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Shareholders agreement

When starting a business, the creation of a shareholders agreement is often overlooked. Spirits are high and the business is going to be a raging success - so why bother talking about what may happen if the business fails?

Unfortunately, businesses do come under strain and fail. Anticipating these circumstances can save you significant time and money down the line. It's well worth the initial investment and provides valuable insurance for the future. A shareholders agreement is likely to cover the following points:

Positive obligations

The agreement should include:

  • The activities that the company will carry on and its intended rate of growth
  • The intended exit route and the timescale for achieving it
  • The company’s dividend policy i.e. the proportion of profits to be paid out as dividend and the proportion to be retained to fund the business
  • The composition of the board of directors and senior management team, along with their remuneration and other terms of employment
  • Levels of borrowing
  • Future funding e.g. how much will be needed, the form it will take, how much each of the parties will put in, whether third parties will be allowed in and on what terms

Shareholders' rights of veto

Other parts of the agreement often provide that important decisions, whether or not they would ordinarily be taken by the directors or the shareholders, cannot be made unless all shareholders agree to them – so minority shareholders can veto them.

Typically, these include decisions to:

  • Issue further share capital
  • Change the company’s articles of association
  • Buy or sell a business, or any asset of more than a certain value
  • Buy or sell a significant stake in another company
  • Acquire or dispose of any premises
  • Appoint or remove a director
  • Award directors or employees more than a certain level of remuneration and/or dismiss a director or employee earning more than that remuneration
  • Borrow above a certain level or grant security over the company’s assets
  • Incur capital or hire purchase commitments above a certain level
  • Take out or vary insurance other than for full replacement value
  • Buy any of the company’s shares back from a shareholder
  • Take action to wind the company up
  • Prevent favourable contracts or arrangements between the company and its directors or shareholders other than on agreed terms

Issue and transfer of shares

Here, options include:

• Allowing minority shareholders a complete veto over any issue or transfer of shares

• Requiring the company (on an issue) and the owners of the shares (on a transfer) to offer the shares to existing shareholders, pro rata to their holdings, before they can be issued or transferred to anyone else, or in any other proportions.

If a pro rata offer must be made, the agreement must provide a means of valuing the shares. This may be by reference to an expert, arbitrator or according to some formula in the agreement.

Rights to appoint directors

Shareholders' rights protect outside investors by allowing them to appoint a director to the board of your company, protecting their interests.

Dispute resolution

A shareholders agreement may contain a mechanism for resolving disputes. It may refer to a third party expert or arbitrator or a buy-out mechanism whereby, if a dispute occurs, one side buys out the shares of the other at a price determined in accordance with the agreement. It can even provide that, in the event of an unresolved dispute, the parties agree to vote to wind the company up.

The issue of which party buys out the other, and at what price, can be extremely difficult to negotiate. A shareholders agreement can become quite complex.

One solution is to say that one shareholder can offer his shares to the others at a price of his choosing. If they accept, they pay the price he has set. To stop the seller from setting an unrealistic price, the agreement may also provide that if the other side does not accept his offer, they become obliged to sell their shares to him. The seller will then be forced to buy the shares at the price he set. He will not want to set too high a price for his shares because he may end up having to buy their shares at that price himself.

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