There is no legal obligation for a company to have a shareholders agreement. Because it’s not a legal obligation many people either put off having one drafted or do not fully understand the benefits of having one in place from the start of a venture.
DO WE NEED A SHAREHOLDERS AGREEMENT?
Preparing the shareholders agreement from the word go will ensure each shareholder is on the same page about the future management and operations of the business. The agreement will then serve as a guide on how the company is to be run and most importantly it will legally enforceable.
At a general level, a shareholders agreement should at least cover the following points –
- The management nd operation of the company
- Shareholder rights and obligations (including voting rights)
- The appointment of directors
- Issuing and selling of shares
- Valuation of shares
- How to restrain a departing shareholder from competing with the company
- Dispute resolution procedure
- Confidentiality and non-disclosure
Perhaps the most important question any shareholder should think of at the start of a venture is “what is my exit strategy?” Although nobody likes to imagine their relationship deteriorating with their co-shareholders (particularly if they’re friends or family) it’s best to determine right from the start how parties will resolve any future disputes.
Imagine working hard on growing a business only to turn around one day and find your partner has sold his or her shares to someone else. Or, where 3 out of 4 shareholders want to sell the business but the sale is blocked because 1 shareholder refuses to sell his or her shares. Typically, a shareholders agreement will incorporate a number of provisions to prevent any of the above scenarios occurring.
RIGHT OF FIRST REFUSAL
Let’s consider the first scenario of the shareholder whose business partner sold his or her shares without the other partner’s knowledge. A provision referred to as a “right of first refusal” in a shareholder agreement would have ensured the other shareholder had first dibs at purchasing the shares prior to the shares being offered to a third party.
DRAG ALONG TAG ALONG
What about the scenario where a majority of shareholders want to sell the business but are unable to because a minority shareholder refuses to sell? A provision referred to as a “drag along” clause prevents a minority shareholder unreasonably delaying or refusing a sale of the whole company when the majority wish to sell. The minority shareholder would then be forced to sell his or her shares to the third party along with the majority.
It is often the case that a “drag along” clause will be incorporated together with what is called a “tag along” clause (commonly under a heading “drag along tag along”). The tag along component aims to balance the interests between majority and minority shareholders. The provision provides for a minority shareholder to be able to require their minority shareholding to be bought out (pro rata) together with the majority if the majority want to sell their shares to a third party.
The above examples only scratch the surface of the practical benefits a shareholders agreement can bring to a business under a company structure. If you have any questions or would like to speak to someone about preparing a shareholders agreement please get in touch with a member of our business and commercial team.
Author: Alex Beagley