If you operate a company with multiple shareholders, you likely have a shareholders agreement in place. If not, you might like to consider entering into a Shareholders Agreement.
What is a Shareholders Agreement?
In its most basic sense, a Shareholders Agreement can be likened to a governance manual for the company and its shareholders which sets out:
- how the company is to operate and how decisions are made;
- the rights and obligations of each shareholder; and
- the processes to follow in certain situations such as the company issuing shares and shareholders selling shares.
Why should I have a Shareholders Agreement?
- As these agreements are essentially a governance manual for the company and its shareholders, a considered, custom, and well drafted Shareholders Agreement is a useful tool to effectively and clearly communicate:
- who is entitled to appoint directors;
- whether it’s the directors or shareholders who make decisions regarding key matters;
- how shareholders can sell their shares;
- how the company can issue further shares; and
- what happens when certain events occur, such as a shareholder breaching their obligations under the Shareholders Agreement,
and more. If you are the sole shareholder, then a Shareholders Agreement may not be necessary. However, if you’re looking to introduce another shareholder (such as an investor), it is worthwhile considering whether you should enter into a Shareholders Agreement.
It’s important the document appropriately deals with your specific needs and while there are a number of factors to take into consideration, it starts by understanding what your intentions are and what you’re planning to do.
It is important to ensure that a shareholder agreement is specifically tailored for how the company and the relationship between shareholders is to operate. The following is a brief overview of the key issues that should be considered.
Management and funding issues
There should be a clear framework for the management and administration of the business. The shareholder agreement should deal with issues such as:
(a) who comprises the board;
(b) whether any individual or blocks of shareholders have the right to appoint a representative director;
(c) whether any principals of the shareholders will be employed by the business.
The agreement should outline the levels of authority of management and clarify which, if any, decisions require approval from the shareholders or a particular majority of shareholders/directors. These might include issues such as:
(a) approval of annual budgets;
(b) decisions on incurring capital expenditure in excess of a specified amount;
(c) sale of the business or substantial assets of the business (e.g. to a consolidator);
(d) employment of new staff (above a given threshold salary);
(e) admission of new shareholders;
(f) any significant borrowing in excess of a specified amount;
(g) declaring dividends.
What obligations (if any) will shareholders have to inject further capital?
Entry/exist of shareholders
It is important to agree at the outset on issues such as:
(a) when a party may retire and sell shares;
(b) when a party may be required to retire and sell shares;
(c) what price will be payable on retirement/expulsion;
(d) how the continuing parties will fund the purchase of shares of an outgoing shareholder;
(e) whether an outgoing shareholder who is paid an amount for their shares, which reflects a value for goodwill, is to be subject to a restraint of trade covenant;
(f) how transfers or sale of shares to an associated entity of the shareholder will be dealt with.
It is quite common to allow a shareholder to retire on giving reasonable notice. In those circumstances, the usual approach is that the continuing parties may, but are not obliged, to purchase the shares of the outgoing party.
The agreement should stipulate ‘triggering events’ that will entitle a majority of principals to require another party to sell their shares. Common triggering events are:
(a) death;
(b) total and permanent incapacity;
(c) bankruptcy;
(d) unremedied breaches of material terms of the agreement;
(e) criminal conduct.
The above list is not exhaustive and can be tailored to your particular circumstances.
It is important to provide clear guidelines as to how and when an outgoing party is to be paid:
(a) If a party dies or is disabled and there is no underlying insurance, the date for completion is generally tied in with the payment of the insurance proceeds;
(b) If a person has to sell shares where there is no insurance funding, ongoing parties may be given a reasonable time to pay for the shares transferred or surrendered.
Pre-emptive rights and tag along/drag along provisions
It is almost universal practice to include a clause in a shareholder agreement that requires
that any shareholder wanting to sell their shares must first offer them to the other
shareholders who have a first right to purchase on the same terms.
If the continuing shareholders do not want to purchase the shares, then a shareholder is generally free to sell to the third party – although this will be difficult to do in practice. In some cases, even this right to sell to a third party is subject to the other shareholders approving the proposed new shareholder.
The agreement should also cover the possibility of a third party wanting to purchase all of the shares or the entire business and assets of the company. It is quite common to have a clause (tag along/drag along) under which a specified majority of shareholders can effectively compel all shareholders to agree to a sale to a third party who is interested in buying all of the shares or the entire business.
How NB Commercial Law can help?
NB Commercial Law are experienced in drafting, reviewing and advising on the provisions of shareholder agreements. We can ensure that your shareholders agreement is tailored specifically for your business needs.