As the name suggests, a Shareholders’ Agreement is an agreement between the shareholders of a company, which sets out the rules and processes that will apply to shareholders investing in and participating in the decision making of the company.
While a company’s constitution may outline the general rules that govern the relationship between, and activities of, the company and its shareholders, the constitution is more of an “off-the-shelf” document, that is not usually customised to address the wide range of issues that arise between shareholders.
While a constitution largely remains static, a Shareholders’ Agreement provides flexibility to accommodate shareholders coming in and out of the business. A constitution will not usually cover topics such as the relationship between the members in their capacity as shareholders, the valuation of shares on their sale or the process to be followed if or when a shareholder acts improperly.
Ultimately, a Shareholders’ Agreement aims to avoid and as needs resolve disputes arising between shareholders and to reduce disruption to the business where a shareholder wishes to sell its shares.
Features of a good Shareholders’ Agreement
Some of the more important clauses covered in Shareholders’ Agreements include:
A Shareholders’ Agreement may provide for restraints which prevent a shareholder from competing with the company or taking the company’s clients, both whilst they are a Shareholder and for a specified period afterwards.
These provide a mechanism that is to apply where decision making in the company on a critical matter is deadlocked. This allows for a resolution to be reached, preserving the value in the company and enabling it to move forward.
These allow existing shareholders to acquire shares prior to the shares being offered to third parties. A more tailored pre-emptive rights regime, with appropriate features to reflect the mix of shareholders in the company, can be incorporated.
Identifying exit strategies
Exit strategies could include a buy out or sale of the business, as well as identifying how, and at what value, shareholders may exit the company.
Future funding obligations
A Shareholders’ Agreement will govern whether or not shareholders are obliged to contribute new debt or equity funding, and also whether existing shareholders have preferential rights if new shares are to be issued.
General decision making, including board composition and reporting
These are important matters that will vary from company to company, depending upon the number and different size of shareholdings, as well as the extent to which shareholders wish to be actively involved in company decision making.
As each Shareholders’ Agreement will be different, we have examined two clauses in further detail to demonstrate how different circumstances can impact on what is included.
Drag Along and Tag Along
Where shares are held equally between shareholders, such as if shares are held 50/50, there is usually no ‘drag’ right, and conventional pre-emptive rights will apply. Where one shareholder holds more than a 50% shareholding, however, a drag along provision would allow a majority shareholder who wishes to sell to compel minority shareholders to also sell their shares. This is particularly useful where a buyer wishes to purchase the entire company.
Tag along provisions, on the other hand, aim to protect the minority shareholder from being ‘stranded’ when the majority shareholder sells. A tag along stipulates that the majority shareholder must ensure that any sale of their shares also extends to the minority’s shareholding – i.e. the minority ‘tags along’ with the majority. The minority shareholder will therefore be able to sell their shares for the same price and on the same terms and conditions as the majority.
Special majority or veto rights
Where the shareholding is held in equal shares, there is usually no requirement for a “special majority” when a vote is called for. Effectively, each shareholder has a right to veto any decision. On the other hand, if there are multiple shareholders, with one shareholder holding more than 50%, the dynamic between shareholders should be customised to fit the particular situation.
When choosing what issues may require a special majority or allow for majority shareholder or group of shareholders a right of veto, you should ensure that only critical items are covered. Matters such as loans and guarantees, key employment contracts, the payment of dividends, the purchasing of assets and entering into contracts over a threshold value or duration are important items to consider.
Ultimately, what items will be covered will depend on your business plan, growth stage and existing administrative or executive structure. It will also depend on the risk appetite of the particular group of shareholders.
A well drafted Shareholders’ Agreement will govern the relationship between shareholders, outlining a set of rules aimed at resolving potential disputes between business owners. Furthermore, a Shareholders’ Agreement should facilitate investment and allow for a streamlined exit by the current owners.
By setting out these expectations from the outset, business owners will have a clear understanding of their rights and responsibilities as shareholders and reduce the likelihood of a costly and value-destructive dispute.
with Elissa Raines, Lawyer