An analogy can be made between shareholders’ agreements and umbrellas; you only tend get them when it’s raining and we do, of course, live in England!
When starting a new business, entering into a joint venture or re-structuring an existing company it is important that shareholders clearly define their rights, restrictions and obligations in the company. While legislation provides a basic framework as to how a company should operate there are a number of key fundamental issues which the law and “off-the-shelf” articles of association fail to address. It is, therefore, important that shareholders enter into an agreement so that in the event of a dispute reference can be made to the document without recourse to the courts or the need to take professional legal advice.
Below is a compilation of ten considerations when entering into a shareholders’ agreement and why such a document is essential for you, your fellow shareholders and your business.
1. Decision Making
It is important to strike a balance between giving directors/shareholders autonomy to make day-to-day business decisions while ensuring that key actions are only made with the agreement of the other members. You should compile a list of matters which require shareholder consent. These may include, for example, amending the company’s articles of association, bringing on board new directors or employees, entering into transactions over a certain value or incurring additional borrowings. We can assist to help create your own ‘a la carte menu’ tailored to your situation and the needs of your company.
2. Dividend Distribution
How will dividends be distributed and who will have the authority to determine the level of dividend payment to each shareholder? You may wish to ensure that a set percentage of the company’s net profits are set aside for dividend payments or alternatively, allow shareholders flexibility to determine payments on an annual basis. In addition, you may wish to issue different classes of shares so that only certain shareholders have the right to determine the divided payments.
3. Share Transfers
In the event that a shareholder wishes to transfer their shares do you want to oblige the departing shareholder to first offer their shares to the continuing shareholders? Preemption rights ensure that sale shares are first offered to continuing members proportionate to their shareholding for fair value before they can be transferred to a third party or a family member.
4. Deemed Transfers
You may wish to include a list of events which would automatically trigger a share transfer such as insolvency, mental incapacity, being absent from employment in the company for a set period of time or a material breach the shareholders’ agreement. The departing shareholder will then receive fair value for their shares or a reduced or nominal value depending on the circumstances of the trigger event.
5. Valuation of Shares
How will sale shares be valued if the members are unable to agree on a price? A valuation mechanism can be included whereby an independent valuer is appointed within a set period of time, whose decision will be binding on all the parties, to value the shares taking into account certain considerations as set out in the agreement.
What will happen on the death of a shareholder? The default position would be that the shares fall into the deceased’s estate and the beneficiary under the will or intestacy rules would then become the owner of those shares. The surviving shareholders may not wish for a beneficiary to have a controlling stake within the company. Accordingly would death trigger an automatic transfer? How will the surviving shareholders then pay for those shares? You may wish to consider putting in place a life policy supported by a Cross-Option Agreement to deal with this scenario.
7. Critical Illness
What will happen in the event of critical illness and a shareholder being unable to carry out their role in the company? Will the other shareholders be able to force that member to sell their shares and how will the share purchase be funded? You may wish to consider taking out critical illness cover and including a provision where the pay-out funds the transfer of the shares.
8. Drag Along and Tag Along rights
Where there are majority and minority shareholders Drag Along rights allow the majority shareholders to force minority shareholders to transfer their shares in the event that an offer is made by a third party to purchase the entire share capital of the company. A Drag Along clause would therefore ensure that a party with a minority shareholding could not block the sale of the company. In the same way that Drag Along rights strengthen the position of majority shareholders, Tag Along Rights protect minority shareholders from a third party seeking to purchase a controlling stake in the business. The minority shareholders can insist that if an offer is made to purchase the majority shares they can ‘tag along’ and ensure that their shares are also sold as part of the deal.
What will happen if you are unable to agree on a decision and there is a deadlock scenario? A deadlock clause sets out a number of formal steps to focus minds and seek to resolve the dispute within a set period. In the event of continued disagreement a provision can be included to have the company wound up or alternatively one member may be given a casting vote to resolve the matter
10. Restrictive Covenants
In the event of a shareholder transferring their shares and departing from the company the continuing shareholders would want protection to ensure that the departing member does not set up a rival business and poach clients, customers and key contacts. By including restrictive covenants you can seek to prevent a departing shareholder from competing for a set period of time and within a certain radius of the business. In a perfect world you may never need to refer to your agreement but should it start to rain, is your umbrella fit for purpose?