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The Value of a Shareholder's Agreement

Ivan Vodanovich - Associate
Ivan Vodanovich - Associate

ARTICLE by Ivan Vodanovich

25 October 2012

While there is no legal requirement for Shareholders in a Company to enter into a Shareholder’s Agreement, having one will certainly result in avoiding problems that may arise between shareholders in the future.

You might for example start a Company with 2 or 3 friends and never envision that you might have a falling out or disagreement about where the business should go, alternatively you might decide to give one of your employees some shares in the Company; if you do this you will want to think about what happens to those shares if that employee stops working for you.

 WHAT IS A SHAREHOLDERS AGREEMENT

 A Shareholder’s Agreement is a written contract between Shareholders regulating the operation of the Company in which they have invested. It provides Shareholders with certainty about their rights and obligations towards each other. Importantly, a good Shareholder’s Agreement will set out clear rules for how to deal with major change events such as the introduction of new investors, the exit or death of a Shareholder or the sale of all or a substantial part of the Company’s assets.

 THE VALUE OF A SHAREHOLDER’S AGREEMENT

 A Shareholder’s Agreement will sometimes provide value before the terms are even settled upon. This is because the negotiation process will often result in issues emerging which makes it untenable for some of the potential Shareholder’s to follow through with their investment. On the positive side, the negotiation of a Shareholder’s Agreement will often crystallise and align Shareholder’s long-term goals in the best interest of the Company.

By dealing with issues at the very beginning, Shareholders will avoid costly disputes in the future. Without a Shareholder’s Agreement, the relationship between Shareholders is regulated by the Companies Act 1993 and the Company Constitution (if it has one). Unfortunately, the Act and a typical Constitution overlook some key matters. A well drafted Shareholder’s Agreement will cover these key matters and avoid the financial loss of the Shareholders.

Company Constitutions are a publicly available document. The advantage of a Shareholder’s Agreement is that it is not a publicly available document and accordingly sensitive commercial terms between Shareholders are able to be kept confidential.

A well drafted Shareholder’s Agreement will contain exit provisions setting out the mechanism for the exit of a Shareholder from the Company. Different exit provisions may be required from case to case. A Shareholder may want to quit the Company. Should they have to hold their shares for a minimum period? Should the other Shareholders have to buy them out? If so, how would this be achieved? If the other Shareholders are not willing to buy the exiting Shareholder out, what should happen? How should the shares be valued? 

What if the Shareholder has died or become physically or mentally incapable? Should the other Shareholders have to buy them out? How should this be done? 

Would you really want to end up in business with the deceased Shareholder’s wife or children? While in some cases this is not an issue; often it is intolerable for the remaining Shareholders. 

A Shareholder’s Agreement is able to specify that in the event of the death of a Shareholder that Shareholder’s shares have to be sold to the remaining Shareholders. To assist with the purchase, a well drafted Shareholder’s Agreement will often specify that the Company takes out Key Man Insurance cover over all of the Shareholders for the purposes of enabling the remaining Shareholders to buy out the deceased Shareholder’s interests. This avoids the problem of the remaining Shareholder’s not having the finances to be able to purchase the shares of the deceased Shareholder.

We have seen this work affectively in many Company situations over the years. 

Without these “buy/sell provisions” together with Key Man Insurance provisions the remaining Shareholder are at risk of suffering severe hardship which may result in the deceased Shareholder’s shares having to be sold to a third party or the company having to be sold.

A Shareholder’s Agreement also has the advantage of allowing non-defaulting Shareholders to pursue a defaulting Shareholder for damages for breach of contract.

WHAT OTHER MATTERS ARE ABLE TO BE ADDRESSED IN A SHAREHOLDER’S AGREEMENT 

A Shareholder’s Agreement is also able to deal with a number of operational matters which may include:

  1. Who has the right to appoint directors and how many;

  2. Whether the Chairperson of the board has a casting vote;

  3. A quorum for Shareholder’s Meetings and Board Meetings;

  4. The Company’s dividend policy;

  5. Directors and Shareholder’s approval, thresholds for key decisions;

  6. Future funding of the Company;

  7. Whether budgets and business plans are to be prepared and if so, how frequently;

  8. Who is to prepare and approve them and to whom are they to be disclosed;

  9. A robust dispute resolution procedure.

 

NEED HELP?

Corban Revell has extensive experience in drafting and negotiating Shareholder’s Agreements. Give Ivan Vodanovich a call to discuss your circumstances and requirements. He looks forward to assisting you.