28 Nov Top 10 things to consider in a Shareholders’ Agreement
Most template shareholders’ agreements won’t provide you enough legal protection.
When drafting a tailored Shareholders’ Agreement, it’s imperative that you make sure that the interests of the company as well as the shareholders are covered properly.
This article looks at the top 10 things you should consider when drafting a tailored Shareholders’ Agreement. If you have any questions or require any assistance with drafting a Shareholders’ Agreement, our approachable and practical lawyers are happy to help protect you and your valuable business.
1. Operation and management of the company
It’s vital to consider how your company will be operated. Generally, a Shareholders’ Agreement will confirm that directors will be responsible for the overall management and operation of the business of the company, however, you should also consider whether the board will have the right to delegate such power to a committee or a managing director.
If a managing director is in control, you should set out the scope of their role and responsibilities. The Shareholders’ Agreement should also set out the duties and obligations of the directors as well as the expectations of and obligations on the shareholders.
If a shareholder, or a key person associated with a shareholder is required to work in the business the shareholders’ agreement should deal with this situation. Otherwise, you could have a situation where a shareholder stops working and is still entitled to retain their shares.
2. The Board of Directors and rights to appoint another Director
It is important to clarify how directors are to be appointed to the Board of Directors and any rights to remove and replace those directors. Sometimes each shareholder will have the right to appoint one director, and in other cases, only those majority shareholders have the right to appoint a director.
You should also consider whether the Board of Directors should have the right to appoint independent directors or alternative directors from time to time. There may be general limitations on the power of the Board of Directors, such as, requiring two directors to approve bank transfers over a certain amount or a general manager to oversee the financial operations of the business.
3. Share transfers (Pre-emptive rights and drag along / tag along)
You should also carefully consider what restrictions (if any) you wish to place on shareholders who want to transfer their shares or exit the company. These restrictions will generally protect both the interests of the other shareholders and the interests of the company. There are a number of risks for shareholders and the company under these circumstances including dilution, competitor sales as well as sales to unknown or incompetent third parties.
The Shareholders’ Agreement should set out any restrictions on the shareholder when transferring their shares and the mechanism for determining the price of such transfer.
Generally Shareholders’ Agreements include pre-emptive rights which essentially give each shareholder the right to purchase those shares being offered to a third party. Such third-party transfers may also be subject to the approval of the Board of Directors.
If you are a major shareholder in the company and your intention is to build up that company with a view to sell it to a larger corporation, it is also important to ensure that you have the ability to ‘drag along’ minority shareholders so that minority shareholders will have to legally sell at the same sale price. We can also put in place ‘tag along’ rights to protect minority shareholders, if that is your intention.
4. Protection of the business’ interests (restraint provisions)
It’s generally recommended that restraint of trade clauses be included in the Shareholders’ Agreement to protect the legitimate interests of the company. This is particularly important when shareholders are involved in the day-to-day operations of the business and are familiar with its trade secrets and client relationships.
These generally include a restraint on shareholders which prohibits them from being engaged in a competing business, and a restraint preventing shareholders from pinching your staff or trade connections (e.g. clients, suppliers). If you have shareholders that hold shares in a company structure, you should also ensure that you include their directors or key persons involved in the business into the restraints.
5. Deadlocks and disputes
These provisions generally operate when shareholders cannot come to an agreement on a matter and as a result, the company cannot move forward and deadlock. This would generally only happen where there are two shareholders and they hold 50% of the shares each. To pass a decision both would need to vote in favour, which ends up in a stalemate.
A common method of resolving a deadlock is a “shotgun clause”, which entitles one or more of the shareholders to buy out the other at an agreed price, however, it also entitles the other shareholders to buy them out if they don’t agree to it. This then allows one party to exit and the other to move forward with the business and breaking the deadlock.
This clause should be carefully drafted so as to prevent minority shareholders from calling upon it. In those circumstances, the company then faces the risk of being left without an option except to apply to a Court for a resolution! Not ideal.
6. Meetings of the Board and Shareholders
The Shareholders’ Agreement should set out how often meetings are to take place, and notice procedures for those meetings. You should confirm that meetings can be held electronically, what constitutes a quorum and what happens if you don’t achieve a quorum (i.e. those in attendance at a second meeting could constitute a quorum).
7. Decision making
You should carefully consider how decisions are to be made in the business. A Shareholders’ Agreement should set out what voting rights each director and shareholder has at a meeting, and the required votes needed to approve a resolution.
Generally, most decisions are made by a majority, with only certain key decision usually requiring 75% or unanimous votes. Please note that some decisions of shareholders must be passed by special resolution (75%) as required by the section 9 of the Corporations Act, 2001.
8. Involuntary Exits (death or total and permanent disability)
In the event of death or total or permanent disability of a shareholder, the Shareholders’ Agreement may give the other shareholders the right to purchase the outgoing shareholder’s shares. The Agreement should also expressly address both the amount and the timing of payments for those shares.
We can also assist with what’s known as an insurance funded buy-sell agreement.
9. Defaults and consequences
The Shareholders’ Agreement should have a clause that deals with those events that trigger a default. For example, this includes a breach of the shareholders’ obligations (such as an obligation to work in the business).
When such a trigger event occurs, a Shareholders’ Agreement will generally require a defaulting party to transfer its shareholding at a valuation price to the other shareholders. You should carefully consider whether you wish to include a provision for discounting any valuations by the damage done by that defaulting shareholder.
10. Valuation of Shares
In certain circumstances, a valuation of shares will be required (such as in default or death, total and permanent disability compulsory buy-back as noted above). You should consider how the valuation price will be determined. Generally a Shareholders’ Agreement should include a fair market valuation to be calculated by an independent valuer. We also see Shareholders’ Agreements contain specific multiples by which the value of the business will be calculated.
Your Shareholders’ Agreement needs to be drafted to tailor-fit the interests of your business and the shareholders. It sets out the expectations of how the company will be run and the shareholders’ involvement in the business. It can be used to prevent and manage disputes, which inevitably happen and reduce the severity or collateral damage of those disputes.
We have seen many companies and good businesses ultimately being destroyed internally through avoidable shareholder disputes that could have been resolved efficiently and quickly – if only they had a well-drafted Shareholders’ Agreement.
Business is risky enough without exposing the owners to an unnecessary risk of a poorly drafted or template document.
Contact us today if you require any assistance with preparing or reviewing your Shareholders’ Agreement.
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