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Harmony in Ownership: A Guide to Shareholders’ Agreement

posted 12 months ago

1. In today’s dynamic business landscape, ventures with multiple stakeholders are becoming increasingly common. Whether you are embarking on a startup journey or managing an established enterprise, a Shareholders’ Agreement is an indispensable tool that serves as a roadmap, outlining the rights, obligations, and responsibilities of all parties involved in the company, providing a framework for decision-making, conflict resolution, and protection of the stakeholders.

2. Who needs a Shareholders’ Agreement

Shareholders’ Agreements are usually used in privately-held corporations such as private companies with multiple shareholders, startups and small businesses, family-owned businesses, joint ventures, partnerships, investment and funding situations.

3. Parties Involved: Navigating the roles of the shareholders

A Shareholders’ Agreement can be entered into between: –

a. Some of the shareholders: The agreement can be signed by a subset of the shareholders who collectively hold a significant portion of the company’s shares. For example, between the majority shareholders and excluding all minority shareholders.

b. Certain classes of shareholders: In companies with multiple classes of shares (e.g., common shares, preferred shares, non-voting shares, redeemable shares), the agreement may be limited to specific classes of shareholders who have similar rights and interests.

c. Founders and key investors: Shareholders’ Agreements are often signed by the founders of the company and key investors who provide significant funding or expertise to the business.

d. Voting shareholders: Shareholders who possess voting rights may be party to the agreement to ensure alignment on important matters that require shareholder approval.

e. Certain stakeholders with special rights: The agreement may include parties who are not necessarily traditional shareholders but have a special role or rights in the company, such as directors or certain executives.

4. Making the company a party to the Shareholders’ Agreement

Companies are not typically parties to Shareholders’ Agreements because the company is a separate legal entity from its shareholders, and such agreements are primarily designed to govern the relationship among the shareholders only. However, there are instances where the company is made a party to the Shareholders’ Agreement when specific circumstances or objectives warrant its inclusion. Examples of such instances are: –

a. where shareholders want to ensure that the company including its board of directors and management be bound by certain terms or obligations that are not explicitly provided for in the company’s constitution. By including the company as a party to the agreement, it would be bound by the terms and provides formal consent to the arrangements made among the shareholders.

Some of the common provisions that may be included in a Shareholders’ Agreement to bind the company include: –

i. Business Decisions: Shareholders might want to or impose restrictions on specific business decisions, such as significant investments, mergers and acquisitions, or changes in core business activities. Including the company as a party can ensure that these decisions are made in accordance with the Shareholders’ Agreement.

ii. Dividend Policies: The Shareholders’ Agreement may establish guidelines for dividend distribution or profit-sharing. By involving the company, the agreement can hold the company accountable for adhering to these policies..

iii. Appointment of directors: Shareholders may want to ensure certain shareholders have the right to appoint directors to the board. Involving the company in the agreement can make this arrangement legally binding.

iv. Management and Executive Compensation: The agreement may include provisions pertaining to the compensation and benefits of key executives and management. Similarly, making the company a party can ensure that these provisions are followed.

v. Non-Compete and Confidentiality: The Shareholders’ Agreement might contain clauses that restrict shareholders, including the company, from engaging in certain competitive activities or disclosing sensitive information.

b. Another common situation is where a minority shareholder who lacks control or a direct voice in the management of the company may seek to make the company, including its board of directors, a party to the Shareholders’ Agreement to put them on notice of certain terms or provisions that safeguard the rights and interests of minority shareholders, such as rights to information, protection from unfair treatment, or mechanisms for resolving disputes. The Shareholders’ Agreement can serve as a basis for negotiations and discussions with the majority shareholders or potential investors to secure additional rights or representation in the future.

However, this does not necessarily guarantee that a minority shareholder will have equal negotiating power or influence over the agreement’s content. Minority shareholders often face challenges in exerting significant influence in the decision-making process due to their limited ownership stake and voting power compared to majority shareholders.

5. What happens when a new shareholder joins the company? Should a new Shareholders’ Agreement be signed?

If a Shareholders’ Agreement is already in place, it is still possible to bind the new shareholder to the existing agreement. This can be done by having the new shareholder to sign a deed of adherence, indicating his acceptance and adherence to the Shareholders’ Agreement. Alternatively, if the Shareholders’ Agreement allows for amendments, the parties may collectively agree to update the agreement to accommodate the new shareholder, subject to mutual consent..

6. Essential clauses in a Shareholders’ Agreement

The essential clauses in a Shareholders’ Agreement can vary based on the specific needs and circumstances of the shareholders and the company. Here is a list of core clauses that are commonly found in most Shareholders’ Agreements.

a. Share Ownership and Structure. To outline the initial shareholding of each shareholder and may include details about future capital contributions and how new shares will be issued.

b.Voting Rights and Decision-Making. This is to specify the voting rights of each shareholder, how important decisions will be made, and whether certain matters require a simple majority, supermajority, or unanimous consent.

c. Board of Directors and Management. This clause defines the composition of the board of directors, the process for appointing directors, their powers, and responsibilities.

d. Dividends and Distributions. This outlines the company’s dividend policy and how profits will be distributed among shareholders.

e. Transfer of Shares and Pre-Emptive Rights. This is important to govern the transfer of shares between shareholders and may include rights of first refusal and pre-emptive rights.

f. Tag-Along and Drag-Along Rights. This clause protects minority shareholders (tag-along) and majority shareholders (drag-along) in the event of a sale of the company.

g. Anti-Dilution Protections. This clause protects existing shareholders from significant dilution in the event of new share issuance, such as during a fundraising round.

h. Reserved Matters. This section identifies certain critical decisions that require the approval of all shareholders, regardless of their ownership percentage.

i. Confidentiality and Non-Compete. It establishes confidentiality obligations for shareholders and may include non-compete clauses to prevent shareholders from engaging in competing businesses.

j. Deadlock Resolution. In case of an impasse or deadlock on important decisions, this clause provides a mechanism to resolve the disagreement and move forward.

k. Valuation Mechanism. This clause sets out the method for valuing the company or its shares, which can be crucial in situations like share buybacks or exit events.

l. Dispute Resolution. It outlines the procedures for resolving disputes among shareholders, such as through mediation, arbitration or court proceedings.

m. Termination and Exit. This section covers how the Shareholders’ Agreement can be terminated and what happens in the event of a shareholder’s exit, either voluntarily or involuntarily.

n. Non-Solicitation. This clause may prevent shareholders from poaching employees or customers of the company.

o.Governing Law and Jurisdiction. It specifies the governing law under which the agreement is interpreted and the jurisdiction where disputes will be resolved.

7. When is a good time to review the Shareholders’ Agreement?

To maintain corporate viability and adapt to evolving market conditions, it is essential to periodically review the agreement to ensure that it continues to align with the current needs and interests of all parties involved. Significant events such as changes in ownership structure, the addition of new shareholders, pursuit of major business decisions, strategic shifts or changes in the law can serve as triggers for a comprehensive review.

Conclusion

In conclusion, understanding the significance of a well-drafted Shareholders’ Agreement is paramount for any company’s smooth functioning and the protection of shareholders’ interests. A comprehensive and carefully constructed agreement can mitigate potential disputes, clarify rights and responsibilities, and foster a harmonious business relationship among shareholders.

 

About the author

Chan Jia Ying
Senior Associate (Dispute Resolution)
Civil Litigation (Corporate & Commercial), Construction Disputes, Debt Recovery & Taxation
Harold & Lam Partnership
[email protected]

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