This document discusses trends in share capital and shareholder agreements. It covers: 1) Tax issues facing entrepreneurs and increasing tax pressures, and how share types like flowering, waterfall, and freezer shares are used to encourage capital growth for tax benefits. 2) Common provisions in shareholder agreements for investors, employees, and joint ventures, such as reserved matters, drag-along rights, good/bad leaver clauses, and restrictive covenants. 3) Current trends in shareholder agreements including the use of SEIS/EIS, employee share schemes, pre-determined fair value buyout formulas, and provisions for mediation and privileged relations.

1. Issues and trends in share capital
By Catherine Gannon and Helen Curtis of
Gannons Solicitors

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Agenda
1. Tax treatment of private companies and entrepreneurs
2. Trending share types: it is all about growth!
3. Trends for investors, employees and joint ventures
4. Effect of tax on Shareholders’ Agreements design: prohibited matters, restrictive covenants etc.

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By Catherine Gannon, CTA, Solicitor
Tax makes ordinary shares
class(y)

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Increasing tax pressures on successful entrepreneurs
SUSPECT
Name: Fred Smith
Age: 55
Occupation: entrepreneur and SME owner
Salary: £150k
Dividends: £100k
Other: small property portfolio
Activities: subscribed for shares @£1, sells for £1m

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Increasing tax pressures on successful entrepreneurs
SENTENCE
•No personal allowance because income over £120k
•Additional rate taxpayer: income @ 45%
•Only £5k dividend allowance a year
•High tax rate on dividends (38.1% in 2016)
•Entrepreneur’s relief @10% but the lifetime limit might be decreased
•Interest on buy to let no longer deductible
•Pressure to recruit and retain talent
•Maxed out pension

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Tax lessons for entrepreneurs
• All about capital growth! Focus on exit
• Use capital instead of income whenever possible to use 10% entrepreneurs’ relief
• Creative ideas emerging

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Share classes that encourage growth
 Flowering shares
 Waterfall shares
 Freezer shares
 Shares for employees

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Summary of why capital growth is attractive
• Capital assessed to CGT where the highest rate of tax is 28% and there is no NI
• If you qualify for entrepreneurs' relief rate of CGT is 10% on gains of up to £10 million (lifetime
allowance)
• Three basic rules
• 5% of share capital (exception is EMI)
• Voting rights
• Employed/director for 12 months pre-sale

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Freezing share rights – drafting ideas
1.1 On a return of assets following a Liquidation or otherwise the surplus assets of the
Company remaining after payment of all of its liabilities (“Surplus Assets”) shall be distributed pari
passu between the holders of the A Ordinary Shares and the B Ordinary Shares (as if the same
constituted one class of share, pro rata based on each holder’s respective holding).
1.2 The C Ordinary Shares and D Ordinary Shares shall not give rise to a right to Surplus Assets
upon Liquidation unless the Value before payment of all of the Company’s liabilities is at or exceeds
the Threshold.
1.3 In the event that the C Ordinary Shares and the D Ordinary Shares do not give rise to a
right to Surplus Assets there is a compulsory transfer.

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Waterfall shares - drafting
On a return of assets or a sale the surplus assets of the Company remaining after payment of all its
liabilities (“Surplus Assets”) shall be distributed in the following order of priority
(a) First, but only where such Surplus Assets shall exceed £5,000,000, each holder of A Ordinary
Shares shall be entitled to 25% of all such Surplus Assets for each A Ordinary share held by him, in
preference to any amount paid to any holder of the Series B shares, Series C shares and Series D
shares,
(b) Second,
(i) where Gross Proceeds shall exceed £10,000 only, each holder of A1 Ordinary Shares shall be
entitled to 0.25% of all Surplus Assets for each A1 Ordinary Share held by him, and
(ii) where Gross Proceeds shall exceed £20,000,000 only, each holder of A1 Ordinary Shares shall be
entitled to a further 0.125% of all Surplus Assets for each A1 Ordinary share held by him
(c) Third, or first in the event that such Surplus Assets shall not exceed £5,000,000, the holders of the
X shares shall be entitled to be paid an amount equal to the Subscription Price for their X shares
etc

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Employee Share Schemes & Share Options
Awarding equity to employees:
•Tax efficient (nil or 10% CGT)
•Improves business performance
•Improves employee motivation
•Competition already does it!

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Employee Share Schemes & Share Options
Awarding equity to employees:
Statistics:
•In 2013-14, the total value of shares and options awarded was around £3.45bn, 21% higher than in
2012-13.
•There were 4,000 total companies granting options or shares in schemes in 2013-14.
•The number of companies operating share schemes has continued to grow to 11,460 companies in
2013-14.

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Impact on dividends
• New dividend tax allowance from April 2016 free £5,000 a year
• Expect big dividends before April 2016
• Structure dividend pay out >£5,000 and work towards exit
• Sale or voluntary winding up – HMRC will deny entrepreneurs' relief on cash balances in excess of
trading requirements

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By Helen Curtis, Solicitor
Current Trends – Main themes
for investors

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Introduction

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Trends in Shareholder’s Agreement
• Investor trends
• Employee Shareholder trends
• Joint Venture trends

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Investors
• SEIS/EIS
Tax efficient but cannot be preference shares
• SEIS/EIS compliant
Undertaking that the Company will remain SEIS or EIS compliant

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Investors
• Reserved matters
Shareholder threshold vs board representative
• Drag-along rights
Risk of joint and several liability

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Investors
• Employee Incentives
Excluded from pre-emption protections

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Investors
• Behaviour
Information requirements
Reporting requirements
• Warranties
Share Purchase Agreement vs no warranties

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Employees
• Good Leavers/Bad Leavers
Incentive to stay
Administrative burden if employees leave
• Pre-determined Fair Value
Traditionally used external valuer
Pre-agreed formula based on EBITDA

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Employees
• Employment expert
Barrister or Solicitor of x years experience
• Power of attorney
To effect share transfer if employee absent

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Employees
• Restrictive covenants
Usually longer periods permissible than in Employment Agreements
• ESS shares
Particular issues for the new Employee Shareholder status

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Joint Venture
• Mediation Provisions
Position without Shareholders’ Agreement
Alternatives to mediation
• Privileged Relations
More extensive definitions to include new family structures

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Thank you!