The top questions any shareholders agreement needs to address

July 2023

Rating system:
Reading time (1-10 minutes): a fair while
Sophistication level (1 (idiot) – 10 (expert)): 6
Entertainment value (1 (turgid) – 10 (side-splitting)): I thought 7. My test panel said 2.

This is the fourth to be released of a series of Guides about shareholder arrangements.

My first Guide explained the default position where you don’t have a shareholders agreement or tailored Articles of Association for your company.

The second Guide was a short introductory one as to why you might need a shareholders agreement in different shareholder scenarios which can arise during the course of a company’s lifecycle.

The third Guide set out some questions founders should consider before they even think of divvying up the shares or asking someone to draft a shareholders agreement for them.

This Guide sets out some of the key starting questions to ask when putting together any shareholders agreement, particularly one between founders. It may look meaty, but it is in no way a comprehensive list as every case is different and should be tailored to its particular circumstances.

The next few Guides will focus on the particular scenario of the ‘deadlock’ company (generally, where the shares are held equally by two founders).

Later Guides will explore in more detail the kinds of issues which need to be considered in other shareholder scenarios (such as bringing in various types of investor).

 

So let’s crack on. Here are just some of the key issues to address in any shareholders agreement:

Control and management

• Voting rights at shareholder and director level. How are the shareholdings on the company held? Which shareholder or group of shareholders holds a controlling interest of shares? Who holds any balance of power? Who controls the board of directors?
• Who should be directors? Should certain shareholders or group of shareholders have any special rights to be directors or to appoint and remove a certain number of their own nominated directors?
• Should all shareholders have voting shares? Do you want different classes of shares with different voting rights?
• Should any shareholders or group of shareholders have the rights to veto certain decisions? Should a particular majority of shareholders have to approve certain key decisions? See ‘veto rights’ below.
• Should the chairman of a shareholders meeting or a board meeting have a casting vote? Who should be the chairman?
• What quorum does there need to be to hold a meeting? Do particular directors need to be present? But what then should happen if someone keeps refusing to turn up?
• Should regular business plans be prepared and agreed each year?
• How should any disagreement or deadlock in decision making be dealt with?

Veto rights

Most investors and other shareholders in private companies are happy for the company to be run by its management, as appointed by the founder shareholders or majority shareholders; but they want to build in the ability to protect their interests if they think things are going awry. This could be to prevent the ‘controlling’ shareholders running the company too much with their own interests in mind, or simply to give the minority shareholders comfort that they can step in if they think the company is being badly managed.

Should certain minority shareholders or groups of shareholders (or their appointed directors, if any) have veto rights over certain material decisions? Or should a specified majority vote of shareholders be required to approve certain decisions? (eg 75%? Much depends on how the shareholdings are actually made up between different shareholding interests).

The following are some examples of issues on which veto rights might be given:

• Issuing new shares/bringing in other shareholders
• Grants of options
• Capital expenditure or contractual commitments over pre-agreed limits
• Borrowing limits
• Major acquisitions/disposals
• Significant changes in the nature of the company’s business
• Declaring dividends
• Appointment and dismissal of directors
• Material dealings with IPR
• Dealings between the joint venture company and its shareholders or anyone connected with them.

Where shareholders’ interests are represented by their appointed directors on the board, most issues can be resolved by the board. But beware the position where a shareholder’s interests are actually different from those of the company itself – an appointed director could be in breach of his duties as a director if he simply votes as directed by his appointing shareholder. So it can be sensible to provide for certain issues to be decided or ratified by the shareholders themselves.

