“We own half each. Neither of us can do anything.”
A 50/50 shareholding can seem like the fairest possible arrangement when two founders establish a business together.
Each founder has an equal financial interest. Neither controls the other. Major decisions are made jointly.
While the relationship is good, the structure can work perfectly.
The difficulty arises when the founders fundamentally disagree about the future of the company.
Without a properly drafted shareholders’ agreement or deadlock mechanism, an equal shareholding can leave a successful company effectively paralysed — with neither shareholder having sufficient voting power to break the impasse.
For a valuable and profitable business, a 50/50 shareholder deadlock can quickly become one of the most commercially damaging forms of shareholder dispute.
Consider the following scenario.
Two friends establish an Irish software company.
Each owns 50% of the shares and both are directors.
When the business is established, the founders decide not to enter into a shareholders’ agreement. They trust each other, share the same ambitions and consider formal deadlock provisions unnecessary.
Four years later, the position is very different.
The company has grown substantially and is now worth several million euro.
One founder believes the company should accept outside investment, recruit aggressively and expand internationally.
The other has a fundamentally different strategy.
He wants the company to remain independent, consolidate its existing position and begin distributing more of its profits to the shareholders.
Both positions may be commercially legitimate.
But neither founder can outvote the other.
As the disagreement continues, the relationship deteriorates.
Board meetings become increasingly confrontational and eventually almost impossible to conduct effectively.
Important recruitment decisions are blocked.
A new annual budget cannot be approved.
Strategic investment decisions stall.
Certain banking arrangements require approval from both directors, creating further operational difficulties.
Employees become aware of the disagreement between the founders and uncertainty begins to affect the business.
The company remains profitable.
But it is becoming increasingly difficult to manage.
Then the situation becomes even more complicated.
One founder receives an attractive offer from a competitor to purchase his 50% shareholding.
The other founder refuses to approve or facilitate the proposed transaction.
The business is successful, valuable and profitable — but the two people who own it cannot agree about its future.
They have reached a classic 50/50 shareholder deadlock.
A shareholder deadlock generally arises where shareholders with equal or blocking voting power cannot agree on decisions necessary for the company to operate or progress.
In a 50/50 company, neither shareholder necessarily has the voting strength to impose their preferred solution on the other.
The problem can be even more acute where the two shareholders are also the company’s only directors.
Important decisions may therefore become blocked at both shareholder and board level.
Deadlock can affect matters including:
Unlike a conventional majority/minority shareholder dispute, there may be no controlling shareholder capable of breaking the impasse.
This is often the wrong question.
In the example above, neither founder’s commercial strategy is necessarily unreasonable.
One wants investment and international expansion.
The other wants independence and increased profit distributions.
The underlying problem is not necessarily that one shareholder is legally or commercially wrong.
The problem is that the company’s ownership and governance structure contains no effective mechanism for deciding what happens when the founders fundamentally disagree.
That distinction can be crucial when considering how a shareholder deadlock should be resolved.
There is no single solution appropriate to every deadlocked company.
The available options will depend on the company’s constitution, any contractual arrangements between the shareholders, the conduct of the parties, the financial position of the company and whether either shareholder ultimately wants to leave the business.
Potential solutions can include the following.
Frequently, the most commercially practical solution is for one shareholder to acquire the other’s shares.
However, that creates another question:
What is 50% of the company actually worth?
The shareholders may disagree significantly about valuation, particularly where one founder believes the company has substantial future growth potential.
Independent valuation evidence or an agreed expert valuation process can help overcome this problem.
A negotiated buyout can also address payment terms, warranties, restrictive covenants, intellectual property, director resignations and the release of personal guarantees.
Mediation in shareholder disputes can provide a confidential environment in which the founders explore solutions that may not be available through litigation.
This can be particularly valuable where the business itself remains commercially successful and both shareholders have an incentive to preserve its value.
A mediator does not simply have to determine which founder’s business strategy is preferable.
Instead, the process can focus on finding a commercially workable separation or governance solution.
Depending on how the shareholders behave once the relationship deteriorates, issues concerning shareholder oppression under Section 212 of the Companies Act 2014 may potentially arise.
