This post highlights and examines some of the issues you will need to consider when forming a new company or establishing an agreement between the shareholders of an existing company dealing with how the company is to be run and the rights and duties of the various shareholders.
It describes the main provisions that may need to be included in the Shareholders Agreement and can act as an excellent aide memoire when deciding on how the shareholders agreement is to be structured with relevant advisors.
Shareholders' agreements are private arrangements between the shareholders in a company that are not appropriate for inclusion in the public documents of a company, i.e. those documents that are filed at the relevant registry.
Note, however, that in some countries (though not in the UK) it may be necessary to consider whether, from a legal perspective, registration is necessary to ensure enforceability of the terms of the shareholders' agreement in relation to the affairs of the company to which it relates.
Key considerations for a shareholders agreement are as follows:-
THE PARTIES
It must be determined whether all shareholders in the Company are to be parties to the Agreement, or whether some only, to reflect any particular agreement that they may have.
Further, thought must be given to whether the Company itself is to be a party to the Agreement as this will give the shareholders rights against the Company for any breach by it of obligations that it undertakes in the Agreement.
THE COMPANY
The usual form of company is a limited liability company; note that different jurisdictions will have different structures or types of company, and advice should be taken as appropriate. Matters of particular importance in relation to any company are:
● The number of shares to be taken by each shareholder and whether the shares carry any special voting rights
● Whether the shares carry any particular right to appoint members of the board of directors.
CAPITAL AND BUSINESS PLAN
If a venture requires the injection of capital by the Shareholders, it will need to be determined at an early stage what capital will be required, who will contribute it, and when it will be required. A business plan is therefore important and it is possible to attach one to a shareholders' agreement. Similarly, the parties may wish to put in hand a feasibility study, or perhaps this will have been done in the pre-shareholders' agreement stage.
MANAGEMENT
Management of a company is generally undertaken through the board of directors; it is therefore important that the shareholders agree how many directors there are to be, who the first directors are, how they are to be appointed and removed and whether the holders of different classes of shares have any particular power to appoint them.
It is usual for each of the principal shareholders to have the right to appoint at least one director to the board and, where a shareholder is an individual he or she may also be a director.
Once appointed, directors may be given authority to determine how often they meet, the quorum for meetings, how their decisions are made and other matters relating to, e.g. the conduct of their meetings.
Alternatively, the shareholders may wish to determine these matters themselves and set out the rules in the shareholders agreement. This is especially likely to be the case when, for example, there is one major shareholder who wants to be sure that only resolutions that have his or her vote will be passed by the board or at shareholders’ meeting.
Another aspect of management which the shareholders should address at the outset is the extent of the directors' powers; the shareholders may wish to reserve certain important matters to a decision of the shareholders in general meeting of the Company. These reserved matters may cover, for example:
● company borrowings or transactions generally in excess of a particular limit;
● joint ventures with other companies;
● any changes in the scope or nature of the Company's business;
● the issue of any new shares in the Company or any change in its capital structure;
● the choice of auditors or the commencement or settlement of litigation.
TRANSFER OF SHARES
Each shareholder may wish to prevent other shareholders from charging or pledging shares in favour of third parties.
Each shareholder may wish to prevent other shareholders from disposing of their shares to third parties without having first offered them to existing shareholders.
The shareholders may also wish to provide that in certain circumstances, e.g. when one shareholder wishes to sell or on the bankruptcy, death or permanent incapacity of a shareholder, then that shareholder's shares are to be offered to the other shareholders at market value under a shareholder agreement defined process.
It may be prudent also to consider taking out insurance so that funds are available to the company or the other shareholders to buy the shares of a member of the company who dies or becomes critically ill.
Where a limited company is a shareholder, it is sometimes a term of the shareholders agreement that if the control of that shareholder changes – e.g. if the shareholder company is taken over – then the shareholder must sell its shares and leave the Company.
The shareholders agreement will usually contain a clause setting out how shares are to be valued when a shareholder leaves and sells his shares to the remaining shareholders.
In the UK, it is usual for tax reasons to give shareholders the option, but not the obligation, to acquire shares of a deceased shareholder.
FINANCING
This important aspect should be carefully considered at the outset of the venture, and shareholders might wish to agree:
● as to how further capital requirements are to be provided, i.e. by the shareholders themselves or through loans from third parties;
● whether security for loans will be granted and, if so, the type of security that will be provided, e.g. by way of charges over assets, or shareholder guarantees.
DIVIDEND POLICY
Shareholders often provide in the Shareholders' Agreement for:
● the means of calculating net profits;
● a percentage of the net profits that must be distributed annually;
● any restrictions on distribution of net profits - e.g. no distribution until certain loans have been repaid.
DURATION
Agreements will generally contain provisions relating to their duration, and how they may be terminated. It is usually also wise to consider whether the Agreement will continue when new shareholders are introduced - in these circumstances, it would be sensible to make approval of a transfer of shares conditional upon the new shareholder specifically agreeing to abide by the terms of the Shareholders' Agreement. In the UK this is often achieved by the new shareholder signing a deed of adherence.
CONFIDENTIALITY
The Parties may wish to impose duties on each other not to disclose to third parties their own and or the Company's confidential information; this obligation is usually expressed to endure for a period of time after the termination of the venture or the transfer of shares by a particular shareholder.
MANAGEMENT DISPUTES
When, in relation to certain specific issues of importance, the shareholders (either through their directors on the board or in general meeting) cannot agree, what occurs is what is known as a "deadlock". It is often agreed by the shareholders at the outset what will be done in such a situation. A solution that is often adopted is for a shareholder to offer to sell its shares or purchase the other shareholders' shares at a particular price. These solutions are sometimes known as "Russian Roulette" or "Texas Shootout" provisions.
DISPUTE RESOLUTION
It is usual to agree a method of resolving disputes between the shareholders that arise out of the Agreement. The shareholders may wish to have disputes resolved by arbitration, or leave it to the courts. Sometimes they may have disputes referred to mediation or disputes on a particular topic - e.g. financial matters - to be determined by an independent expert.
GOVERNING LAW
It is also usual to select the system of law by reference to which the Agreement will be construed and the jurisdiction in which the dispute will be heard, if no arbitration clause is incorporated in the agreement.
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