What is a Shareholders Agreement?
Start-up companies create shareholders agreements that are supplementary to the company’s constitution. Shareholders agreements define the legal relationship (rights, obligations, liabilities) between the company and its shareholders as well as the legal relationship between the shareholders themselves.
What is a Deed of Accession?
Shareholders who buy shares in an established company are not automatically bound to the terms of the shareholders agreement. Companies can overcome this issue by using a deed of accession. Incoming shareholders who sign a deed of accession agree, by signing the deed, to be bound by the provisions of the existing shareholders agreement.
Balancing of Rights
Shareholders might be majority shareholders (meaning they own more shares than most other shareholders) or minority shareholders (they own less shares than other shareholders). A good shareholders agreement will carefully balance the rights of minority and majority shareholders. For example, minority shareholders want to make sure that they have rights that are not sidelined by majority shareholders. Majority shareholders want to make sure that minority shareholders don’t wield disproportionate power over the company by being able to veto important decisions.
What should you find in a Shareholders Agreement?
The types of clauses you will usually find in a shareholders agreement include:
- The roles, rights and obligations of key people in the company such as directors and shareholders
- How and when board meetings will be conducted, including the voting rights of directors
- How and when general meetings will be conducted, including the voting rights of shareholders
- The ability for shareholders to appoint directors
- Rights of shareholders to access to financial information and reports
- How shares are acquired, for example are they bought with cash, or can they be purchased through transferring intellectual property to the company or are they payment for services rendered
- The circumstances under which dividends are paid
- When new shares can be issued
- How and when shares can be sold (including first rights of refusal)
- Drag-along and tag-along clauses
- The exit strategy for shareholders if there is a takeover or sale of the business
- What would happen if majority shareholders want to sell (i.e. drag along rights)
- Dispute resolution including breaking a deadlock
What should be in a Shareholders Agreement?
Some of the clauses mentioned above might be confusing. Are you thinking, what are drag-along and tag along clauses and what is first right of refusal? Fair call.
Drag-along clauses allow majority shareholders to force minority shareholders to sell their shares under certain circumstances. These clauses are most commonly used when there is a takeover bid. If the buyer wants to acquire 100% of the company, the majority shareholders can force minority shareholders to sell their shares, usually for the same value as the majority shareholders.
Tag-along clauses allows minority shareholders to sell their shares for the same value as the majority shareholders. Generally tag along clauses allow the minority shareholders to take advantage of offers made to purchase shares off majority shareholders. Tag along clauses help minority shareholders to be part of the sell out.
A first right of refusal is what it sounds like. When a first right of refusal applies to issuing new shares, the company has to offer any new shares to its shareholders before issuing them to third parties. This protects shareholders by giving them the option to not dilute their shareholding in the company. When the first right of refusal applies to selling shares, it means that shareholders who are selling have to offer to sell to other shareholders before selling them to a third party.