A shareholders’ agreement can help your company run smoothly

When you are settling up a business, a shareholder’s agreement may not be the first thing on your mind. However, it has an important role in determine a shareholder’s rights, obligations and liabilities. In this context, think of shares as being a portion of the business hence, shareholders being people who own a part of the business. The number of shares owned determines how much of the company you own. The more shares you own, means more control of the business.

The business is run by a director but, shareholders have a say in how the company is run. If you are unsure about who the director is and what they do, refer to our blog, ‘Directors Duties 101’.

A shareholders’ agreement can set out rules for as many or as little issues as the parties want. Usually, the agreement is made in addition to the company’s constitution. Refer to, ‘Do I have to set up a company constitution?’ for more information about company constitutions.

A good shareholders agreement will deal with the following:

1. Participation in Decision Making

A shareholders’ agreement can outline the conditions for decision making. The agreement can lay out the percentage of votes required to pass a decision.  There are some decisions which may be a good idea to have all shareholders agree to before implementing. For example, changing directors, closing the company, issuing more shares or changing the main activity of the company.

For some other decisions like, buying or selling assets or other financial transactions, it may be better to require 75% of votes to pass. This is called a special majority.

2. Exit Strategies

Directors and/or shareholders may choose to leave the company. In these situations, a shareholders’ agreement can inform them of their obligations towards the company and visa-versa. An exit strategy will usually ensure that the departing shareholder’s shares are sold at a fair price.

3. Selling Shares to Third Parties

The agreement should outline when and how shares can be sold to a third party. A third party is someone who is not a part of the company. One of the main benefits of this provision is that it protects pre-existing shareholders from owning a company with an unfamiliar person. The shareholders’ agreement can also allow existing shareholders the chance to purchase the shares first. This is sometimes referred to as a “pre-emptive right” or “first right of refusal.”

Determining the sales of shares is beneficial for both majority and minority shareholders. A majority shareholder is someone who has equal to or more than 50% of the company’s shares and a minority shareholder is someone who has less than 50%.

For a majority shareholder, a ‘drag along’ option may be beneficial. This option will allow a majority shareholder to force a minority shareholder to sell their shares. If a better price has been offered on bulk shares, a majority shareholder may want to use the ‘drag along’ provision.

The opposite of a drag along option is the ‘tag along’ option. This will allow a minority shareholder to opt into someone else’s sale of shares on the same terms. The tag along option also means that minority shareholders don’t have to remain in business with a purchaser if the conditions are not favourable.

4. Business Goodwill

Business goodwill includes how the company will be valued, property belonging to the company as well as where and who employees can work for after they have left the business.

Valuing a Business

When valuing the business, the shareholders can decide to do it themselves using a formula or hire a qualified evaluator. The value of a business is important to know when wanting to sell the business or is new shares will be issued.

Intellectual Property

Intellectual property includes ideas, designs, branding, inventions and other forms of property which has been thought of. A shareholders agreement can outline who these belong to when a shareholder leaves the company.

Restraint of Trade

A restraint of trade is a clause which controls who, where, and when an employee can work after they’ve left the company. This usually prevents an ex-employee from working for a competitor, creating a new competitor or poaching your staff and clients.

For more information about restraints of trade, visit our blog, ‘What is a Restrictive Covenant/Restraint of Trade?’

5. Deadlock Procedures and Dispute Resolution

A deadlock occurs when there are equal votes for and against an arrangement. The three most common ways to resolve this problem are alternative dispute resolution, bidding and winding up.

· Alternative dispute resolution includes processes such as expert determination and mediation. Mediation is like business counselling – it involves a neutral third party who will promote talking over the matter in good faith. For more information about alternative dispute resolution, visit our blog “What is Dispute Resolution?

· Bidding involves shareholders bidding for the shares of the other, the one with the highest price will buyout the other person.

· Winding up is shutting the company down hence, usually it is the last resort.

Deadlock procedures may not necessarily resolve the issue which is why it may be important to include a deadlock clause in the shareholders agreement. The various types of deadlock clause can be read here, ‘Types of Deadlock Clauses’.

6. Appointment and Removal of Directors

A shareholders’ agreement can decide the appointment or removal of a director. It can require for there to be a minimum number of votes present and of eligible votes, a certain percentage is required to vote for the motion to remove or appoint a director. Usually, the shareholders’ agreement will also deal with vacancies created by automatic removal, such as death or statutory disqualification such as bankruptcy.

Please visit our blog “Appointing and Removing Directors,” for more information.

If you have any question about setting up a business or drafting shareholders’ agreements, contact us today.