Exit clauses are vital in UK private companies, where shares are hard to sell and disputes can arise. This article explains the main types, who they protect, and how to use them to secure a fair exit or avoid deadlock.

1. What is the 5 Shareholder Rule?

The so-called “5 shareholder rule” is a phrase that pops up in UK company law and tax planning, but it’s often misunderstood. It’s not an exit clause itself, but it does influence how shares are structured and how certain rights or obligations might arise.

Technical Context:

• In UK tax law, a “close company” is one controlled by five or fewer shareholders (or by any number of directors who are also shareholders). This definition matters for things like the application of close company rules, which can affect loans to shareholders and certain tax treatments.

  
  

• For EMI (Enterprise Management Incentive) options, there are restrictions on the number of “material interest” holders, which can impact eligibility.

Why it matters for exits:
If you’re one of five or fewer significant shareholders, you may have more leverage in negotiations, but you’re also more exposed to deadlock or disputes. For example, if you’re one of five equal shareholders and two want out, the company could be paralysed if there’s no exit mechanism.

Example:
A family business with five siblings as shareholders falls out. Without clear exit clauses, any attempt to sell shares or force a buyout can become a legal and emotional quagmire.

2. Key Clauses in a Share Purchase Agreement

A Share Purchase Agreement (SPA) is the contract that governs the sale and purchase of shares in a company. The exit-related clauses in an SPA are critical for protecting both buyers and sellers, and for ensuring a clean break.

Important Exit Clauses:

• Tag-Along Rights:
  Allow minority shareholders to “tag along” and sell their shares if the majority sells theirs. This prevents them from being left behind with a new, possibly hostile, owner.
  
  

• Drag-Along Rights:
  Enable majority shareholders to “drag” minority shareholders into a sale, ensuring a buyer can acquire 100% of the company. This is vital for attracting buyers who want full control.
  
  

• Put and Call Options:
  A “put” option lets a shareholder force the company (or other shareholders) to buy their shares at a pre-agreed price or formula. A “call” option allows the company or other shareholders to force a shareholder to sell.
  
  

• Good Leaver / Bad Leaver Provisions:
  Define what happens to shares held by employees or directors who leave the company. A “good leaver” (e.g., someone who retires or is made redundant) may get fair value, while a “bad leaver” (e.g., someone dismissed for misconduct) may have to sell at nominal value.
  
  

• Deadlock Resolution Clauses:
  Mechanisms like “Russian Roulette” or “Texas Shootout” force a resolution if shareholders can’t agree, by triggering a buyout at a set or offered price.
  
  

• Pre-emption Rights:
  Give existing shareholders the first right to buy shares before they’re offered to outsiders, protecting against unwanted third parties entering the company.

Example:
A tech start-up’s SPA includes a drag-along clause requiring 75% shareholder approval to force a sale. When a US buyer offers to acquire the company, the majority triggers the clause, and the minority must sell on the same terms.

3. What Rights Does a 75% Shareholder Have?

In UK company law, holding 75% of the shares is a powerful position. It’s the threshold for passing “special resolutions,” which can fundamentally change the company’s constitution or approve a sale of the business.

Key Rights at 75%:

• Amend the Articles of Association.

• Approve a sale of the company’s assets.

• Authorise a reduction of share capital.

• Pass a drag-along clause (if not already present), though doing so after a dispute can be risky.

Risks and Legal Nuance:
A 75% shareholder can, in theory, force through major changes. However, if these actions are taken to prejudice minority shareholders—such as adding a drag-along clause specifically to force a sale after a dispute—minorities can bring an “unfair prejudice” petition under Section 994 of the Companies Act 2006. Courts have the power to unwind such actions or award compensation.

Example:
A founder with 76% of the shares wants to sell to a private equity firm. The minority objects, claiming the sale undervalues the business. If the drag-along clause is in place, the majority can force the sale, but if it’s added after the dispute, the minority may have grounds to challenge it in court.

4. What is the Exit Clause in a Shareholders’ Agreement?

An exit clause in a shareholders’ agreement is any provision that sets out how and when shareholders can leave the company, or be required to do so. These clauses are the “rules of engagement” for a corporate divorce, and their absence can leave shareholders trapped or exposed.

Types of Exit Clauses:

• Voluntary Exit: Allows a shareholder to sell their shares, often with a right of first refusal for existing shareholders (pre-emption).

• Involuntary Exit: Triggered by events such as death, incapacity, or breach of contract. The agreement may require the shareholder (or their estate) to sell their shares, sometimes at a pre-agreed valuation.

• Leaver Provisions: Specify what happens if an employee-shareholder leaves the business, distinguishing between “good” and “bad” leavers.

• Deadlock Resolution: Mechanisms to break a stalemate, such as Russian Roulette or Texas Shootout.

