SME entrepreneurs regularly sell their business (partially) to investors, including private equity (PE) parties. In practice, this often means that the entrepreneur does not exit completely, but "rolls over": he buys back a minority share.
After the acquisition, the PE party then keeps the majority of the shares and the entrepreneur still a small(er) percentage. We also often see that the entrepreneur stays on (for some time) as a director.
This raises important legal concerns, such as how is the entrepreneur protected as a minority shareholder and how is the director role fulfilled?
The shareholder role
If an entrepreneur sells his business to an investor and in that transaction also "rolls over" himself, i.e. will still hold some of the shares, it is essential to make good agreements about the cooperation.
The selling entrepreneur is often a minority shareholder after the transaction. That means he has less influence over what happens in and with the company. Especially if the entrepreneur is still financially involved (for example, because he provided a seller's loan or he may still have to receive a portion of the purchase price with an earn-out arrangement), it is advisable to include protective provisions for his position.
The cooperation between the investor (as majority shareholder) and the selling entrepreneur (as minority shareholder) is then usually laid down in a shareholders' agreement. Thinking from the position of the selling entrepreneur, when drafting the shareholders' agreement it is good to at least take into account the following points of interest:
- Influence on important decisions: which decisions may be taken without the minority shareholder's consent and which decisions require his consent? Consider mainly decisions that affect the existence or value of the minority shareholder's shares.
- Tag-along: a tag-along right offers the minority shareholder the protection that if the investor decides to sell his shares, he may co-sell his shares on the same terms.
- Exit agreements: how will the termination of share ownership be handled? What is the investor's investment horizon? Private equity parties often aim for an exit within a few years.
The director's role
In many cases, the selling entrepreneur stays on as a director for several years after the acquisition. This must be properly recorded not only in the shareholder agreement, but also in an employment contract or management agreement. Important points of attention here are:
- Non-competition and relationship clauses: often a non-competition and relationship clause is included in the share purchase agreement and the shareholder agreement, but it also often appears in the employment and/or management agreement. It is important to look at these critically.
- Termination: what happens if the management agreement ends and does that affect share ownership?
Conclusion
Selling an SME to a private equity investor offers opportunities, but also legal complexity. For the selling entrepreneur, it is crucial to properly arrange control and protection as a minority shareholder in the shareholder agreement and also to legally secure his position as director.
Good contractual arrangements can prevent many conflicts and uncertainties and ensure successful cooperation with the investor.
