The terms of a shareholders' agreement

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In the hype of big brands and big business, many people lose sight of the fact that a company is in essence nothing more than a group of people working together towards the common goal of year-end profit. But it is often this key characteristic of a company that determines its success or failure.

Without a properly defined structure regulating the working relationship between shareholders and directors, a business can become weighed down by internal disputes, animosity and deadlock. 

A company’s articles of association, read with the provisions of the Companies Act, provide a broad framework for the operation of a company, but do not deal with the specifics of a company’s management or the regulation of the internal affairs of the company. These aspects need to be governed by a shareholders’ agreement.

A shareholders’ agreement is perennial in nature. It must govern the company’s internal affairs consistently for the full lifetime of the company. This is important to remember when having one drafted. If a term in the agreement won’t make sense in fifty years time, it probably shouldn’t be there.

Including terms in a shareholders’ agreement that are specific to particular shareholders, or the current (but changeable) circumstances of the company, will only mean that every change in these circumstances will require the company to incur the cost of making amendments to the agreement. 

It is far better to deal with fluid and changing aspects such as asset ownership, director’s employment terms and intellectual property license arrangements in the annual financial statements of the company, or in separate and specific agreements.

Ideally the terms of a shareholders’ agreement should focus on the following issues:

  • The share capital that the company is authorised to issue, its par value and the terms on which further shares in the company may be issued
  • The basis on which the company will be managed; How many directors will the board have?  What rights will the shareholders have to appoint directors? The voting rights of directors.  Will alternate directors be permitted and how will they be appointed and removed?
  • The procedures applicable to directors and shareholders' meetings, including notice periods for meetings, quorums, voting rights and the procedures to be followed in passing resolutions
  • A clear description of the decisions of the company that will require a special resolution (75% approval), such as the sale of the bulk of the company’s assets or taking on substantial debt
  • The terms on which all shareholders may be required to fund the company, including initial contributions and the interest rates and repayment terms applicable to all loan accounts, the circumstances in which the company may call for further funding from the shareholders and the consequences of a failure to provide funding (including dilution of shareholding).
  • The dividend policy of the company
  • Comprehensive provisions dealing with the sale of shares, including the circumstances in which a shareholder will be forced to sell his/her shares (such as the shareholders’ sequestration), the valuation of shares at the date of sale, pre-emptive rights and the procedures to be followed by a shareholder wishing to sell shares
  • Dispute resolution mechanisms dealing with deadlock, arbitration and minority shareholder protection
  • An exit strategy. What will happen when a third party wants to buy the company as a whole and not all of the shareholders want to sell? The inclusion of minority protection, or “come-along” and “tag-along” clauses, can be essential in these circumstances

Ideally, a shareholders agreement should be drafted in the early stages of a company’s existence and before disputes arise. Previously, this was a process beyond the financial reach of most newly formed companies, but by combining legal know-how with the latest technology, online solutions to properly regulate the internal affairs of a company are now making this much more accessible.

The content in this article has been provided by Richard van Helden, Director of Legal Services at Law Unlocked. Law Unlocked is generally regarded as the current market-leader in the provision of web-based legal solutions, offering fully customised legal documents online and delivered the same day.

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