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Why have Shareholders Agreements?

May 25, 2017

Should there be a Shareholders Agreement?

Mostly yes, at least for relatively closely held companies.

Will it always solve all problems?

No, but it often will and it may avoid costly, time consuming, and bitter wrangles. It’s often much worse and much more costly trying to solve problems without a shareholders agreement.

Companies are paper creations. Ever seen one walking about, driving? Of course not. But you will have seen their directors doing that and some shareholders (that aren’t companies). Real people drive companies and real people have falling outs, sometimes very bitter. Not only that, but it can make good sense to deal with some important issues so that everyone knows what they will be in for.

There’s a long list of important issues that could be dealt with in a shareholders agreement. Especially important issues include:

  • Exit – shareholders may want to exit, or may be required to exit, for different reasons. Different reasons for exiting may require different considerations. For example the rules might be different if someone just wants to go as opposed to where they are required to go because they have breached the shareholders agreement or because they have died or become incapacitated.
  • Ongoing funding – are shareholders required to fund and if so how, and if they don’t, what should happen?
  • Conflicts - can shareholders or directors be involved in competing companies?
  • Intellectual Property – who owns IP developed within or for the company?
  • Restraints – what restraints would be reasonable on shareholders or directors when they cease their involvement with the company?
  • Directors - who can appoint and remove directors?
  • Transfer of shares – what restrictions should there be on shareholders transferring any or all of their shares (whether to other shareholders or to third parties)?
  • Issue of shares – when can shares be issued, whether to existing shareholders or third parties?
  • Drag along and tag along rights – can majority shareholders force minorities to sell their shares if the majority find a buyer? Can minority shareholders insist in tagging along in those circumstances?
  • Deadlocks in relation to shareholders agreement - how should deadlocks be resolved in relation to matters dealt within the agreement?
  • Deadlocks in relation to company matters - how should deadlocks be resolved in the board or between shareholders in relation to other company matters?
  • Employees Directors Shareholders – often, a party is each of these. What happens if they cease to be an employee or a director or a shareholder? For example, if they cease to be an employee, should they have to cease to be a director and/or shareholder? The answer will be different for different companies.
  • Default – what should happen if a shareholder defaults under the agreement?

With all of these matters, there’s no point dealing with them halfheartedly. They need to be considered fully, in detail, so that all of the foreseeable possibilities and alternatives are considered and, where appropriate, dealt with. I’ve seen many shareholders agreements where the shareholders didn’t bother to consider the hard issues. Whether this was because they didn’t want to incur the cost or because they thought that it was too hard (or whatever the reason), these shareholder agreements were a waste of time. At least with a fully considered shareholders agreement, there’s a chance of avoiding ongoing disputes and deadlocks and of achieving a resolution.

The best time to have a shareholders agreement prepared is at the outset, when everyone is a mate and is prepared to consider things on a fair and rational basis. But it will require work by the lawyer, the parties and quite possibly, a good accountant.

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