If you run a company, no matter how big or small, your company shareholders agreement will be the most important legal document you’re likely to deal with.
A shareholders agreement governs the relationship between the shareholders of a company, sets out their obligations relating to the operation of the business, and identifies the duties of the directors.
In short, the shareholders agreement tells the company’s shareholders, directors and other related entities what they can and can’t do. Indeed, many entrepreneurs have lost control of their companies due to poorly drafted shareholders agreements.
Conversely, many investors have seen their investment reduced to a worthless rump for the same reason. This article sets out some of the clauses you need to keep an eye out for when drafting, reviewing or just reading a shareholders agreement.
Operation of the business
One of the first clauses in a shareholders agreement sets out how the business will be operated. In some agreements the specific duties of those shareholders who are also executives of the business will be set out. This is common in the shareholders agreements of start-ups, but less common for larger businesses.
Directors and directors duties
One of the most important clauses to review is the one relating to directors and their duties. The shareholders of a company appoint the directors.
Generally each shareholder holding a certain percentage of shares in the company will be entitled to appoint one or more directors. This information must be provided clearly in the shareholders agreement. The duties of the directors should also be clearly enunciated.
Board meetings
It’s important that the company has a formal process for running board meetings, how they can be called and the percentage of shareholders (on a holdings basis) necessary to create a quorum.
Shareholder contributions and share splits
Obviously the shareholders agreement needs to set out the share split of the total shares in the company. There are many ways businesses choose to allocate shares – this can be based on monetary contributions, sweat equity and other contributions.
Regardless, the total shareholding needs to be set out clearly, usually in a schedule to the agreement, so it can be easily amended if you bring on board investors or certain shareholders exit from their holding.
Share sales (Right of first refusal, tag along, drag along)
It’s vital that the clauses relating to any sale of shares in the company are drafted or reviewed carefully. Clauses that many businesses choose to include in the agreement include right of first refusal, tag along and drag along clauses.
A right of first refusal clause essentially gives each of the shareholders the right to purchase shares owned by another shareholder who wants to exit. If an outside party offers, for instance, $1 per share, then the existing shareholders have the right to purchase the shares at that price before the outside investor gets the opportunity to do so.
Tag along clauses are designed to protect minority shareholders in the event that a majority shareholder decides to exit and sell his or her shares. The minority shareholders will have a right to be bought out, on a pro rata basis, along with the majority shareholder.
Drag along clauses allow a majority shareholder to “drag along” a reluctant minority shareholder in the event of an exit.
Although these clauses may not seem important when initially drafting the shareholders agreement, make sure you review them properly – they can dramatically affect the relationship between shareholders during a potential exit.
Key to remember
The issues mentioned in this article are only some of the important concepts you need to look at then entering into a shareholder’s agreement. There is no substitute for working with a lawyer on the document itself, but you can certainly save time and money if you understand the various clauses referred to above. If you want more information on shareholder’s agreements click here.
