The Advantages Of Having A Shareholders’ Agreement

A shareholders’ agreement is a formal agreement between all or some of the shareholders in a company. A shareholder agreement is usually considered alongside the company’s articles of association, which defines the relationship between the shareholders and is in law considered a contract inter se between the shareholders.  Nevertheless, invariably a shareholders’ agreement will have a clause which makes its provisions superior to those in the articles of association. A shareholders’ agreement is intended to protect the shareholders’ investments in the company, define the government structure, working relationship and power inter play between shareholder as well as protect the interests of the majority and minority shareholders in a company.

Salient Features of a Shareholders’ Agreement

As indicated before, a shareholders’ agreement will encompass the rules that regulates the relationship between the shareholders and their respective interests. It acts as a record of parties’ agreement regarding the governance and running of their company. It also regulates the conduct of shareholders in terms of what can and cannot be done as well as their rights and responsibilities. Some of the matters that will be covered in a shareholders’ agreement include:

• The agreed business or businesses of the company;
• The company governance structure including the structure of the management team;
• Provisions on how or how the senior management team (like CEO, COO and CFO) will be appointed;
• How key decisions will be made in the company; that is, by who or what majority;
• The rights, duties and obligations of shareholders and directors;
• Modes of financing of the company’s business or businesses;
• Regulations relating to sale of shares in the company (e.g. permitted transfers, transmission of shares, pre-emption rights, as well as drag along and tag along provisions) or major assets of the company;
• Procedure regulating the number of directors, quorum in meetings and director’s appointment and removal from office;
• Regulate the sale of material assets of the company;
• Outline the appointment and dismissal procedures in relation to directors;
• Outline the dividend policy;
• Make provisions for confidentiality and non-compete provisions;
• Outline the procedure for addition of new shareholder’s in a company; and
• Make provision for dispute resolution mechanism.

When is a Shareholders’ Agreement Required?

Though there is no legal obligation or requirements in the Companies Act, 2015 for there to be a shareholders’ agreement, it is a good practice and highly recommended for a shareholders’ agreement to be negotiated and signed off between the shareholders after formation of their company and before any business has been started.   It is advisable to even negotiate a shareholders’ agreement before the promoters have registered the company and signed off after the incorporation.  This can give promoters a clearer idea of what they would be entering into, the purpose of the company, the shareholding structure as well as funding options for the company. For existing companies, a shareholders’ agreement should be negotiated and signed offer at the earliest opportunity and before any disagreements have arisen in order to record the parties’ understanding and agreement on the management including on governance and financing of their company as well as disputes resolution mechanism. A new shareholders’ agreement should also be put in place when:

• The shareholding structure of the company changes (e.g. as a result of new entrants (allotment of shares to a new shareholders or in event of transmission of shares to relatives of a deceased shareholders or exit of a shareholder through death or sale of shares);
• The company adopts a new business models or new businesses or subsidiaries;
• When a company is borrowing money from its shareholders
• Where a shareholder’s shares are transferred to related parties who might not have relationship with existing shareholders;
• When a major director-shareholder is newly appointed or exits the business.

What are the benefits of having a shareholders’ agreement for your company?

There are many benefits of having a shareholder agreement, and below are just a few examples:

• Confidentiality- Unlike memorandum and articles of association and special resolutions, a shareholders’ agreement does not need to be filed at the Companies Registry. Therefore, a shareholders’ agreement can provide mechanisms for internal working of the company and relationship between the shareholders which need not be disclosed to the general public.
• Establishes shareholders’ rights, powers and restrictions– A shareholders’ agreement defines and offers clarity on the rights and powers as well as restrictions of both the majority and minority shareholders. It also defines the processes to be followed when one is exiting the company or when a new shareholder is being incorporated into the business.
• Assists in management and governance issues- The shareholders’ agreement will generally offer clarity on governance and management issues such as the purpose and nature of the business of the company, the duties and powers of the board and the interplay between the roles of the board and the shareholders and their decision making rights.
• Define exit and entry procedure- a shareholders’ agreement can encompass provisions governing the processes of allotment or issuance as well as transfer of shares, the roles of the transferee, transferor, the board, shareholders and the company in such processes including prescribing the procedure involved in the valuation of the company and its shares in such transactions. The shareholder’ agreement can also provide for good and bad leaver clauses which will allow the shareholders to dictate at what price they purchase the shares from a departing shareholder, dependent on their reason for departing.  This can also include definitions of what constitutes a good leaver, such as retirement, and what is a bad leaver, such as breach of duties or misconduct.
• Drag along rights: These are provisions that ensure that if the majority shareholders wish to sell their shares, the minority shareholders must sell their shares as well. This is meant to prevent the minority frustrating majority when selling their shares as a purchaser may wish to obtain 100% of the share capital in a company.
• Tag along rights: As with drag along rights, tag along rights can be included in a shareholders’ agreement to ensure that when the majority shareholders are selling their shares, any shares held by a minority shareholder must be bought also. This is intended to prevents minority shareholders becoming trapped in a company which is controlled by shareholders with whom they may not have a relationship or may not what the business with.
• Providing guidance on how to deal with profits and lossesas well as a dividend policy- A shareholder’s agreement can prescribe what will be considered when computing profits and losses, when the profits will be distributed and even how to deal with losses in the business. It is also critical for shareholders’ agreement to provide how shareholders are to receive the profits of the business, especially in companies where shareholders have varying shareholdings and this should include the percentage of net profit that must be distributed annually. This provides clarity to shareholders besides preventing disagreements.
• Can provide for confidentiality and competition restrictions- A shareholders’ agreement can outline protective measures for the shareholders and the company including protection of the company’s confidential information and trade secrets and restrict directors-shareholders’ from setting up or joining competing business or putting themselves in conflict of interest situations. Such a non-compete provision will often continue in force for a certain time after a shareholder ceases to be a shareholder of the company.
• Provides guidance dealing with dead lock situations- A shareholders’ agreement will generally outline the step that can be taken if a deadlock situation occurs, e.g., providing for a gunshot clause, or through meetings and voting systems.
• Aids dispute resolution – The shareholders’ agreement will generally outline the dispute resolution mechanisms.

Conclusion

At CM Advocates LLP, we have a team of legal experts who can assist you in drafting and perfecting your shareholders agreement and any other commercial agreement that you may require. Kindly get in touch with us on email at cmsmeclub@cmadvocates.com or visit our portal to book an appointment for consultation with our legal experts.Related Services: Commercial/ Business LawRelated Documents: Shareholders AgreementsWritten By: Cyrus MAINA - Managing Partner & Miriam MUGO - Senior Associate