A genuine disagreement about commercial strategy does not automatically amount to oppression.
However, the position can become more complicated if one shareholder begins using company powers or resources in a manner alleged to be oppressive or in disregard of the other shareholder’s interests.
The conduct of the parties during the deadlock can therefore materially affect the legal options available.
In serious cases, consideration may ultimately be given to whether an application to wind up the company on the just and equitable ground is available.
For a profitable company worth several million euro, winding up may appear commercially unattractive.
That is precisely why shareholder deadlock can be so difficult.
The business itself may be successful. The problem is the relationship between the people who control it.
The possibility of winding up can nevertheless become highly significant where the breakdown in the relationship is fundamental and there is no realistic mechanism for resolving the impasse.
Legal advice should be obtained on the specific circumstances before contemplating such a step.
A founder who wants to leave may assume they can simply sell their 50% shareholding to a third party.
The position can be more complicated.
The company’s constitution and any contractual arrangements between the shareholders may contain share transfer restrictions, pre-emption rights or approval requirements.
A third-party purchaser may also be reluctant to acquire 50% of a private company knowing that the remaining 50% is owned by a shareholder with whom relations have already broken down.
This can substantially affect the commercial reality of a proposed sale.
In our scenario, the competitor’s offer does not necessarily resolve the deadlock.
Instead, it creates another issue for the shareholders to fight about.
The best time to decide how a shareholder deadlock will be resolved is before there is a deadlock.
A properly drafted shareholders’ agreement for a 50/50 company can contain a staged process for resolving disagreements.
That might include:
The agreement can define what constitutes a deadlock and require the founders to follow a structured escalation procedure before either side can pursue more drastic remedies.
A mandatory mediation stage can require the shareholders to attempt a negotiated resolution with an independent mediator.
Certain technical or financial disputes may be referred to an independent accountant, valuer or industry expert for determination.
This can be useful where the disagreement concerns a specific issue rather than the entire future of the business.
A shareholders’ agreement can also contain mechanisms designed to bring a deadlock to an end by allowing one shareholder ultimately to buy the other out.
Depending on how the agreement is structured, these are sometimes described as Russian roulette clauses or Texas shoot-out provisions.
The precise mechanics matter enormously.
A mechanism that appears fair where both shareholders have similar financial resources can produce a very different outcome where one founder has substantially greater access to capital.
Carefully drafted put and call options can provide circumstances in which one shareholder may require another to buy, or sell, shares according to an agreed process.
The agreement should also identify which decisions genuinely require unanimous approval.
If every operational decision requires agreement between both founders, deadlock becomes much more likely.
Well-designed reserved matters provisions distinguish genuinely fundamental decisions from ordinary management decisions.
When a shareholder deadlock results in one founder leaving, valuation can become the central commercial issue.
Questions may arise about:
For a technology company, intellectual property and anticipated growth can make valuation particularly contentious.
A difference in valuation methodology can translate into a very substantial difference in the price paid for a 50% shareholding.
Where a founder dispute becomes contentious, relevant evidence can include:
In founder disputes, the history of the relationship can be particularly important.
Informal arrangements that worked perfectly when the founders trusted each other can become major areas of disagreement once that relationship has broken down.
A 50/50 shareholding is not inherently a bad corporate structure.
Many highly successful companies are established and operated on that basis.
The danger is a 50/50 company with no effective deadlock mechanism.
When establishing a business, founders understandably focus on the opportunity ahead rather than what might happen if they eventually disagree.
That is precisely when a shareholders’ agreement is easiest to negotiate.
Once both founders believe they are right and the company is worth several million euro, agreeing the rules for resolving a deadlock becomes considerably more difficult.
Sherwin O’Riordan Solicitors advises founders, directors, shareholders and companies in Dublin and throughout Ireland on complex shareholder and corporate disputes.
Our work includes 50/50 shareholder deadlocks, founder disputes, shareholder buyouts, Section 212 oppression claims, director disputes, company control disputes, share valuation issues and disputes arising from shareholders’ agreements.
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