Working commitments to the company and consequences of failing to meet commitments

• Are the other shareholders relying on any shareholders to provide ongoing work or other commitments to the company?
• Should any shareholders have employment contracts with the company?
• Should a majority of shareholders be able to remove any other shareholder as a director or employee?
• Should any shareholders have to put their shares up for sale if they resign as directors or employees or are removed as directors or employees?
• If so, should some or all remaining shareholders have pre-emption rights to buy their shares?
• How should their shares be valued? Would it depend on the circumstances of their leaving, or on how long they have worked in the business?
• Are any shareholders expected to commit to provide or find future funding for the company in certain circumstances? Are some or all shareholders expected to contribute to future funding, or to provide guarantees? What happens if they don’t?

Information rights

What rights should any non-director shareholders have to receive information about the company?

Loyalty to the company

• Should shareholders agree to give confidentiality obligations to the others and to the company?
• Should shareholders commit not to compete with the company or poach its staff or customers for another business both while they remain as shareholders or directors and for a period of time afterwards?

Leaving the company

• What can a shareholder do if they want to leave the company? It can be very hard to find a buyer for your shares if you are not the controlling shareholder of a company!
• How should their shares be dealt with? Can they sell to anyone they want, or should any particular shareholders have the first right to buy these shares (‘pre-emption rights’)? If other shareholders don’t take up their right to buy, can the seller then sell to anyone outside the company instead? Should any outsiders have to sign up as parties to the shareholders agreement?
• Permitted transfers:
  • Should a shareholder be permitted to transfer shares to some family members or family trusts?
  • Should a shareholder be permitted to transfer shares to particular business associates, or to other companies he has a stake in (or group companies in the case of corporate shareholders)?
  • Should a shareholder be permitted to transfer his shares to anyone else? What about competitors of the joint venture company or of any of its other shareholders?
• Should there be a period of time when some or all shareholders should not be entitled to sell their shares at all? – a lock-in period? How long?
• Mandatory transfers:
  • Should a shareholder be forced to offer his shares to other shareholders (a mandatory transfer notice) in certain circumstances? Eg:
    • If they resign or retire as employees or directors.
    • If they are removed as employees or directors? (This begs questions as to possible circumstances in which this might happen).
    • On death or critical illness? This is one circumstance which can often be insured against, and there are a number of arrangements which can be entered into enabling the remaining shareholders or the company itself to acquire the shares of a deceased shareholder for a pre-agreed amount using the proceeds of an insurance policy.
    • Insolvency of a shareholder?
    • Material breach of the shareholders agreement?
    • A change in how a particular shareholder is itself owned or controlled?
    • Any other prescribed events?
  • How should the shares be valued on a mandatory transfer notice?
    • On a going concern basis?
    • On a net asset basis?
    • Any other accounting criteria to factor in?
    • Who should make the decision – the company’s auditors? By reference to last audited accounts? Should new accounts be drawn up?
    • What discount if any should be applied to reflect the minority shareholding?
    • Should the value be reduced to penalise the shareholder?
    • Should a shareholder who is an employee be paid a reduced value depending on the timing or circumstances behind his employment ending, eg if he has resigned before a certain date, or if he is dismissed for misconduct?
  • Would there be any other terms governing any such sale? For example should the buyer be able to pay the price in instalments?
  • If the other shareholders cannot or will not buy, what should happen? Should the company be wound up?

Dividends

• If you have over 50% of the voting shares you can decide when to make dividends. Otherwise shareholders have no automatic right to receive dividends. So, do the shareholders need to agree dividend policies in advance?
• Are any director shareholders expecting to be paid dividends rather than salary? Have you considered setting up a share structure with different classes of share (‘alphabet shares’) so that this can be done?

