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13 September 2018
A benefit of a shareholders’ agreement is you can regulate the affairs of the company privately without the public gaze that attaches to articles. You can also impose restrictions on the activities of shareholders both during ownership of shares and after sale of their shares.
Please do call us if you have a question or need your shareholders’ agreement reviewed. We are always happy to provide a scope and estimate.
Our expertise in dealing with shareholders’ agreements is not just limited to drafting clauses. We deal with tax questions, valuation of shares in private companies and resolution of shareholder disputes. We do handle contentious situations between shareholders and directors always seeking out workable solutions. Some of the benefits we offer include:
To help you understand the issues we have explained below some of the more common considerations in play.
Different companies will have different reasons for implementing a shareholders’ agreement. Based on past experience we see the most common uses as including:
The most common reason why shareholder agreements are implemented is to set out the rights of shareholders.
To cater for different shareholder groups the solution is often to create different classes of shares each class carrying different rights to dividend, voting and capital. The shareholders’ agreement can be the means through which the different share classes and rights are managed and capital is controlled by the intended shareholders.
If an employee or director stops working for the company do you want that person keeping the shares? Retaining shares is often not in the employer’s nor the remaining shareholders’ interests. But, without a shareholders’ agreement forcing the transfer of shares the ex-employee or director will be allowed to retain shares indefinitely.
In a shareholders agreement there can be a variety of formulas for share valuation. The benefit of pre-agreed provisions is, it will cut down on shareholder disputes. The most common disputes arise over the value shareholders’ can demand for their shares if they either want to exit or are forced to transfer shares under a compulsory transfer provision.
A shareholder can refuse to sell his shares even if other shareholders think the sale is a good deal. This risk can be removed with a shareholders’ agreement.
A shareholders’ agreement can be used to enhance the powers of minority shareholders granted under the Companies Act. In effect, the shareholders’ agreement can overwrite the Companies Act or the articles of association to give them more rights to all or any of the dividends, voting or capital.
You may find it impossible, or at best difficult, to remove directors if you have not secured this power in the shareholders’ agreement. The process under the Companies Act can be speeded up via the shareholders’ agreement. In practice if a director is not performing, delay in removing him can be commercially damaging to the business.
It pays to have considered and to have documented before a dispute arises:
Your investment can be diluted without your approval if you have not taken steps to protect your position. Directors and shareholders need to consider dilution carefully and weigh up preserving capital against using new share capital for funding.
A shareholder does not owe any fiduciary rights to other shareholders. There is only a fiduciary obligation placed on directors. This means that if you do not build in restrictions a shareholder may abuse his position. A way to prevent abuse is to include restrictions on the shareholder in the shareholders’ agreement.
A common approach is to require the shareholders to enter into non-compete covenants. For example, a shareholders’ agreement could prevent existing or former shareholders from say:
The restrictions can apply to all or selected shareholders.
The length of time after ceasing to be a shareholder that the restriction can apply does have to match the business needs. But periods of up to two years are not uncommon. Different restrictions can last for different amounts of time. We can talk to you have what would be suitable for your business.
The value to be paid on a transfer of shares in a private company where there is no “market” is often an area of difficulty. Often there is little or no published material reporting values of similar transactions.
The shareholder agreement can cover off certain aspects to reduce this vulnerability. For example:
There are a variety of valuation methods which could be adopted. For example a percentage of the EBITDA is often adopted for trading companies. With investment based businesses, an asset based valuation may be more appropriate. Dividend yields can be taken into account. The best formula to use will depend upon the business and the shareholder group.
The shareholders’ agreement can deal specifically with discounts for minority interests by either specifically catering for a discount or expressly stating there is no discount.
Another area for discount can revolve around whether the shareholder is a good or bad leaver.
Referral to an independent expert can resolve issues or it can be left in the hands of the company’s accountants.
It can be tax efficient for the company to buy back shares from a departing shareholder. The shares bought back are cancelled thereby increasing the percentage of shares held by existing shareholders. The buy back is funded from distributable reserves.
To avoid problems, it is possible for the Company to preserve the right to buy back shares in priority to the transfer of shares to other shareholders under the shareholders’ agreement. It is also possible to include provisions for the method of calculating the transfer value.
A shareholders’ agreement gives the parties flexibility to create options over shares. We describe three of the common options below:
Here, a shareholder is given the option to “call” on the company to issue further shares, i.e. create more shares for the benefit of the shareholder. Another variation of a call option is where the company or a shareholder(s) can call on another shareholder to buy more shares. The circumstances in which the call can be exercised are set out in the shareholders’ agreement.
With a put option a shareholder or the company can force a shareholder(s) to sell his shares. Like a call option, this option is usually subject to certain conditions. The key condition here is usually price, the fall back being fair value determined by an expert. We do value shares in private companies.
One of the most complex relationships to disentangle is two 50/50 joint owners of a company. Typically, each is a shareholder, a director and an employee. Each has different rights and responsibilities in each role.
50/50 shareholders often think, wrongly, that they do not need a shareholders’ agreement. But, without a shareholders’ agreement:
In our experience problems can be avoided if there is a shareholders’ agreement with a dispute resolution clause. The requirement could be that:
Unlike the company’s articles of association the shareholders’ agreement is not a public record filed at Companies House. The shareholders’ agreement sits alongside the articles of association filling in the details the business may not want made public.
However, the shareholders’ agreement will have to be signed by all shareholders. There are often competing interests to navigate. We do get involved with negotiating points and steering matters to a conclusion.
A shareholders’ agreement cannot be amended without the consent of all shareholders. This contrasts with the articles where unless agreed otherwise only 75% of shareholders have to consent to change the articles.
Without undue fuss and complication Gannons dealt with my worries.
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