Look before you leap!

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Published: 29 Apr 2015

The value of a share might not be all it seems

Recently, an accountant referred me to a successful sales manager; let’s call him Jo. Jo had just been appointed sales director of XYZ Ltd (XYZ). In addition to which he was offered shares in XYZ by one of the three directors, each of whom owned 10,000 ordinary £1 shares in the company. There were no other shareholders.

The price offered was £6.00 per share and the dividend history indicated that the return on investment at that price for future dividends (i.e. dividend yield) would be 15% p.a. In spite of the risks involved, that is not bad when comparing it to bank deposits (1%p.a.) and dividend yields of quoted investments (2 to 5 p.a.%).

Turnover had increased from £200,000 p.a. to over £500,000 p.a. within the space of 2 to 3 years. Being close to the figures and now on the Board, Jo thought that buying 300 shares now and similar tranches in future quarterly intervals at that price was a good offer, until I mentioned the following:-

a) From a review of the profit and loss account a low salary of £8,000 was paid to each director just to cover their personal tax allowance so that a higher amount could be paid in dividends.

Although this reduces the overall tax bill, it does not show the true managerial cost of the directors working in the business. A purchaser of the company would need to take this into account in arriving at the buying price of XYZ, by reducing the annual profits before and after tax.

b) Two of the three other directors are withdrawing from the day to day running of the business. This meant that Jo will be working on a day to day basis with one director.

So do they get on well enough to maintain the company’s success and have compatible aspirations about the company’s future direction?

c) Jo is starting off with a 1% share interest, to gradually go up over the years. As a minority shareholder, he would have little influence over the major decisions in running the company.

Consequently, if, after 6 years, Jo could not continue to work at XYZ and wished to leave, in what position would he be regarding his holding of 7,200 ordinary shares which he had now accumulated? This represents a 34.3% share interest which has cost him £43,200 and no ready market to sell the shares? Would the other director be prepared to buy for £6-00 per share, assuming the same level of dividends then as now?

In a word, Jo could be put in a difficult position if a share price could not be agreed upon. He could visit David Cane at Sundial Tax & Finance Ltd for a share valuation and his lawyers to fight the case. That is the long drawn out and possibly expensive option.

The better alternative would be to be advised by Sundial Tax & Finance Ltd and the lawyers to agree the basis of valuation of the shares and the procedures for the outgoing shareholder/directors, which can be included in a shareholders agreement from the outset. As always, money invested up front on these matters can save spending a lot more money later on.

In the event, Jo emailed to thank me for the advice and said that he is going for an “alternative option”. I did not enquire, but I guess it was a bonus scheme or monetary reward based on results. Oh for the simple life!