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Shareholder agreements in family companies

A shareholders’ agreement is an important document for both the shareholders in a business and the underlying business itself, particularly in family owned businesses where the number of shareholders increases as the next generation becomes involved in the business. Many disputes which arise between shareholders can be avoided if an effective shareholders’ agreement is in place which deals with issues which can otherwise cause conflict.

A shareholders’ agreement is effectively a contract between the shareholders of a company and provides additional protection around ownership and the procedures to be taken in relation to certain decisions. While some of the matters to be dealt with in the shareholders’ agreement could be covered by the Articles of Association, it may be preferable to include these provisions in the shareholders’ agreement as this is a confidential document – whereas the Articles of Association are available to the public.

This article outlines the main provisions of a shareholders’ agreement.

Board of directors
For many companies the day to day running of the business rests with the management team, with the board of directors having a strategic oversight role. In large companies the distinction between the board of directors and the management team is evident; however in smaller businesses they are usually one and the same. In these latter companies a shareholders’ agreement would usually have specific provisions relating to the composition of the board of directors, the number of individuals permissible on the board of directors, provisions for non-executive directors and a directors’ election mechanism, including an entitlement for certain family members or shareholders with a specific shareholding interest, to make certain appointments to the board of directors.  

Voting rights
There are certain requirements in the Companies Acts which provide that certain decisions require a majority vote (51%) e.g. a decision to increase the authorised share capital of the company, whereas other decisions require a 75% majority vote e.g. alterations to a company’s memorandum and Articles of Association or a change to a company’s name.

Surprisingly other decisions that could potentially significantly impact a company such as the means of financing or its strategic goals fall outside the remit of the Companies Act and are therefore left to the Board of Directors, unless there are provisions to the contrary.

A shareholders’ agreement can provide additional protection in relation to key decisions for the company, such as strategic acquisitions or borrowing facilities, decisions to repay any directors’ loans or any shareholders’ loans, decisions to incur or permit borrowings in excess of a specified amount, decisions to transfer, sell or otherwise dispose of any part of the business, decisions to pay any dividend or make any distribution to the members of the company. This can be achieved by including a clause in the shareholders’ agreement which provides that these and other decisions will not take effect unless they are agreed on by a certain percentage such as 75% or even 90%.

In addition, a shareholders’ agreement can only be amended by unanimous agreement of all shareholders, whereas a change to the Articles of Association requires only a 75% majority and therefore a shareholders’ agreement affords additional protection to minority shareholders.

Transfer of shares
A shareholders’ agreement can include provisions governing the transferability of shares to either impose restrictions or to allow for the type of transfers that would be permitted. The rationale for these provisions involves the following:

Control: provisions can rule that certain transactions may not be undertaken without the consent of a specified shareholder. This allows the shareholder to maintain control and protect his/her investment.

Preventing outsiders from becoming shareholders: provisions can oblige shareholders not to sell their shares to third parties without first offering them for sale to the existing shareholders or to the company at a specified price.

Providing for situations on death/divorce: provisions can ensure that the shares are transferred to the shareholder’s spouse, to a family member other than the spouse or provide that the company buy back the shares.

The above restrictions on the transfer of shares are important in order to ensure shareholders do not find themselves in a situation whereby shares are transferred to an individual who may be incompatible with existing shareholders. In the case of family companies, there may be several of these restrictions to ensure that the business remains within the family. Other issues for consideration around share transfers involve:

Valuation of shares: Provisions can be made for share valuations in the event that a shareholder wishes to exit the business. This reduces the potential for conflict.

Discounts: should a shareholder wish to exit the business, provisions can oblige the shareholder to sell their shares to the existing shareholders at a discount.

Cash flow considerations: While it is important that the shareholders’ agreement protects the shareholder who wishes to exit by ensuring they receive a fair value for their shares, it is also important that it protects the remaining shareholders by ensuring that any payment to the exiting shareholder does not negatively impact on the cash flow of the business in a case where the company buys back the shares. Therefore it is recommended that a clause would be included to allow for the buyback of the shares by the company to be funded over a period of time.

Tag along rights
The shareholders’ agreement will often provide additional protection for minority shareholders by including a clause in relation to tag along rights. If a majority shareholder is selling his shares in the company, the minority shareholder is entitled to “tag along” and sell his/her shares to the same purchaser on the same terms.

Drag along rights
A shareholders’ agreement can also include a clause in relation to drag along rights. If a shareholder wishes to sell his/her shareholding, a drag along clause will allow them to compel the other shareholders to sell their shares, on the same terms.

The ability to derive value from shares can be of key concern to shareholders, particularly in the case of shareholders who are not employed in the business as they are not receiving a salary from the company. The shareholders’ agreement can be used to agree on a dividend policy for shareholders which can be of great benefit in terms of ensuring continued harmony among shareholders.

It is important that any dividend policy does not have a negative impact on the cash reserves of the business. The shareholders’ agreement can protect the liquidity of the company by including provisions that dividends are only payable if profits or cash reserves are at a certain level. Striking the right balance between the needs of the business and the needs of the shareholders is paramount.

Dispute resolution
A key benefit of a shareholders’ agreement is that it can provide an effective mechanism for resolving any disputes that arise among the shareholders and ensure that any resolution is kept confidential. The shareholders’ agreement would normally include an arbitration clause where all parties agree to be bound by the decision of the arbitrator.

Having an effective shareholders’ agreement in place is vital for companies. It sets out a pre-determined framework which addresses certain situations where conflict may otherwise arise. If no shareholders’ agreement is in place and conflict occurs this can give rise to significant cost and damage to the business. There is no one size fits all solution and each shareholders’ agreement will be tailored to suit the specific circumstances of the company and its shareholders.

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