How a Shareholders Agreement Can Protect Your Business
Too often we see businesses get embroiled in costly disputes in circumstances where a shareholders agreement could have prevented these unnecessary legal costs. Most successful businesses we deal with have well drafted shareholders agreements in place.
When entering into a business arrangement, whether it is with a colleague, family member, friend or strictly business partner, it is imperative that the nature of the relationship and terms and conditions of the arrangement are documented to protect the interests of all parties.
What is a shareholders agreement?
A shareholders agreement is an agreement that will formalise the arrangement that you intend to enter into, or have entered into, with your business partners and set out how the business will run. It should cover a range of matters some of which are set out below. The below is not an exhaustive list of clauses that should be covered off on in your shareholders agreement, however it should give you a brief idea of the number of matters that need to be considered and covered off on within the shareholders agreement.
When should you get one?
We suggest entering into a Shareholders Agreement as soon as possible and before your new idea is launched or before any of the parties involved have made any financial or other contribution. As you will read below the Shareholders Agreement should cover a number of critical aspects to the business operations, rules and regulations and it is therefore prudent that these matters are agreed between business partners at the outset of the arrangement.
What does the shareholders agreement cover?
The following are examples of clauses your Shareholders Agreement should cover to best protect the interests of the parties and the business:
a. Sale of Shares
A Shareholders Agreement should outline the process involved with sale or sale of shares. Generally this will include drag-along and tag-along rights, pre-emptive rights and what happens in the event that a shareholder is totally and permanently disabled. These clauses provide both minority and majority shareholders with protections with respect to the transfer of shares.
b. How the Business is to be Managed
In addition to information regarding sale of shares, a shareholders agreement should include all other required policies and procedures including general management of the company, how and when decisions can be made, how what happens in the event that a director defaults under the shareholders agreement and when the shareholders agreement can or will be terminated, how dividends are calculated and paid. These policies and procedures are included in the shareholders agreement to clarify from the outset how important decisions will be made for the business in the further.
c. Dispute Resolution
This clause will typically require one shareholder to issue the other shareholder/s with a notice of dispute then require the parties to explore other options to resolve the dispute (for example by way of informal dispute resolution techniques such as negotiation, mediation or independent expert appraisal). The Shareholders Agreement may set out the order of these informal disputes resolution options (typically from least formal to most formal) and may also require certain steps to be taken within a particular timeframe to avoid having disputes drag out unnecessarily.
Things to watch out for:
a. Restraint of Trade
Shareholders Agreements will more than likely include provisions regarding restraint of trade that will apply in the event you or your business partner leaves the business. This clause will generally include definitions of the restricted activity (being the activities the relevant person is restricted from carrying out), the restraint area (where the relevant person will be restricted from carrying out the restricted activity), and the restraint term (being the period of time the relevant person is restricted from carrying out the restricted activity within the restraint area). The parties must ensure that each of the restricted activity, restraint area and restraint term are not too onerous but still provide the requisite protection for the reaming partners and business. This clause should be reviewed and advised upon from both an exiting and a remaining shareholders perspective.
A confidentiality clause will generally cover:
the information or type of information that is deemed to be confidential for the purposes of the Shareholders Agreement
who a party is able to disclose confidential information to
requirements when disclosing confidential information (the relevant third party may be required to enter into a confidentiality agreement)
what happens in the event that the confidentiality provisions are breached by a party
Again, this clause needs to be considered and drafted carefully. If confidential information is leaked it could have detrimental effects on the business and in turn the shareholders. You will also need to consider your confidential information must continue to be kept confidential after termination of the shareholders agreement or if/when the business ceases to operate.
c. Rights and Obligations
Shareholders will have certain rights and obligations under their shareholders agreement and it is important that these rights and obligations are fully reviewed to ensure that they are fair in the circumstances and each shareholder must fully understand their rights and obligations so that they are carry out what is required of them. For example, certain shareholders may be entitled to appoint a director in the company. This could be based on classes of shares or any other factor set out under the shareholders agreement. If you are not a director, or do not have the right to appoint a director your rights may be limited with respect to receiving company information, or making decisions or entering into documents/agreements on behalf of the company.
The above are not exhaustive lists of what your shareholders agreement should cover or what things you need to watch out for when your shareholders agreement is being prepared. Shareholders agreements are complicated documents that require a unique understanding of the current or proposed business operations and individual shareholders concerns in order for them to be drafted correctly.
If you require any assistance preparing or negotiating your shareholders agreement or with any other commercial legal issue, please do not hesitate to contact our dedicated commercial team.