Exit planning

• What should happen if some shareholders want to sell the company but others don’t?
• Unless you have at least a 90% shareholding, you cannot force a sale of all the shares in the company. It is up to each shareholder to decide if he wants to sell. And unless you can sell the entire company (ie all the shares in it) you are generally unlikely to be able to find a buyer.
• Have all shareholders agreed a timeframe within which the objective is to sell the company? What might happen if this objective is not achieved? Can any shareholder try to force a sale of the company after that time so that they can sell their shares?
• Should any particular shareholders or prescribed majority of shareholders be entitled to put the whole company up for sale at any time and ‘drag along’ all other shareholders so they have to sell on the same terms? For a client who is setting up a company in which he will be the majority shareholder, this is one provision I will always recommend. Apart from this, he may not really need a shareholders agreement, as he already holds all the cards. But unless you own over 90% of shares in a company, you can’t force another shareholder to sell his shares.
• Conversely, if you are a minority shareholder, do you want a provision saying that if the majority shareholders want to sell their shares they should also make sure that the prospective buyer also offers to buy your shares as well, and on no worse terms?
• Should a majority of shareholders be allowed to sell some or all of their shares without being required to allow other shareholders to ‘tag along’ by selling their shares as well?
• If you have a controlling shareholding you may be able to arrange for the business and assets of the company to be sold as a going concern leaving the sale proceeds to be distributed between the shareholders by way of dividends or by way of a return of capital on a subsequent winding up. If you have over 75% of the voting shares you can decide when to wind up the company, which can occasionally be a sensible way to realise and sell its assets and distribute the proceeds to the shareholders by way of a ‘return on capital’.

How to deal with future investors or shareholders

• Who decides if new investors or shareholders can come into the company?
• Business start-ups often get started on a little money (friends, family and fools, as the saying goes) and a lot of effort. More serious money is often likely to be needed at a later stage. People with serious money want a serious stake in the business, and want to be able to protect their stake in various ways. When setting out with a new business you need to be aware in advance of the kinds of issues which are likely to arise at this stage, so you can prepare yourself as far as possible in advance.

Do you also want to have tailor-made Articles of Association?

There are many ways to structure a company or to entrench particular rights for different shareholders. Some of these can be dealt with by shareholders agreeing things between themselves. But most things are more conveniently done by having tailor-made Articles of Association.

The Articles can be as complicated as simple as you want them. In particular, you can create different classes of shares, each of which has different rights, such as:

• Different (or no) voting rights.
• Different rights to dividends (for example rights to fixed dividends in priority over other shareholders).
• Different rights to returns on capital on an exit (share sale, winding up or listing) (for example, growth or hurdle rights which only kick in when the company value reaches a certain level)
• Different rights to appoint or remove chosen directors.
• Different rights to veto key corporate or business decisions.
• Different rules relating to how shares can (or must) be transferred.

Summary

I trust this Guide sets out enough issues to be getting along with!

My approach is to advise that the parties to a joint venture company should consider and agree how they want to deal with all the potential issues; but should then try to keep the company structure, the Articles and any shareholders agreement as clean and simple as they can be comfortable with.

This Guide lists issues which commonly need thought when a number of different founders are going into business together. A whole lot of other issues may also need to be considered as and when the company looks to take on new investor shareholders. Any shareholders agreement should be considered on a regular basis to see whether it remains fit for purpose.

My next Guide will go in-depth (so in-depth that it will come in four separate Chapters) into the particular scenario of the ‘deadlock’ company (generally, where the shares are held equally by two founders).

What next? Contact me for a complimentary Shareholder Arrangements’ consultation:

If you are thinking of entering into any shareholder arrangements with business partners or investors or are having any issues or difficulties with existing arrangements please feel free to email me at andrew.james@onhandcounsel.co.uk to arrange a complimentary ‘Shareholder arrangements’ consultation where I can help you to identify what might be involved and how I can help. This will help you to avoid some of the pitfalls to which you might otherwise be exposed, and give you the peace of mind of knowing that you have an approachable competent corporate lawyer ONHAND who can provide you with experienced, effective and cost-effective advice and assistance.

If you are a director or shareholder of a company and want more information on how to deal with shareholders and director relationships so you can protect the value of your business and your role in it, together with your business and exit objectives, then please contact me.

Would you like to receive further Guides and other published articles containing legal updates and tips? If so, click below…
Sign up for more Guides and legal updates