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Posted on April 24, 2021
Getting into a new business, or carrying- out a newly structured existing one, is a much exciting venture yet there are lots of pivotal things to consider before it. The one aspect which is often overlooked during this process is the apt frame of a shareholder agreement.
This agreement is a type of official document which nurtures the relationship between many shareholders of a company and gives you the provision about how a company should run the long way.
Though it is not a mandatory legal requirement for a private organization to have a shareholders’ agreement, we at Kanakkupillai would always recommend doing that. This provides you with the opportunity to frame how you want your company to be, but also what should be done if things are not happening as per the plan.
At the initial stage, it is hard to imagine what could actually go wrong, especially when your business is going to happen with family or friends. This is the reason; shareholders’ agreements are often an afterthought if the relationship between the shareholders breaks down.
Added to this, various shareholders may require different provisions depending on how many shares they own in the company. For instance, minority shareholders will be more interested in provisions that safeguard them from being confined from taking decisions, and majority shareholders usually are more interested in provisions that allow them to ensure they are not bonded to some randomness by the minority. The founder shareholder agreements often differ from that of shareholder agreements involving later investors(external). Some of the important points to be noted on shareholder agreement are
Retaining Shareholder Power
When the Director of a privately held organization holds the maximum power of running the company day-to-day, it is vital to produce an outline in the shareholder agreement that what power each shareholder should possess. This includes when a director wants to obtain shareholder permission to obtain further investment. Such restrictions on directors permit the shareholders to cut short the power of a director in making major company decisions by having shareholder approval.
A falling back position to appoint a director is more than 50% majority of the shareholders. It may not be always favourable, so the remaining percentage of the shareholders have never had a wise choice. In such a case, the shareholder agreement may include some provisions so that the decisions would require75% majority over the other. This gives an option for the majority of the shareholder interests to be counted for and give them a choice on whom and when to appoint a director.
One major concern of a shareholder will be how to receive profit from the company they have put their money in. The shareholder document should henceforth determine how each shareholder is going to receive a beneficial business profit.
The part of this contains very crucial importance if the shareholder holds a much different variety of shares and have different rights attached to the shareholders. When such data are documented can be resulted in preventing disputes being arisen, when dividends are paid properly.
Protection of Majority and Minority Shareholders
Every private organization has both the majority and minority shareholders. This indirectly conveys that the shareholder agreement requires provision which protects every minority shareholder from being taken out of all the important decisions, especially during the allotment and transfer of shares. In such cases, the shareholder agreement should require unanimity with the shareholders. On the other side, provisions are to be included to protect majority shareholders from preventing the minorities-blocking some prominent decisions and that resulted in the company being stagnant on its growth.
Good or Bad Leaver Provisions
While the shareholders are all together, any requirement of a shareholder being left is not a priority or acceptable. In the event, the shareholder agreement should add both the good and bad leaver provisions. This may influence on what price the shares can be sold to another shareholder when a particular shareholder leaves. For example, a good leaver will be probably a retiring shareholder and may sell his/her shares back for the best market value, whereas a bad leaver, the one is terminated can also be forced to sell the shares at the bare market value or the nominal price paid for them.
Dividends and financing
The agreement of all shareholders must specify the apt circumstances when the dividends may be payable, as such whether to pay or not to pay the past shareholder contributions which have to be repaired initially. Another set of shareholders’ agreements can also provide for broad terms & conditions on which shareholder has “initial or first rights” to initiate further funding before the company is looking for some external funding.
Transfer of shares
A critical factor in a shareholders’ agreement, and usually has a bundle of pre-emptive rights, drags, tags, come along, me too and some other similarly named clauses that broadly provides for circumstances against which some shareholders may require other shareholders, or required by one or two other shareholders, to come in a sale to a third party. Shareholders should also consider whether he/she must transfer the shares if they being no longer participate in the management or operations of the company, and if so, whether some of their shares or even all of the shares are transferred at a nominal value.
The shareholder agreement must also make a clear note and identify the proper exit strategy. It could be a buy-out, sale of a business, listing, as well as making strategies on what might happen if a much-needed shareholder wants to exit, and at value, they may or want to exit.
The shareholders’ agreement should set out a list of events of default and the consequences of default by a shareholder, including whether that shareholder is forced to transfer their shares, and if so whether the valuation would be at the market or “fire sale” value.
Deadlocks and disputes
Every shareholder agreement must set out the consequences list and it would be useful when there is a deadlock or if a dispute that cannot be resolved at ease. Provisions that are usually seen in a shareholder agreement must also have included “shotgun” provisions; where a specific party nominates a price by which it is willing to buy-out or be bought out by the other shareholders. Other provision includes call and put options or even sometimes a forced shutdown or winding up of the company.
Rights to access information
Particularly, when you are not a director, the rights to receive the company’s information will relatively be confined. If you need any regular reports from the company and if you wish to be aware of some specific or important events, then it should be mentioned priory in the shareholders’ agreement.