A shareholder can sell his or her shares at any time, without the approval of the other shareholders. However, shareholders of a privately-owned business may have agreed to certain restrictions on this right when they invested in the business. Additionally, the stock market takes a dim view of shareholders who also work in a business suddenly dumping a whole lot of shares without having a compelling reason to do so. You can find details of directors' dealings in their own shares by going to the
www.investegate.co.uk
Web site and clicking on ‘Transaction in Own Shares'.
Shareholders can either put themselves in key management positions or delegate the task of selecting top managers and officers to a
board of directors
,
which is
a small group of persons selected by the shareholders to set the business's policies and represent shareholders' interests. If you put up more than half the money in a business, you can put yourself on the board and elect yourself president of the business. The shareholders who own 50 per cent plus one share constitute the controlling group that decides who goes on the board of directors.
If you want to sell your shares, how much can you get for them? Shares in privately-owned businesses aren't publicly traded, so how can you determine the value of your shares in such a business? To be frank, you can't really. Until you actually sell your shares for a certain price per share, you simply don't know their market value for sure. On the other hand, you can use certain benchmarks, or valuation methods, to estimate market value. For example, you could look to the
book value per share
,
which is based on values reported on the business's latest balance sheet:
Total shareholders' equity ÷ total number of shares = book value per share
Book values are historical - based on the past transactions of the business - whereas market pricing looks to how the business is likely to do in the future. The past is important, but the future prospects of the business are more important in setting a value on the business. Market value depends on forecast profit performance (future earnings), which in many cases is much more important than book value per share. One way of estimating the value of your shares in a private business company is the
earnings multiple
method, in which you calculate the theoretical value of a share by using a certain multiple of the business's earnings (net income) per share.
For example, suppose a privately-owned business company earned £3.20 net income per share last year. You calculate the book value per share at the end of the year, which, let's assume, is £20. You may be able to sell your shares at ten times earnings per share, or £32 per share, which is considerably more than the book value per share. If someone paid £32 per share for the shares and the business earned £3.20, again per share, next year, the new shareholder might be satisfied to earn 10 per cent on his or her £32 investment - calculated by dividing the £3.20 earnings per share by the £32 cost of the share. (Not all of the £3.20 may be paid out as a cash dividend, so part of the 10 per cent earnings on the investment consists of the increase in retained earnings of the business.)
Keep in mind that the £32 market value is only an estimate and just a theoretical price. However, you don't know the market price until you sell the shares. As potential investors in the business, we may be willing to offer you £35 or £40 per share - or we may offer less than the book value per share.
Shareholders and managers
Shareholders (including managers who own shares in the business) are concerned, first and foremost, with the profit performance of their business. The dividends they receive, and the value of their shares, depend on profit. Managers, too, are concerned with profit - their jobs depend on living up to the business's profit goals. But even though shareholders and managers strive toward the common goal of making the business profitable, they have an inherent conflict of interest that revolves around money and power:
The more money that managers make in wages and benefits, the less shareholders see in the bottom-line net income. Shareholders obviously want the best managers for the job, but they don't want to pay any more than they have to. In many companies, top-level managers, for all practical purposes, set their own salaries and compensation packages.
The best solution is often to have outside directors (with no management position in the business) set the compensation of the top-level managers instead.
Who should control the business: the managers, who were hired for their competence and are intimately familiar with the business, or the shareholders, who probably have no experience relevant to running this particular business but who put up the money that the business is running on? In ideal situations, the two sides respect each other's importance to the business and use this tension constructively. Of course, the real world is far from ideal, and you have situations in which managers are controlling the board of directors rather than the other way around. But this book isn't the proper place to get into all that.
In particular, watch out for actions that cause a
dilution effect
on the value of your shares - that is, cause each share to drop in value. Now, the dilution effect may be the result of a good business decision, so even though your share of the business has decreased in the short term, the long-term profit performance of the business (and, therefore, your investment) may benefit. But you need to watch these decisions closely. The following situations cause a dilution effect:
