I am often asked by clients “what should we include in our shareholders’ agreement?” and, of course, the answer will depend on what the clients want to achieve and factors such as:
- The relative bargaining positions of the shareholders
- The shareholding structure (as what is appropriate for a 50: 50 joint venture will be totally inappropriate where one or more shareholders have minority holdings)
- What the clients want to achieve: are they in it for the long haul or are they looking for an exit within a foreseeable timeframe?
Save where the parties have equal shareholdings (when the questions are very different), I normally begin by sending the clients a list of issues to consider, to help me produce a sensible first draft.
I normally preface this with a comment that I tend to advise clients to include the more mechanical provisions (share transfers etc.) in their articles and the more commercial ones in a separate shareholders’ agreement.
That is a typical approach, though some people prefer to keep everything in the shareholders’ agreement.
The advantage of having things in the articles is that they automatically bind all new shareholders (such as those inheriting shares on death).
The points that I would normally suggest that clients consider in connection with a shareholders’ agreement include:
1. A description of the business and perhaps a mechanism for agreeing and updating a business plan.
2. How the company is to be financed: by share capital or loans from some or all shareholders or both?
A shareholder who is to fund the company by way of loan will probably want interest paid/capital repaid before any profits are distributed among the shareholders and so the implications of that need to be considered..
3. Clients will often say that, wherever possible, any further cash required would be provided by an external lender but that, if that is not possible or the terms are unattractive, the funds would be provided by the shareholders proportionately by way of loan but on pre-agreed terms (interest, security, repayment etc.).
4. Dividend policy and profit sharing generally: dividends to be agreed by the board or to be the decision of the shareholders (by majority vote or otherwise?).
In tandem with this, the agreement would typically also restrict what each director/shareholder can take out by way of salary, fees, bonuses, loan repayments/interest etc.
5. Board appointment rights: would each shareholder have the right to be on the board (or represented on the board) while a shareholder? A majority shareholder would be able to appoint and remove directors anyway, agreed otherwise but a minority shareholder would normally want to restrict that.
6. Frequency of board and other meetings and does the chairman have a casting vote?.
7. Provision of information to shareholders over and above the annual accounts: for example, would shareholders expect to receive monthly/quarterly management accounts?
8. The extent of time commitments to the business of the company – which would normally also be covered in any service/consultancy agreements, which would also set put how the parties would be remunerated.
9. Restrictions on being involved with a competing business.
10. Any agreement as regards an eventual exit mechanism – sale of the company etc.
The majority shareholder would normally be in the driving seat but parties especially external investors) will sometimes want a mechanism to enable them to “drive” through an exit (although that can be extremely difficult if management are hostile).
11. Any mechanism to resolve any “disagreement” or “deadlock” between the parties – there are several alternatives but it is common to have a mechanism under which one party can buy out the other(s).
This is far from ideal, though, where one party has far deeper pockets than the other(s).
12. Minority protection provisions.
The default position under company law is that most major decisions require a 75% majority of the shareholders but shareholders often want to increase that majority so that a higher majority (or all shareholders) have to consent to changes to the company’s constitution, the issue of further shares, the sale of the business and so on.
Other decisions normally require a majority vote at board and shareholders’ meetings but the parties can increase the percentage if they wish.
I would normally recommend that the parties identify key decisions which would require the consent of all (or an enhanced majority) of the shareholders: there is always a certain tension, as the minority will normally want as many powers of veto as possible, while a majority holder would be concerned that the tail should not wag the dog.
Turning now to matters which I would normally include in the articles:
1. Dividend rights and rights to capital/sale proceeds.
2. Voting rights
3. Should shareholders have the ability to make lifetime transfers to close family and family trusts? Should shareholders be allowed to leave their shares by will to close family or family trusts or should they offer them to the other shareholder (at a fair price) in that situation?
4. Transfers of shares generally: I often suggest that the default position should be that any shareholder who wishes to sell or transfer any shares should be required to offer them first of all to the other shareholders (in proportion to shareholdings) at a price to be agreed or (if they are unable to agree) to be determined by the auditors.
I would normally suggest that, in valuing the shares, the auditors should value all holdings on a pro rata (%) basis.
5. What happens if a shareholder who is also a director/employee decides to leave or is dismissed?
Should they be allowed to keep their shares or to offer them to the other shareholders/the company at the fair value?
The answer may depend on the reasons for leaving: others might be content to allow them to hold the shares if they left as a result of ill health/retirement but what if they left under a huge cloud or left to join a competitor?
Articles sometimes say that you have to offer up your shares if you leave but with the price being lower if you are a “bad leaver”.
6. Minimum number of directors
7. Quorum for board meetings
8. Quorum for shareholders meetings
9. Chairman’s casting vote (generally inadvisable)
10. Drag along: should a majority shareholder be able to force the rest to sell out (as long as it was a sale to an independent third party)?
11. Tag along (to allow all other shareholders to sell on the same terms if the majority wanted to sell).
Written by Andrew Stilton