Legal Briefing: Selling Shareholders’ Interests
The shareholder agreement is usually an agreement made among friends, relatives and people who are talking directly to each other rather than through their respective attorneys.
In the alarm industry the goodwill should encompass the alarm contracts and the recurring monthly revenue required to be paid pursuant to those contracts. Image: Jirapong/stock.adobe.com
Stockholder agreements in close corporations (nonpublic and generally shares held by small number of shareholders, more than two and fewer than 35, typically) will commonly address the sale of a shareholder’s interest in the corporation. (A discussion of an interest in an LLC would be similar.)
A sale of the interest can arise in several ways:
- disability
- death
- unable to meet capital calls (if required in the shareholder agreement)
- voluntary withdrawal; retirement
- involuntary withdrawal; age requirement in shareholder’s agreement or forced out by remaining shareholders
The shareholder agreement will typically have a formula to calculate the selling price; the value of the selling shares. It’s common to fall back on established accounting principles that will account for capital contribution, assets, liabilities, all of which are calculable by an accountant. The calculation may or may not include a calculation for “goodwill,” which includes, among other things, reputation, brand, intellectual property and commercial secrets. All of those factors lend themselves to subjective evaluation and, thusly, lead to disagreement.
In the alarm industry the goodwill should encompass the alarm contracts and the recurring monthly revenue required to be paid pursuant to those contracts. If the business has been successful, it’s this category that is going to add the significant value to the selling price. Technically, this asset is “recurring revenue for future services,” which means the portion of a company’s revenue that is highly likely to continue in the future. This revenue is predictable, stable and can be counted on in the future with a reasonably high degree of certainty.
In the alarm industry, we refer to this revenue as RMR, because we calculate it on a monthly basis, no matter how it’s invoiced. To qualify this, RMR must be “under contract.” Predictable RMR that is not under contract has little or no value in the alarm industry.
When calculating the value of an alarm company we apply a multiple to the contracted RMR. That multiple can range from less than 18x RMR to over 40x RMR, so there is obviously a great deal of subjectivity involved in arriving at a “multiple.”
Now back to the shareholder agreement. Keep in mind that the shareholder agreement is usually an agreement made among friends, relatives and, more to the point, people who are talking directly to each other rather than through their respective attorneys. The shareholder agreement should be discussed and agreed upon by people who are friendly with each other and optimistic about the business they are about to start or memorialize their relationship in a business that is successfully operating.
If you look at the times when selling shares may arise, you can easily see that in many situations not all shareholders may be equal (e.g. age, health or differing interests). Two shareholders may be able to predict which shareholder is likely to be the one who is selling; the other, buying. Sure, it’s a gamble, but sometimes disparity makes it a better-than 50/50 bet. When that’s the case, they may have different views on how to value the selling shares.
For example, close analysis may reveal that the selling shares should be priced differently for each or at least some of the contingencies mentioned above for selling. Let’s assume the alarm business has been operated using established best practices. We would hope to get 36x RMR for this company if selling to another alarm company. But this is the selling and buyout multiple the shareholders want to use when they aren’t selling to a third party, but selling among themselves for any of the contingencies calling for a sale (e.g. disability, death).
The shareholders may want to agree that a disabled or deceased shareholder be paid based on X multiple, a shareholder who wants to retire Y multiple and a shareholder booted from the business Z multiple. Or they may not want any different calculation. A young, healthy shareholder may want a lower selling price than an older shareholder, figuring they are going to be the one buying. But that same young shareholder may be the one selling, so he wants the higher calculation. There are many scenarios that can influence how a shareholder will want to calculate the selling price.
Don’t make the mistake of delaying addressing these issues in a shareholder agreement because if the time comes when you are forced to address a buyout it’s going to be much more difficult to reach agreement at that time.
If you enjoyed this article and want to receive more valuable industry content like this, click here to sign up for our FREE digital newsletters!
About the Author
Ken Kirschenbaum, SSI Contributor
Security Sales & Integration’s “Legal Briefing” columnist Ken Kirschenbaum has been a recognized counsel to the alarm industry for 35 years and is principal of Kirschenbaum & Kirschenbaum, P.C. His team of attorneys, which includes daughter Jennifer, specialize in transactional, defense litigation, regulatory compliance and collection matters.
Related Content
Security Is Our Business, Too
For professionals who recommend, buy and install all types of electronic security equipment, a free subscription to Commercial Integrator + Security Sales & Integration is like having a consultant on call. You’ll find an ideal balance of technology and business coverage, with installation tips and techniques for products and updates on how to add to your bottom line.
A FREE subscription to the top resource for security and integration industry will prove to be invaluable.
