Unless there is a prior agreement between shareholders and a company in either a shareholders agreement or a rule in a company’s articles of association, shareholders in a company may transfer shares that they own to anyone they choose. For that reason, some companies opt to include restrictions on share transfers within either of those documents.
Publicly traded companies on the New York Stock Exchange or Nasdaq issue such a large number of shares that it is normal for shares to change hands from time to time. With such a volume of shares being issued, share transfers have little effect on who controls the corporation. However, in the case of a private company or limited liability company that has fewer shares issued, a share transfer can affect the dynamics of a corporation. Since investors in private companies usually make their investments based on trust in the other shareholders, when shares are transferred to someone outside the company, it sometimes can be detrimental to the well-being of the company. To prevent this from happening, a the corporation may draft a share transfer restriction.
Offering Shares to the Company First
Some corporations draft a share transfer restriction that requires shareholders wishing to sell their shares to offer the shares back to the company itself. Under this provision, if a company is in a position to repurchase the shares, the burden of buying the shares is removed from the existing shareholders. If a company buys back the shares, then usually the repurchased shares are canceled. If company is not in a position to repurchase the shares, then a provision can be drafted in the shareholders agreement giving the remaining shareholders the right of first refusal to buy the shares, so that the shares stay in the ownership of remaining shareholders.
Minority and Majority Rights
As a company looks toward a possible future purchaser of the company, a restriction that it may want to include in the shareholders agreement is to what extent a minority shareholder should be able to stop the sale (a minority shareholder being someone who perhaps owns only 5 to 10 percent of a company’s shares). More than likely, the purchaser will want to buy all the shares and not just a majority; a minority shareholder wanting to hold on to their shares could possibly hamper the sale. To prevent situations such as this, a provision could be drafted to force the minority shareholder to sell his shares; this is often referred to as “drag along” rights. Alternatively, if the purchaser just want to purchase a majority of the shares and a minority shareholder does not want to be left out of the purchase, then a provision could be drafted that forces the majority shareholder to make sure the minority shareholder's shares are purchased along with the majority shareholder's shares; this is often referred to as “tag along” rights.
In situations where a shareholder dies, becomes mentally ill, disappears, leaves the company or declared bankrupt, a share restriction provision may be imposed. In such situations, the provision may require that the shares be offered back to the company or to the other shareholders in a corporation. A provision be implemented that requires that an appraisal be performed to determine the value of the shares being offered or have a stipulation in place that sets the value each year for these situations.