Business

Why your company needs a shareholders’ agreement

Jacob Mutevedzi

Launching a business can be so exciting that it is difficult to imagine that anything might go wrong. This is especially the case if one is venturing into business with loved ones. 

Despite our best wishes, business relationships, just like marriages, tend to fall apart. The true reality of business does not always resonate with our fantasies; arguments between business partners are unavoidable and you will not always see eye-to-eye on all matters. 

An assortment of reasons can cause the collapse of shareholder relations. 

Examples of shareholder disputes you may find yourself embroiled in include tussles over the direction of the company, failure by one shareholder to meet its obligations, disputes over directors’ remuneration and valuation of shares where one shareholder is minded to sell. 

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 In those dark times when your relationship with fellow shareholders is teetering on the edge of a cliff, the shareholders agreement has often proved itself to be a conflict management tool without equal. 

When starting a new business, it is counter-intuitive to envisage ourselves locked in mortal combat with our fellow shareholders. 

However, undesirable as it may seem, we are better off biting the bullet and discussing certain issues from the beginning to eliminate future disharmony. 

No legal document can achieve this outcome better than a good old   shareholders’ agreement. A shareholders’ agreement is a contract concluded by shareholders of a company which spells out the shareholders’ rights, privileges and obligations. It also sets out how the company will be set up, managed and operated. I cannot imagine a more cost-effective mechanism for minimising future disputes between business partners. 

The shareholders’ agreement curtails future conflict by setting out, in clear terms, how shareholders will deal with certain matters. Further, it typically provides a forum for dispute resolution in the event of a dispute down the road.  

Parties have scope to stipulate that in the event of a conflict between the shareholders’ agreement and the articles of association or any other document, the provisions of the shareholders’ agreement shall take precedence.

Some of the important issues that a shareholders’ agreement typically deals with are addressed below. 

Decision Making 

Generally, company law gives majority shareholders ascendancy over the minority because decisions can be made with the positive vote of a simple majority. 

There are a few exceptions which require what is called a “special majority”, meaning two-thirds of votes for the purpose of making decisions concerning important aspects of the company. 

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In drafting shareholders’ agreements, however, parties have the freedom to decide the percentage of votes required for particular decisions. 

Thus, for example, important decisions such as financing or business structure may require the agreement of all of the shareholders, while a simple majority will suffice for less important decisions. Without such provisions in a shareholders’ agreement minority shareholders may find themselves with little or no voice.  

Govern management of the company 

Ordinarily, running of the company is invariably left to the board of directors.  However, the shareholders may prescribe that, certain decisions, due to their gravity should require shareholder approval.  

Protection of minority shareholders 

A shareholders’ agreement can protect minority shareholders by providing that certain decisions, such as the issuance of further shares, require the unanimous consent of all shareholders.  

The agreement may also have what are known as “tag along” provisions. A tag along provision is a clause that allows minor shareholders to “tag along” with major shareholders if they find a buyer for their shares. 

These provisions are designed to ensure that minor shareholders are not left behind when a major shareholder exits the venture. 

Protection of majority shareholders 

Shareholders’ agreements may also contain drag-along provisions. 

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These are clauses which enable a majority shareholder to force a minority shareholder to join in the sale of a company. 

“Drag along” provisions usually operate where an offer is received to buy the entire shares in a company and the majority shareholders wish to accept that offer.  The rights allow the majority to force the holders of the remaining shares to accept the offer on the same terms so that the deal does not fall through. 

5. Regulating transfer of shares 

In the event that one shareholder wishes to sell their shares, the shareholders agreement can give other shareholders a “right of first refusal”. 

This mechanism is often used to restrict who may or may not buy the company’s shares. For small entities whose initial shareholders wish to retain their shareholding, this is an important tool for keeping external investors and unfamiliar individuals out.  

Shareholders’ agreements are also convenient devices for spelling out what happens to the shareholding of a deceased shareholder. 

A compulsory buy-out provision can be included, which provides that if a shareholder dies, the remaining shareholders, or the business, will be compelled to buy the deceased’s shares, and the executor of the deceased estate would be required to sell the shares. 

Restraint of trade 

It is not unusual for shareholders to exit companies and immediately set up another company to rival their erstwhile partners. 

A shareholders’ agreement is a handy tool for restricting a departing shareholder’s ability to set up or work in a competing business. 

Depending on the jurisdiction, these restrictions can be more stringent than those applicable in an employment contract and can be extremely valuable in protecting the interests of the company. 

Resolution of disputes 

A properly drafted shareholders’ agreement can prevent or minimise disputes by setting out the policies for managing many of these issues. 

In the event that conflicts do occur, a shareholders’ agreement will often specify the dispute resolution process. They also set out the timeframe within which the dispute should be resolved.  

Shows business stability 

Having an agreement that sets out how future conflicts will be dealt with engenders a sense of stability. Banks and other creditors that may be looking to invest in your company will find this reassuring.  

Financing the business 

A shareholders’ agreement can specify how the company will access funds and whether shareholders are obliged to contribute such funds in accordance with their relative interest in the business. 

Further, in the event that some shareholders are unable or unwilling to contribute funds when needed, a shareholders’ agreement may stipulate preferential interest rates for those shareholders who contribute. 

Additionally, it can also prohibit the directors of a company from declaring any dividends until the contributing shareholder’s loan has been repaid. 

If the company wishes to access debt financing from a bank or third-party lenders, a shareholders’ agreement can set out whether or not shareholders are required to give personal guarantees and also specify the consequences of a shareholder’s failure to provide a personal guarantee. 

Jacob Mutevedzi is a commercial lawyer and commercial arbitration practitioner contactable on jmutevedzi@gmail.com, on Twitter @jmutevedzi_ADR and on +263775987784. This author writes in his personal capacity. 

HERALD