Disputes between shareholders can be very costly, even to the point of mortally wounding the company.
Shareholder Agreements are the business "pre-nup"
A Shareholder Agreement provides a framework to allow all parties to work together for the good of the company.
The rights and obligations of shareholders in listed companies are protected by a number of pieces of legislation. These include the Companies Act, the Securities Act and New Zealand Stock Exchange Listing Rules. However, the vast majority of New Zealand companies are small or medium sized and are not listed on the Stock Exchange. Of this latter group there are two main types of companies:
- The so called 'mum and dad' type companies. Although a separate legal entity, in reality these companies are the trading entity of a self employed person. They usually have one director and one or two shareholders,
- Companies where the shareholders are at arm's length, and have come together to pursue a common business interest. These are commonly referred to as 'closely held companies'.
Closely held companies
Typically closely held companies have between two and six shareholders. The shareholders may be related, good friends or business associates. A shareholder agreement benefits this type of company, and its shareholders, the most. Common situations of closely held companies where a shareholder agreement can be used include:
- Inter-generational business ownership e.g. father/son
- Ownership by family e.g. sister/brother
- Ownership by friends, often having a common interest in the business
- Companies formed to undertake a specific venture
- Established businesses where the owner is bringing in a successor
- Existing businesses where the owner wants to reward employees with some shareholding but wants to retain overall control
What is a shareholder agreement?
A shareholder agreement is, in effect, a 'pre-nuptial agreement between shareholders. It is signed by all shareholders and the company; it sets out rules and procedures for as many situations as the shareholders want it to deal with. An agreement can be as flexible and varied as the parties require. It can deal with any number or just one or two major issues which the shareholders regard as fundamental.
A shareholder agreement works hand in hand with a company's constitution. The shareholder agreement is a vital addition to a company's stable of documentation because it:
- Can regulate rights and obligations before incorporation of the company
- Is usually confidential
- Can protect shareholders' rights from any alteration without the shareholders' consent
- Sets out the parties' intentions from the outset and in doing so the shareholders will inevitably address and consult over a number of key issues
- Regulates entry, exit and control
- Is uniquely-tailored to the shareholders and the company, rather than being a generic document as frequently the case with constitutions.
What does it include?
The contents of a shareholder agreement can be as varied as the parties require. It can be flexible or rigid, but it should cater for the parties' particular requirements. A shareholder agreement usually deals with the issues below:
Who are the shareholders and how many shares do they hold?
It is common for one shareholder/group f shareholders to want a majority of the shareholding. Is the intention for the majority to always win out? This is common where one party is being brought in as a minority shareholder to an existing business or when one party brings in significantly less to the business than the others.
If there are three or more groups of shareholders the shares may be grouped into classes of shares, eg: A, B, etc. Each group has specific rights, such as the appointment of a director.
How much control do shareholders have?
Generally speaking, in a closely held company the directors make business decisions about the running of the company. Major transactions need a 75% shareholder consent. Is it intended that the 75% threshold be lower to avoid minority shareholders paralysing the company? Conversely, is a higher threshold required to ensure the majority do not run roughshod over the rights of the minority?
Some decisions may require a 100% shareholder consent, especially those involving a significant financial commitment. In those situations it is common that minority shareholders do want a right to withhold their consent to a transaction.
- Who will the directors be?
- Who can hire and fire directors?
- Do different shareholder groups have a right to appoint a director (or two)?
- How are directors removed? What is the retirement/rotation policy?
- Will shareholder groups always have a right to have a director representing their interest? Given that directors control the day to day running of the company, the make-up of the board and its ability to control appointment or removal of directors is vital.
Do the shares have to be paid for straight away or may payment be delayed? Is a share purchase a pure cash arrangement or are goods and/or services provided in lieu? In the latter situation, the transaction value must be recorded.
Do all shares have an equal vote? Is there more than a 50% majority required to pass a resolution? How many shareholders are required for a quorum?
It is common for each class of shareholder to have a say in each shareholder vote
as well as each class of shareholders being represented at a vote. If shareholders refuse to attend a meeting, are there to be provisions allowing their votes to be discounted?
A shareholder agreement should have provisions governing the exit of one or more shareholders. These provisions will cover issues such as:
- Can a shareholder be compulsorily bought out, or can one shareholder require the others to buy him/her out?
- Procedure to value the shares
- Will the departing shareholder be subjert to a restraint of trade? If so, for how loi and what geographical area and industry is involved?
- Will the payout be in one lump sum or spread over time? A lump sum often places a great deal of financial pressure on a business. Payout over a term is reasonably common. If this occurs, will the departing shareholder get security for the money owed?
Finally, a shareholder agreement should include a dispute resolution process.
A common approach is to use mediation which is extremely cost-effective. If there is no resolution, this is followed by arbitration. Mediation in particular can ix_ a valuable tool where the parties agree on how to resolve their differences.
A shareholder agreement breaks down into three general headings:
- Entry into the company and the terms on which a person becomes a shareholder
- Governance and control
- Exit arrangements.
A shareholder agreement need not be lengthy and complex. Many shareholder concerns can be addressed in a reasonably short document. In going through this process shareholders will discuss potential issues and make at least some provision to cover them. The alternative is an agonising stalemate which will be costly and time consuming, and can ultimately cause a company to fail,