Going into business with another person or group of people can be a remarkably rewarding experience. However, it can also have its challenges.
Shareholder deadlock is a common problem for limited companies set up and running with more than one shareholder. In this article, we explain what a shareholder deadlock is and then look at the steps you can take to prevent it from happening in your company.
What is a shareholder deadlock?
All significant decisions in a limited company require a vote of the company’s shareholders, most of which need a majority vote to be passed. A deadlock occurs when shareholders cannot make a decision; an impasse has been reached.
This can leave a company in a state of stasis. The business may be able to continue, but progress might be stunted.
The problem is compounded when shareholders are also directors (as they often are in small companies), as grievances can seep into the boardroom, leading to further issues.
Typically, a shareholder deadlock occurs when a company has two shareholders, each holding 50% of the company’s shares and having equal voting rights. However, the problem can also exist if a company has several shareholders.
Not every 50/50 vote is a shareholder deadlock
It is important to understand that a decision is made by shareholders whenever there is a vote and a motion is not passed – that is, the required % of votes required to pass the motion has not been reached. The decision, in this case, is to not proceed with the proposal.
For example, looking at an ordinary resolution, more than 50% of votes must be cast in favour of a motion for it to pass. If two people vote, one for and one against, the motion can not be put through; not enough votes favour it. This is a valid result.
When this happens, hopefully, the shareholders will be able to agree to disagree, respect the outcome of the vote and continue to work together for the company’s betterment.
The term ‘shareholder deadlock’ applies when shareholders consistently follow the same voting pattern to intentionally neutralise other shareholders’ votes. As this would suggest, they are generally the result of a breakdown in a working relationship.
Let’s look at some examples that could be considered deadlock situations if Shareholder A has fallen out with the other shareholder(s):
Example 1
A company has two shareholders. Shareholder A has one share with one vote. Shareholder B also has one share with one vote.
The shareholders are voting on whether to remove a director from the company. An ordinary resolution typically needs to be passed to remove a director, and so more than 50% of all votes must be cast in favour of the motion.
Shareholder A votes in favour of the resolution, and Shareholder B votes against it. The motion cannot be passed.
If the two regularly vote against each other to nullify the other’s vote, this would be a deadlock situation.
Example 2
A company has three shareholders: Shareholders A, B and C. Shareholder A has 74 shares, each with one vote attached. Shareholder B has 25 shares, each with one vote attached. Shareholder C has 1 share, with 1 vote attached.
The shareholders are voting on whether to change the company’s articles of association (the document that outlines how the company should be operated). A special resolution typically needs to be passed to update the document, so at least 75% of all votes must be cast in favour of the motion.
Shareholder A votes in favour of the resolution, and Shareholders B and C vote against it. This results in a 74/26 split, not enough to pass the motion.
If Shareholders B and C regularly vote against Shareholder A to nullify their vote, this would be a deadlock situation.
How you can prevent shareholder deadlock in your company
Now that we’ve explained shareholder deadlock, let’s look at ways to prevent it from happening in your company.
1. Choose your business partners wisely
Setting up a company with someone else has advantages and disadvantages.
More people mean more skills in business, pressures can be shared, and you have companionship through the good and bad times. On the other hand, with a partner, you won’t always have complete autonomy, financial rewards must be shared, and – pertinently to this article – there is always a potential for conflict.
Regarding this final point, you should be extremely careful about who you go into business with. Whether it’s a friend, family member, colleague, or new business contact, you must weigh up their personality to gauge if they would be a suitable business partner.
If an individual possesses traits that indicate they would be a tricky collaborator, you should steer clear, or at least bring in another partner accommodating to these characteristics. Otherwise, you are likely to find yourself in a deadlock situation.
2. Consider how shares are allocated
As this article highlights, how you allocate company shares can have serious repercussions. Because of this, it’s important to carefully consider the share split in the company and the voting rights attached to the shares.
If there are only two shareholders, rather than opting for a simple 50/50 split, consider whether this is a true reflection of how the business will operate. Is one shareholder going to contribute more? Would a 51/49 arrangement be more suitable?
Or, if it is a genuine split down-the-middle arrangement, could you devise a compromise whereby voting rights are not attached to all shares, and a shareholder is given priority to dividends to compensate for this?
If you can reach an alternative to having a 50/50 split, we recommend exploring this, as it will help you avoid shareholder deadlock.
3. Appoint a chairperson and give them a casting vote
Companies can give the chairperson of a general meeting a casting vote. This means that, in the event of a deadlock at a general meeting, the chairperson can swing a resolution one way or another. The one requirement here is that the chairperson must also be a shareholder of the company, as only shareholders are allowed to vote on a resolution.
In addition to providing this casting vote, you might choose to alternate the chairperson on a regular basis, to ensure fairness in the use of this voting power.
4. Use a shareholders’ agreement
While not compulsory, a shareholders’ agreement should be seen as a fundamental piece of documentation for companies running with more than one shareholder. A good agreement will cover many aspects of how the shareholders should work together, including what happens if a shareholder deadlock arises.
Common provisions that deal with deadlock that are often included in the shareholders’ agreement include:
- Russian roulette: A shareholder must sell their shares at a price of their choosing, but if the other shareholder(s) refuse said offer, the shareholder must buy them out at the same price.
- Texas shootout: Shareholders make sealed bids for each other’s shares to a third party, with the highest bidder having to buy the shares at that price.
- Company buyback – this allows a company (not the shareholders) to buy back shares from a shareholder (as a result of a deadlock) at no cost to the remaining shareholder(s).
As you can see, the provisions are more concerned with making it easier for shareholders to sell their shares and leave a company than preventing a deadlock. However, by having these in place, the hope is that shareholders will be more accommodating and act to avoid a deadlock in the first place.
So, there you have it
We hope you now have a thorough understanding of shareholder deadlock and how to prevent it from happening in your limited company. Please leave a comment if you have any questions, and we’ll get back to you as soon as possible. Thanks for reading.
