Points to look out for in a Shareholders’ Agreement

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Tim Edwards Thursfields

When setting up a new company, it is common for shareholders (SH), as owners of the company, to enter into a Shareholders’ Agreement (SHA). It is highly recommended and common for SHs to enter into on the registration of a new company but may be entered into at any time in the life of a company.

Tim Edwards, Director in the Corporate Team, Thursfields Solicitors considers what to look out for in Shareholder’s Agreements.

 Purpose of a Shareholders’ Agreement

Through entering into a SHA, the SHs can regulate the exercise of their rights in relation to the company and commit to how they will behave and run the company. If you have a SHA, it is therefore important to keep it in order to protect each SH’s interests.

There  are a number of key clauses that should be included that will facilitate decision making both for board members and shareholders.

Company decisions can be taken by the board (as appointed directors) to manage the company on a day to day basis, however, to main control and in some cases as a legislative requirement, SHs can reserve certain important decisions and restrict director decision making on the management of the company to the SHs.

A SHA should set out the restrictions that the SHs are likely to want to control, as far as possible e.g. changes to the articles of association, alteration of share rights, increase or reduce the amount of share capital.

A SHA can help protect a minority SH and their interest where they would not otherwise have that protection. Important changes to the company can be decided by all the consent of the shareholders (100%) and not just by the standard position i.e. by majority voting rights.

Therefore, for certain reserved matters, there should be an undertaking in the SHA that the company will require the consent of all parties and not simply the majority of SHs.

  • Voluntary Transfer of shares – pre-emption rights and permitted transfers

What happens if a shareholder wants to transfer their shares?

A common position is that pre-emption rights apply (right of first refusal) e.g.  if anyone wishes to transfer their shares, they must first offer them to the existing shareholders (pro-rated in accordance with their % shareholding) on the same terms.

If the existing shareholders refuse the offer, the shares may then be offered to the company (which may choose to buy back the shares if it has sufficient distributable reserves and cash to do so).

If neither the existing shareholders nor the company wish to acquire the shares, the SHA can outline whether the shares be transferred to a third party. The SHA should prohibit transfers to specific third parties or to any third party that competes with the business of the continuing shareholder.

The SHA may also specify various transfers to third parties which are free from restrictions such as pre-emption rights. These are commonly known as permitted transfers. Examples of permitted transfers may include transfers to family members and family trusts.

  • Issue of shares – anti dilution

 The SHA should include provisions dealing with the directors’ authority to allot and issue further shares. Additional equity subscriptions can dilute the voting power and rights of existing shareholders. It is important that the SHA contains anti-dilution mechanisms before the issue of any new shares to protect the SHs against a dilution of their shares and voting rights.

  • Buy out events  

It is important that the SHA deals with what happens to a SH’s shares when certain events occur e.g. death, bankruptcy, mental incapacity, termination of employment (if the shareholder is a key employee) or if there is a material breach of the SHA.

These are often known as “buy out events” or “compulsory transfer events”, where on the occurrence of such event a SH’s shares are automatically offered for sale to the other shareholders or the company at a specified price (often nominal value).

This is particularly important where a SH is also key employee. SHAs may contain detailed leaver provisions governing the circumstances surrounding the termination or cessation of the SH’s employment.  Generally referred to as “Good Leaver” “Bad Leaver” provisions, these circumstances will ultimately determine the sale price for the SH’s shares on his or her exit.

  • Drag along and tag along rights

Drag and tag along rights are commonly included in SHA to deal with a majority and a minority SH.

Drag along right provides for a majority of the SHs to accept an offer for the sale of the entire issued share capital of the company and to force the holders of the remaining minority SHs to accept such an offer.

Tag along rights puts a minority SH first. Tag along rights enable certain shareholders (usually minority shareholders) to force other shareholders (who wish to sell their shares) to procure that an offer on the same terms is made to them also.

  • Restrictive covenants when a shareholder leaves

The SHA should include provisions dealing with the departure of a SH. These are called restrictive covenants and are usually included to prevent shareholders from competing with the business of the company.

The following set of restrictions are common:

No holding out – to associate with the company or hold out being employed in any way with the company.

Non-compete – to protect the goodwill of the business and not to operate in the same geographical area of the company or for a certain time period deal with any clients of the company.

Non-solicitation – offering of employment to employees or enticing away from the company any employees.

It is usual for these restrictions to apply at any time when the party in question is a SH and for a time period after ceasing to be a SH e.g. a number of months or a number of years.

  • Dividends

The SHA should include provisions on dividend policy (sharing the profit) and whether the board or SHs will decide the payment of dividends.

Conclusion:

 A SHA is highly recommended where there is more than one shareholder. This is to regulate the exercise of their rights and control in relation to the company and to set out how they will commit to run the company.

A SHA may be entered into at any time in the life of a company and there are a number of things to look out for in a SHA to protect a SHs interest during their ownership of the company.

Thursfields Solicitors have built our reputation by providing timely and practical advice to our clients.  We understand that it can often be difficult to find the time to deal with corporate matters.  With this in mind, we will tailor our approach to suit you and take your instructions in whatever way best suits you – by ‘phone, video conference or in person at our Birmingham, Solihull, Worcester, Kidderminster or Halesowen  offices. We have an excellent team of specialist corporate, personal, and family solicitors to look after you, your family and your business.

More information

If you would like more information, please contact Tim Edwards at Thursfields on 0345 20 73 72 8 or tedwards@thursfields.co.uk

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