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1) Reasons
A Shareholder Agreement is entered into by the current shareholders in a company. A shareholders agreement is similar to a partnership agreement and is designed to assist in resolving issues when:-
a) one of the shareholders dies;
b) it is not possible to have unanimous agreement;
c) a deadlock arises between the Shareholders; and
d) a shareholders decides to sell his interest.
A shareholders agreement will provide stability and guidance when conflict arises between the shareholders.
This note is designed to help you have clear discussions in relation to the agreement. Coupled with the enclosed response form it is also an aid to provide clear instructions.
2) Shareholder Unanimity
Shareholders need to have control of their investment.
A Shareholder agreement and the articles of association can set down rules in relation to which decisions have to be unanimously made and which decisions can be made by a majority vote.
Common areas for the directors to require unanimity on are:-
a) Change of name;
b) Selling or disposing of the assets of the company;
c) Alter any shareholder class rights;
d) Conduct business with any family member or connected person;
e) Enter into any voluntary liquidation or winding up;
f) Merge with any other company;
g) Acquire any asset or interest greater than a specified sum;
h) Enter any contract of a value exceeding a specified sum;
i) Amend the share capital of the company;
j) Borrow money in excess of a limit agreed between the shareholder;
k) Give a guarantee other than in connection with the companies ordinary business.
l) Lend any money other than in the ordinary course of business;
m) Remove any Director appointed by a shareholder;
n) Resolve to change the nature of the business or the way the business is conducted;
o) Hold any meeting of shareholders unless all are present or they have appointed suitable representatives or proxies.
p) The listing of the company on a stock market or the change in the nature of the business;
q) Amendment of the articles of association or clause 3 in the memorandum of association;
These resolutions are designed to increase the control shareholders have in the running of the company.
3) Good Leaver/Bad Leaver
In an owner managed venture it is often the case that shareholders are also employees. Should the employee/shareholder act in a way prejudicial to the company how much value is attributable to the shares?
It is common that a fine is levied on a bad leaver whereby their shares are bought over for nominal value. A good leaver's shares will be bought for full value as determined by the independent expert.
A good lever is someone who leaves the company by retirement, death or disability. A bad leaver means leaving under circumstances where summary dismissal is justifiable i.e. fraud etc.
4) Pre-emption
Shareholders may require the right to buy the shares of a leaving shareholders or to buy a proportionate quota if new shares are being issued to raise capital to protect the value of their investment. These rights are called pre-emption rights.
The pre-emption right can be waived with a letter from each shareholder.
5) Lock In / Lock Out
Shares are assets and provided the Board of Directors agrees to accept the transfer a shareholder can leave at any time provided he has a buyer. This can create insecurity in a new business.
Shareholders can agree to a lock in period to prevent investors leaving the company at a time when there may be instability such as start up.
Alternatively Shareholders can agree not to issue further shares and therefore lock out any other potential shareholders. This may be useful in a business which is established. It will prevent dilution of the shareholders assets.
While both lock in and lock out agreements put in place restrictions the Agreement can be drafted to ensure that these rights can be waived if there is Shareholder unanimity.
6) Deadlock
In a 50:50 company there is a potential situation whereby the shareholders/board of directors can not agree how to manage the company. There are multiple options for resolution.
a) Reciprocal Put/Call Options - A put option requires one party to sell shares to the other. A call option requires one party to buy shares from the other. Put/Call Options if used can decide the deadlock and set in place a pre-ordained mechanism for valuing the shares. If a deadlock exists one party can automatically buy the other out by evoking the option.
b) Russian Roulette – Notice is served on one party requiring the other to sell the shares at a value. Should the other party not wish to sell they are required to buy the other parties shares at the value specified in the notice.
c) Texas Shootout – If the provision is invoked it requires both parties to submit a sealed bid to an auctioneer. The party who has offered the highest amount for the other shares wins the shootout and is given the opportunity to buy the shares.
(a) is the simplest provision to operate under however it means the shareholding is insecure and the one shareholder could easily remove the other whether or not there is a deadlock. (b) and (c) take longer to evoke however reduce the opportunity for one shareholder to easily obtain all shares.
In any event, valuation is an inexact science. Advice should be sought from an accountant as to the best way to value your particular business. The two main ways of valuing a company are:
(i) totalling the value of the asset; or
(ii) multiplying turnover by a P/E Ratio common to your companies market.
7) Dealings in Shares
Under the Shareholders Agreement it is common to prohibit the dealing in the shares subject to the agreement of both parties. To protect the interest of the majority or minority shareholder you can alter the Articles of Association to give specific rights and make the Shareholders Agreement subject to those.
a) Drag Along – The right for the majority of shareholders to accept an offer to buy their shares and to force the holders of the remaining shares to sell to the intended purchaser at the specified value.
b) Tag Along – The right to require the majority shareholders to procure an offer for the shares benefiting the rights. This right is a protection for minority shareholders.
In a 50:50 company adding the above rights mean if one person finds a purchaser both will have to sell. A higher purchase value can be achieved if the entire share capital of the company is sold.
8) Permitted Transfers
Whilst the transfer of shares may be prohibited the parties can agree to a list of permitted transfers. In relation to individuals these may include a specified relation, family trust or trustee of a family trust.
Permitted transfers are used in estate and IHT Planning. They may also be useful if the shareholder wishes to leave his part of the business to a son or daughter who is interested in carrying on the business.
9) Finances
When planning for future business dealings you should also review your finances and your ability to raise capital in the event that one shareholder wishes to buy the other out. While it is difficult to predict future financial states it is key in any exit strategy.
a) Charging personal assets – If you are a shareholder in a personal capacity you may be able to mortgage your property to purchase the shares. You should review your personal equity before making any decisions.
b) Debenture or Floating Charge – If you wish the company to buy or redeem the shares you should decide whether the company will have the ability to raise a loan on the assets of the company. It may be an idea to talk to your relationship manager at the Bank who will be able to advise you in this matter.
c) Life Policy – If you are planning for a situation involving the death of one shareholder you should consider an adequate life policy. The life policy should be written in trust for the other shareholders. You should also put in place reciprocal options to buy those shares on the event of death.
11) Conclusion
These notes have been designed to assist in planning your shareholder relationship. Should you require any further information or assistance please do not hesitate to contact our Business Services Team.
