Key Clauses in Shareholders’ Agreements

Balancing the wishes of company directors against those of shareholders can be difficult. Directors need to have a certain amount of freedom to conduct business as they see fit and create a profitable company. Shareholders, who have a vested interest in the company, also want to have some input and to impose some restraint on directors in respect of bigger decisions.

This is where a shareholders’ agreement comes in. It sets out the rights and responsibilities of the shareholders and directors who are signatories to it and gives each party enough of a say in the business so that they feel they have an element of control.

Where payment is made and shares are issued in return, the document is a binding contract.

It is worth putting some time and effort into drawing up exactly the right agreement, tailor-made for your company, as this is the document that will be put before the court should a dispute arise.

In fact, the document can help avoid costly legal action by setting out exactly what behaviour is allowed by directors and shareholders and by insisting on arbitration and mediation before legal proceedings are issued.

The agreement should be drawn up by a commercial lawyer who has a thorough working knowledge of company law. Each signatory should take independent legal advice before signing.

Some of the key clauses usually found in shareholders’ agreements are as follows:- 

1. Rights reserved for shareholder

To prevent shareholders’ interests being overlooked, the agreement will include matters which are to be decided by shareholders. Examples include the appointment or removal of a director, the issuing of new shares, directors’ salaries and salary review, bank loans and the appointment of professionals such as banks and valuers.

2. Matters requiring a vote by shareholders

Again, to give shareholders a say and prevent their interests being excluded, some matters can require their approval by vote. These can include the company’s business activities, the amount of any borrowing, rate of expansion, the amount of dividends to be paid and employment contract terms of senior employees.

3. Transfer and veto of shares and pre-emptive rights

To prevent the shareholdings of existing shareholders being diluted by the issue of new shares, a right of first refusal can be included in the agreement. Shares will then be offered to existing shareholders in proportions equal to their holding and at the same price as it is proposed to offer them on the open market.

Alternatively right of veto can be given to shareholders to prevent the issue of new shares or transfer of existing shares.

4. Buyout provisions and share vesting

In the event that shareholders no longer wish to continue together, the agreement will set out details of how one party may buy out the other. There are numerous ways of doing this, for example sealed bids, where the highest offer buys the other party’s shares.

A share vesting clause will ensure that shareholders cannot abandon the company shortly after receiving their shares; it will state that the shareholder must serve a specified period of time with the company or meet a target before the shares are fully vested in them.

5. Non-compete clause

This clause will prevent shareholders from having involvement in a competing company during the period of their shareholding and for a set period afterwards. Similarly, they can be prohibited from approaching the company’s employees with a view to poaching them.

6. Good and bad leavers clauses

Examples of good leaving include incapacity due to health problems, retirement, redundancy or death.

Examples of bad leaving include dismissal, gross misconduct, bankruptcy or leaving before the end of an agreed period.

The shareholders’ agreement will define good and bad leavers and make provision for the buying back of their shares. The good leaver will receive more for their shares than the bad leaver. This clause prevents someone from leaving the company but holding on to shares or selling them on to a third party.

7. Drag-along and tag-along provisions

Drag-along and tag-along provisions prevent minority shareholders from being excluded from a share deal. Where a majority shareholder wants to sell, a drag-along clause can force minority shareholders to sell as well. This allows a potential buyer to acquire all or most of the company’s shares and makes the purchase more alluring than it would be if a new buyer had to deal with numerous smaller stakeholders.

A tag-along provision allows minority shareholders to join in with any sale, should they wish to. This prevents them from ending up with a new majority shareholder who may be intent on taking the company in a different direction.

8. Dispute resolution

Dispute resolution provision is one of the most important clauses in the agreement. It should set out in detail the procedure to be followed in the event of disagreement. Usually arbitration is stipulated before any court case can be commenced, with the intention of legal action being avoided if at all possible.

9. Rights and restrictive covenants

Restrictive covenants can prevent shareholders from acting in a way that may be detrimental to the company. For example, they can be bound by a duty of confidentiality in respect of the company’s dealings and financial affairs, to include the shareholder agreement itself. Rights can be granted to shareholders, for example to view management accounts and other financial documentation.

Do I need a Shareholder’ Agreement?

A well-drafted shareholders’ agreement can take time to put together. It should be tailored exactly to the particular business it seeks to protect and should be detailed and precise. By taking time at the outset to cover every eventuality, it is hoped that expensive and time-consuming trouble will be avoided later on.

An excellent shareholders’ agreement is also a sign of a well-run business and will be a point in its favour should the company ever be sold. In fact, a serious buyer is likely to insist on a properly drafted shareholders’ agreement before proceeding.

Make sure that the agreement is detailed and extensive and that each signatory obtains independent legal advice before signing. That way, the document is likely to provide a framework for future share dealings and give shareholders the security of knowing that their rights and responsibilities are properly protected.

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