disclaimer: this case study is not legal advice. If you require legal advice on the subject matter then please don’t hesitate to contact us. We don’t provide tax advice, if you require tax advice then please discuss with your tax adviser.