What’s the proceedure for putting together a shareholders’ agreement?
Setting up a partnership? Here's how to put together a successful shareholder agreement
I’m starting a business with a long-term friend and we’re in the process of drawing up the shareholder agreement. This is the first business for both of us so we’re not very familiar with the procedure. What exactly do we need to include?
Michael Harris writes:
When partners establish a business through a corporate vehicle they are invariably excited by the commercial and financial aspects of the set up. In the haze of enthusiasm for the business concept and their spirit of co-operation, they often fail to appreciate the need for properly documenting how to regulate the management of the business and the relationship between the shareholders. To ensure good corporate governance, a shareholders’ agreement from the outset is essential in order to deal with unforeseen issues.
Typically a shareholders’ agreement will include provisions relating to:
- the management and strategy of the business;
- allocation of responsibilities between the shareholders
- financial structure, including the split between debt and equity;
- dividend policy
- how to address the need for further finance;
- provisions for the protection of minority shareholders;
- restrictions (if any, on disposing of shares);
- deadlock resolution;
- protection of the goodwill of the company; and
- exit routes.
The following outlines some of the issues that may need consideration:
Control and minority protection
There are two models to consider in a start-up: a deadlock company, where no decision can ordinarily be made without unanimous consent or a company where there is a controlling shareholder and one or a number of minority shareholders.
In the latter case, a minority shareholder may seek protections by requiring his consent to certain fundamental decisions and transactions. The key commercial issues need to be identified. There are many, but can include the commitment of expenditure beyond pre-defined limits, departing from the agreed business plan or dilution of shareholdings.
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Having identified the issues where consent is required or, in the case of a deadlock company where unanimous consent is needed, the shareholders’ agreement sets out a process for resolving differences and caters for the situation where the necessary consents or consensus cannot be achieved. More finance needed?
There is often a need for additional funding; a growing business may wish to exploit opportunities or conversely, things may not be going to plan but it is considered there is a commercial case for injecting more money into the business. Whether or not shareholders make a commitment, at the outset the agreement should consider what should happen if one shareholder is able to or in fact does provide additional resources and the other does not. The agreement will deal, for example, with the process for requesting new funding and accepting the opportunity (or otherwise), the structure of such new finance (e.g. debt or equity) and the consequences of imbalances that may arise.
Who is my partner?
Some arrangements may be based on the mutual trust of the partners. This may be of such fundamental importance to them that it would be unacceptable for one to cease to be involved, certainly within an initial defined timeframe. This may mean that no transfers of interests in the company will be permitted during that time, which should be governed by a shareholders’ agreement. Alternatively, agreements may provide pre-emption rights requiring any interests proposed to be sold to be offered around the existing shareholders before selling to outsiders.
In other situations, one or more of the shareholders may also have key executive roles in the business, whose departure could have a material adverse effect on the company. The shareholders agreement may cater for this by incorporating the appropriate restrictive provisions to safeguard the business.
I’m an investor, get me out of here!
There are a number of drivers for setting up a business: promotion of a work environment for oneself or co-investors or generation of an income stream. These issues form the way the shareholders’ agreement should be drafted. Ultimately, investors should be looking to capitalise on their commitment and exit. Whilst a shareholders’ agreement cannot always be definitive as to what may happen in the future, it is a proper medium in which to address exit goals and options.
There are many pitfalls in start-up arrangements. Having good legal advice and a well drafted shareholders’ agreement is one way to avoid them.
Michael Harris is a corporate partner at Howard Kennedy