Essential Clauses in a Shareholder’s Agreement
Unlock the power of a shareholder’s agreement – your secret weapon beyond company articles. Dive into a private world of rights, obligations, and smart strategies for seamless operations, share transactions, and dispute resolution
A shareholder’s agreement is contract that regulates the management of the company. It essentially supplements the articles of association and will include clauses that may not be included in the articles. It outlines rights and obligations, company operations, shareholder roles, regulates share transactions, and governs dispute resolution.
Unlike the Articles of Association, the shareholders agreement is private document which does not require registration at the Companies Registry therefore safeguarding confidential information.
The following are salient terms in a Shareholders Agreement:
1. Capital contribution
The shareholder agreement should outline the obligations and the processes by which additional capital can be raised.
2. Company operations
The shareholder agreement should specify the frequency for meetings, quorum to vote on issues, and how meetings can be called when special issues arise. The agreement should also provide the rights and responsibilities of Shareholders and Directors and rules on appointment of Directors.
3. Share Transfer
a. Good and bad leaver rights
This is a provision that governs how shares are treated depending on the circumstances of departure of the shareholder, normally an Employee who has been offered shares as an incentive for working in a Company.
A good leaver refers to a shareholder who departs from the company due to circumstances beyond their control such as death, retirement, permanent disability or permanent incapacity through illness, or redundancy. In this case the shareholder may retain their shares if they are able to. A bad leaver is a shareholder who departs from the company within their control or through an agreement, such as resignation, dismissal, breach of contract or bankruptcy. A bad leaver is obliged to sell their shares on exit to the other shareholders and will in return get simply the nominal value of the shares.
b. Pre-emptive rights
As the name suggests, pre-emption rights allow existing shareholders to acquire shares prior to those shares being offered to third parties. This means that existing shareholders have the opportunity to preserve their proportionate ownership in the company, even if new shares are issued.
c. Tag-along and Drag-along rights
Tag along rights enable minority shareholders to have their shares bought on the same terms and for the same price as shares of majority shareholders. Tag-along rights provide minority shareholders with a potentially viable exit route as they will not be forced to remain in partnership with a new and unfamiliar partner. In the context of share transfers, a tag-along right will often afford minority shareholders with a greater degree of protection as compared with a right of pre-emption, especially in situations where the minority may not have the financial resources to acquire a majority stake.
Drag along rights require the minority shareholders to sell their shares to a bona fide purchaser, on the same terms and for the same price as a majority shareholder. A drag-along right enables the selling majority shareholder to procure an exit by forcing the remaining minority shareholders to similarly sell their shares to a bona fide third-party purchaser on the same terms.
4. Dividend Policy
The shareholder agreement should provide guidelines for distribution of profits among shareholders.
5. Non-Compete
The shareholder agreement should contain a non-compete clause, prohibiting shareholders and Officers from participating in competitive business to the company while they remain Officers of the Company and for a period of time afterwards. It includes the dos and don’ts, the scope and the period of these restrictions. On the flipside, such a covenant may prohibit shareholders from luring key customers, employees or suppliers of the company after exiting as shareholders from the company.
The aim of this clause is to ensure that internal knowledge, which is crucial for the company to stay competitive, stays confidential.
6. Dispute resolution
There must be a procedure outlining how disagreements should be resolved. Differences in the views of shareholders of a company can occasionally become problematic especially with respect to critical business matters. Such disagreements may lead to deadlock situation which ends up hampering the execution of critical business decisions. To mitigate this, a shareholders’ agreement must define what constitutes a deadlock and the process to follow if this situation occurs. There are various types of deadlock resolution clauses, each bearing its own set of implications.
The shareholders should only include important matters in the deadlock clause to avoid the process being triggered for matters which do not have a significant impact on the company’s business.
Conclusion
A shareholders' agreement establishes a structured framework for company operations. It safeguards the Company’s interests and creates transparency, promoting stability and confidence among shareholders.
It is important to note that the shareholders’ agreement and the articles need to work cohesively. If there are contradictions, it can be complex to make decisions.
How we can help
At CM SME Club, we provide valuable legal advice and guide businesses on the incorporation of Companies including advising on the documentation required to protect the interests of the Company. Contact law@cmsmeclub.com for assistance.
Published on Aug. 22, 2024, 1:10 p.m.