A voting trust is an arrangement where the voting rights of shareholders are transferred to a trustee for a specified period. The shareholders are then awarded trust certificates that provide evidence that they are beneficiaries of the trust. They also retain a beneficial interest in the company’s stock and receive all dividends and distributions of profits payable to the equity shareholders.
In some voting trust agreements, the trustee may be allowed to sell and redeem the shares. Such powers should be expressly stated in the voting trust agreement.
Purposes of a Voting Trust
There are several reasons for the existence of voting trust arrangements. They include:
1. Resolve conflicts of interest
Shareholders can use voting trusts to help resolve conflicts of interest in some functions of the company. Ordinarily, such shareholders would transfer their shares to a trustee who would then vote on their behalf at arms-length to mitigate against conflicts of interest.
The usual practice is to transfer the shares to a blind trust who has no knowledge of the holdings of the trust and has no right to intervene in voting. In such a way, there is minimal conflict of interest between the shareholders and the investments.
2. Increased shareholder voting power
When voting as individuals, shareholders exercise little power and may not perform specific functions that large shareholders can. For example, shareholders are required to hold a majority of the shares of a company in order to gain the power to call for meetings.
When the shareholders transfer their voting rights to a trust, they get more voting powers than if they voted individually. A combined voting power may enable the shareholders to undertake certain actions that they could not carry out when voting individually.
3. Prevent a hostile takeover
When a company is facing the threat of a hostile takeover, shareholders can lock up their shares in a trust. The practice deters the company from pursuing the takeover from trying to acquire a major portion of the target company shares since a large number of shares are locked up in a trust for a specific duration of time.
They will need to wait until the expiry of the voting trust period before implementing a takeover bid, and that period of time can range between two to 10 years.
Safeguard control of a company
When the promoters of a company feel that the control of the company is at risk, they can aggregate their shares in a trust. Transferring the promoters’ shares into a voting trust creates a strong voting block that may exceed any individual shareholder’s voting power. The promoters aggregate their shares to retain decision-making powers and prevent strong shareholders from taking over the control of the company.
A voting trust agreement is a contractual agreement that records the transfer of shares from a shareholder to a trustee. The agreement gives the trustee temporary control of the voting powers of the shareholders. Voting trusts are operated by the current directors of the company to prevent third parties from gaining control of the company without their (the directors) involvement. A voting trust agreement is most commonly used by shareholders to create unified voting blocks.
In the United States, companies are required to file their voting trust agreements with the Securities and Exchange Commission (SEC). The agreement must show how the voting trust will be carried out and the relationship between the shareholder transferring the shares and the trustee.
Typically, the voting trust agreement details the duration of the trust period, procedures in the event of a merger or dissolution of the company, duties, rights, and compensation of the trustee, rights of shareholders, and any additional rights granted to the trustees.
Voting Trust Certificate
A voting trust certificate is a document issued to a shareholder in exchange for the shareholder’s transfer of shares to one or more individuals known as trustees. By the shareholder accepting this certificate, he/she agrees to give temporary control of their rights and powers to a voting trustee to make decisions regarding the corporation without interference. The voting trust certificate lasts for the voting trust period, after which the shares are returned to the equitable owners.
Uses of Voting Trusts
The following are some of the instances when voting trusts are used:
1. Company reorganization
When a company is facing financial challenges, it may go through a reorganization to help it restructure its operations and restore its profitability. By transferring their shares to a group of trustees or creditors, the shareholders express their confidence in the trustees’ ability to efficiently rectify the problems that caused the financial problems.
The transfer of shares also gives the trustees the power to vote towards certain critical decisions that will help the company regain its profitability.
2. Transfer of shares from parent to child
Voting trusts are also used when a parent is transferring a part or all shares of a company to a child. Children who already reached the majority age will be allowed to vote on decisions of the company on behalf of their parents.
Also, when a parent is retiring or leaving a company, they may transfer the shares to a child or children on condition that the shares will be subsequently transferred to a voting trust with known trustees.
The trust ensures that the family’s stake is passed to other generations, and that the investments continue to grow even in the absence of the parents. The duration of the trusts varies from state to state, and some impose a limitation of up to 10 years for voting trustees.
3. Mergers and acquisitions
During a merger or acquisition transaction, the majority shareholders of the target company can transfer their shares in a trust that will offer a unified vote. This will help the owners of the company maintain a strong control after the transaction.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful: