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Providing certainty and security for your business interests
In the pursuit of common goals and the marriage’ of ideas between friends, family or close business partners, it is easy to brush aside the details on the understanding that ‘everything will pan out’ or that you will deal with problems reactively as and when they arise.
A shareholders’ agreement, analogous to a pre-marital agreement, is a private agreement between you and your business partner(s); clarifying your responsibilities to one another, what happens when circumstances change, and more. In fact, the agreement could be crafted to cover almost any area of uncertainty between shareholders, leaving you much less scope for argument and giving you more time to concentrate on your wider business plan.
Control of the directors
The default position is that shareholders do not exercise day-to-day control over the company affairs, this is managed by the directors. If all the shareholders are also directors this may be satisfactory, but if you are not a director you may want to ensure you have some say in the company’s management to protect your investment.
A shareholders’ agreement can require unanimous, or some other level of, shareholder consent before the directors take certain action. For example, entering into transactions over a certain value or expansion of the business, could be controlled at shareholder level. It might also be important to include provisions or restrictions on the appointment and removal of directors to protect your position.
Deciding on salary and dividends
Setting out a framework for varying the salaries of directors or a policy for declaring dividends can give certainty to all the contributors to the business, avoiding disappointment later down the line. The agreement could set annual dividends at a certain percentage of the company’s profits and require profit retention for future growth and expansion.
Transfer of shares
Many do not consider from the outset that a business partner’s circumstances may change such that he might have to leave the company. A shareholder can usually transfer his shares to anybody he wishes, which might leave remaining shareholders with a partner they do not recognise and who does not share a common agenda.
A shareholders’ agreement would typically provide a mechanism for remaining shareholders to have a right to acquire shares from an exiting shareholder in certain circumstances. It is common for such a right to arise if a shareholder leaves employment or dies. However, consideration should also be given to other situations such as divorce. For example, if one shareholder has passed shares to his wife and then suffers a divorce you may want to recover the shares from the ex-wife.
The agreement could also set out the circumstances when shares can be sold or transferred to certain people (i.e. spouses, family members or trusts). Any new shareholders would be required to sign the shareholders’ agreement. In the event of an acquisition of the company by a third-party buyer, minority shareholders could be protected by including a right for them to sell their shares along with the majority, or conversely the minority could be forced to accept an offer if a buyer wanted to purchase all the shares. Such provisions are typically known as ‘drag and tag’ along provisions.
If you have an equal shareholding with one or more business partners, ‘deadlock’ occurs when no majority decision can be reached over a certain issue. If deadlock was to occur frequently, it could become difficult for important decisions to be made, at the expense of the company and its profits. The shareholders’ agreement could include a veto for certain matters which any shareholder could exercise. This protects the interests of minority shareholders, but should be restricted so it does not prejudice wider decision-making.
The Shareholders’ Agreement and Articles of Association
Where a shareholders’ agreement deals with the relationship between shareholders, a company’s articles of association (which is a public document) deals with the relationship between the company and its shareholders, and the general principles of how the company will be run. For this reason, it is often recommended to review and consider the company’s articles whenever a shareholders’ agreement is being considered. The articles may need to reflect what has been agreed, and to harmonise the approach to management and procedure in both documents ensuring that one supports the other.
In conclusion, if you are embarking on a new venture or are part of any existing venture, it would be wise to reach agreement on key issues at the outset and document them in order to minimize problems and avoid disagreement later on down the line.
This article was first published in Mills & Reeve’s Summer 2012 publication, Private Affairs. Correct as of May 2017
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