Funding & Finance
Shareholders’ Agreements should include provisions around company funding.
Shareholders should discuss and clearly record in a Shareholders’ Agreement:
- How the company is to be initially funded.
- Whether shareholders will be required to make further capital contributions.
- Whether shareholder loans will be required and on what terms.
- Whether personal guarantees from shareholders for company borrowings will be required.
- When the company may raise capital by the issue of new shares.
Restrictions on Transfers of Shares
A Shareholders’ Agreement should provide clear terms around what a shareholder can and cannot do when it comes to any proposed sale or purchase of their shares.
Restrictions on how shareholders may exit the company protect all shareholders. They also provide an important framework for the buying or selling of shares in times of dispute.
The 5 most common restrictions placed on share transfers under a Shareholders’ Agreement are:
- Pre-emptive Rights: these restrict shareholders from selling their shares to an outside third-party, without first offering the shares for sale to the other shareholders. If the other shareholders do not wish to purchase the outgoing shareholder’s shares then, and only then, can the outgoing shareholder sell or transfer their shares to an outside third party on terms no less favourable than those offered to the other shareholders.
- Drag Along Rights: apply where a majority shareholder receives an offer from a third party to buy all the shares in the company, which in turn gives the majority shareholder the right to require all remaining shareholders to sell their shares to the third party on the same terms.
- Tag Along Rights: apply where one or more shareholders receives an offer for the purchase of their shares in the company, and give the remaining shareholders a right to ‘tag along’ and sell a proportionate quantity of their shares on the same terms.
- Lock-ups: prohibit a shareholder from disposing of their shares during an initial lock-up period. This is either measured from the date of the Shareholders’ Agreement or the date on which a later shareholder accedes to a Shareholders’ Agreement.
- Default: set out what restrictions apply when a shareholder is in default. A defaulting shareholder might be defined as someone who breaches a term of the Shareholders’ Agreement, or becomes bankrupt or insolvent, in which case their rights are often automatically suspended (no rights to vote and dividends) and the company can buy back their shares or trigger a Transfer Notice on behalf of the defaulting shareholder.
Whilst typically covered under a separate Buy/Sell Option Agreement or Business Succession Planning Agreement, Buy/Sell Options can also be included in Shareholders’ Agreement. These options allow shareholders to record what they want to happen to an outgoing shareholder’s shares in the unfortunate event of death or disability of a shareholder.
When considering the above restrictions and their inclusion in a Shareholders’ Agreement, the method for valuing shares on a sale or exit by a shareholder is of great importance. In times of dispute, for example, it is vitally important that the Shareholders’ Agreement includes a mechanism whereby shares can be valued and a price set, for example by way of independent expert valuation, if the shareholders cannot agree on a price between themselves.
Restraints of Trade
Shareholders often bring different skills and resources to a company.
- The founder might bring the IP (intellectual property rights).
- Investors may bring the money.
- The managing shareholder might have the business systems.
As such, one or more shareholders may be more important to the success of the company than another.
In situations where the company would suffer loss if a particular shareholder ceased to be involved in the operation of the company, provision is often made in a Shareholders’ Agreement requiring the shareholder(s) who is integral to the day-to-day success or management of the company, to enter into fixed term Executive Employment Contract with the company and/or to be a party to the Shareholders’ Agreement personally..
Just as importantly, a Shareholders’ Agreement should record that all shareholders and any related key persons are bound by mutual restraints of trade. These restraints restrict shareholders (and key persons, where applicable), from:
- engaging in activities that compete with the business of the company, in a defined territorial area, while they hold shares in the company and for a set period after they cease to hold shares in the company.
- using or disclosing confidential information or soliciting or enticing away customers or employees of the company.
It is often said that Shareholders’ Agreements are important at the outset of business and critical in times of dispute.
In times of dispute, it is important that the parties have the ability to fall back on and resolve disputes in accordance with a clearly defined dispute resolution procedure. Generally, dispute resolution procedures must be followed before a party can commence any Court proceedings in relation to a dispute.
Dispute resolution procedures generally provide for a party to serve a Dispute Notice clearly articulating what is in dispute and then require the parties to meet to try to resolve and write down the dispute. In the absence of a resolution, the clause will typically provide that the parties must attempt mediation.
If mediation is unsuccessful, and the parties do not agree on an alternate mechanism for resolution of the dispute, the Shareholders’ Agreement may require the dispute to be determined by independent expert determination or Arbitration.
These alternate dispute resolution mechanisms can be particularly useful for avoiding protracted and costly litigation and maintaining confidentiality in relation to the subject of the dispute.
Dispute resolution clauses coupled with provisions around restrictions on transfer of shares, therefore, reduce legal costs and stress and protect share value in times of conflict.
- A Shareholders’ Agreement is a private contract between shareholders of a company.
- A good Shareholders’ Agreement creates a pathway and plan that allows shareholders to understand how a company will be managed and operated.
- A comprehensive Shareholders’ Agreement clearly defines the rights and responsibilities of shareholders on entry and exit.
- Shareholders’ Agreements increase a company’s chances of success and protect share value.
- Every company with 2 or more shareholders should have one in place.