A well-drafted Shareholders’ Agreement should prevent and pre-empt any falling out between shareholders. Failure to agree and sign a Shareholders’ Agreement at the time of capitalisation of a company by its shareholders or use of a generic “standard form” agreement will more often than not end in disaster.
This legal briefing summarises the ten key factors that must be considered by a managing shareholder granting shares to an investor (or investors) in his company. Each of these factors should be addressed in the Shareholders’ Agreement.
1. Control: Will the managing shareholder retain control of the board and a majority shareholding? If so, will there be any matters on which the unanimous consent of the directors/shareholders will be required? Can the managing shareholder be removed as a director or forced to sell some or all of his shares?
2. Capitalisation and Business Plan: Is the amount of the investment in the company sufficient? Have all shareholders been involved with producing the business plan and have all shareholders taken responsiblity for it? Is the business plan realistic?
3. Further capital and dilution: Have the shareholders discussed and agreed how additional capital would be raised if required? Who would provide additional capital? By loan or equity? If by equity, are all shareholders comfortable with having their shareholdings diluted?
4. Accountability: Who will run the business on a day-to-day basis? Where some shareholders will be “silent”, are mechanisms agreed for them to be kept informed about the performance of the business? What documentation will they receive and when? Is this practical? What powers do they have if they feel that the business is being poorly run?
5. Risk Allocation: Have the shareholders discussed the allocation of risk amongst them? Are some shareholders better protected on an insolvency than others (e.g. they have security over company assets) or do some shareholders have preferential access to profits?
6. Profit Allocation: Have the shareholders agreed the remuneration of directors (if any), the extent of management fees paid to a shareholder (if any) and the dividend policy of the company?
7. External work and conflicts of interest: Have the shareholders agreed what work shareholders are permitted to do for other companies? Does this include competing businesses? Does the shareholder owe a duty of confidentiality to the company? Are non-compete, exclusivity and non-approach provisions appropriate in respect of any shareholder?
8. Dispute resolution: Notwithstanding the above, is there a mechanism by which disputes will be resolved? Will this mechanism operate if a shareholder (or group of shareholders) refuses to take part in any process? What happens if a shareholder breaches any provisions of the Shareholders’ Agreement.
9. Exit: Have the shareholders agreed their exit strategy? When do shareholders wish to exit? Will all shareholders exit at the same time (e.g. by sale or listing of the company)? Is there a mechanism to force all other shareholders to sell their shares if an offer for the company is made? Do pre-emption rights kick in if a shareholder wishes to sell his shares? Is there a mechanism for valuing the company for the purposes of a sale?
10. Insolvency: To the extent possible, are the assets of the business operated by the company protected from an insolvency of the company? Do any of the shareholders have preferential rights on an insolvency of the company?
Disputes between shareholders are very common. They generally arise because of differing views on how the business should be run or differing expectations about how the business should perform. Where disputes become bitter and damaging to the business, it is generally because the rights and duties of the shareholders and their relationship with each other was not clearly defined at the outset of the relationship.
War between shareholders almost always results in a reduction in profitability of the business and often in its insolvency. Pre-empting potential disputes by detailing in the Shareholders’ Agreement how the most important matters will be dealt with is hugely important. In addition, detailing exactly how disputes will be dealt with in the Shareholders’ Agreement helps protect the smooth running of the business and its profitability if war does break out.
How can Buckworths help you?
Buckworths is expert at drafting and negotiating Shareholders’ Agreements. Please contact Michael Buckworth as early as possible and keep the above checklist in mind when conducting early commercial discussions with potential partners.