Example:
Two founders each own 50%. Their agreement includes a Russian Roulette clause. When they can’t agree on strategy, one triggers the clause, offering to buy the other’s shares at £10 each. The other must either accept the offer or buy out the first at the same price.

5. Persona-Driven Scenarios

The Trapped Minority:
A “friends and family” investor holds 10% of a private company. The majority sells their stake to a new owner, but there’s no tag-along right. The minority is left with an illiquid stake and no influence over the new direction.

The Ruthless Majority:
A founder with 80% wants to sell the company. The buyer insists on 100% ownership. Thanks to a drag-along clause, the founder can force the minority to sell on the same terms, ensuring the deal goes through.

The Ousted Employee:
A director with 5% equity resigns. The shareholders’ agreement defines voluntary resignation as “bad leaver” status, so the company buys back their shares at nominal value, not market value. If the director had left due to redundancy, they’d be a “good leaver” and receive fair value.

The Deadlocked Partner:
Two co-founders, each with 50%, fall out. Their agreement includes a Texas Shootout clause. One names a price per share; the other must buy or sell at that price. This forces a resolution, but the partner with less cash may be forced out.

6. Comparison Table: Which Shareholder Exit Clause Do You Need?

7. Common Pitfalls and Legal Challenges

Exit clauses are only as effective as their drafting and timing. Several pitfalls can undermine their purpose or even lead to litigation:

• Unfair Prejudice:
  If a majority shareholder introduces or amends exit clauses (like drag-along rights) after a dispute has started, minority shareholders may claim “unfair prejudice” under Section 994 of the Companies Act 2006. Courts have broad powers to grant relief, including ordering a buyout at fair value or even reversing certain actions.
  
  Example: In a family business, the majority tries to add a drag-along clause after a buyer is found. The minority challenges this as unfair, and the court sides with them, blocking the forced sale.
  
  

• Valuation Disputes:
  The definition of “fair value” is often contested. If the exit clause is vague, parties may end up in costly arguments over whether the price should include a discount for minority holdings or a premium for control.
  
  Example: A minority shareholder is forced out under a put option, but the formula is unclear. The parties end up in arbitration over whether the value should reflect recent losses or future potential.
  
  

• Enforceability:
  Clauses must be properly incorporated into the company’s Articles or Shareholders’ Agreement. If not, they may be unenforceable, especially against new shareholders who didn’t sign the agreement.
  
  Example: A drag-along right is only in a side letter, not the Articles. When the majority tries to enforce it, the minority refuses, and the clause is found unenforceable.

8. Action Steps for UK Shareholders

To avoid being caught out by these pitfalls, shareholders should take proactive steps:

• Review Existing Agreements:
  Check your Shareholders’ Agreement and Articles of Association for the presence and clarity of exit clauses. If you’re unsure, seek a plain-English summary from a trusted adviser.
  
  

• Negotiate Before Disputes Arise:
  The best time to negotiate or amend exit clauses is when relationships are good. Once a dispute starts, changes are likely to be challenged and may be struck down by the courts.
  
  

• Use Clear Valuation Formulas:
  Specify how shares will be valued—whether by an independent expert, using a set formula (e.g., EBITDA multiple), or referencing recent transactions. Avoid vague terms like “market value” without definition.
  
  

• Consider Mediation for Deadlocks:
  If you’re facing a deadlock, mediation or arbitration can sometimes resolve matters more quickly and cheaply than litigation or triggering a “nuclear” clause.

9. Templates and Tools

For those looking to strengthen their position, practical resources can make a real difference:

• Sample Clauses:
  Access templates for Tag-Along, Drag-Along, Put/Call Options, and Deadlock Resolution clauses. These should be adapted to your company’s needs and reviewed for compliance with UK law.
  
  

• Good Leaver/Bad Leaver Calculator:
  Use a calculator to estimate what you’d receive if you left the company under different scenarios—helpful for employees and founders alike.
  
  

Checklists:
A checklist for reviewing your Shareholders’ Agreement can help ensure all key protections are in place, from pre-emption rights to valuation mechanisms.

10. Final Thoughts

Exit clauses are not just for when things go wrong—they are a vital part of responsible company stewardship. They protect founders, investors, and employees alike by setting clear expectations and reducing the risk of costly, emotionally draining disputes. The absence of robust exit provisions can leave shareholders trapped, undervalued, or forced into litigation that benefits no one but the lawyers.

The best time to negotiate and clarify these clauses is at the outset, when relationships are strong and everyone’s interests are aligned. Once conflict arises, options narrow and the risk of “unfair prejudice” claims or deadlock increases sharply. For international or minority shareholders, the right exit clause can mean the difference between a fair return and being left with “paper money.”

Disclaimer: This content is for general information only and does not constitute legal, financial, or tax advice. Outcomes may vary depending on your individual circumstances.