FAQs on Shareholders Agreements
1. What is a shareholders’ agreement?
A shareholders’ agreement (SHA) is a binding contract between the shareholders of a company and the company, which governs their relationship, regulates control, ownership and management of the company.
SHAs are used as a secondary means to the articles of association of a company in order to govern the shareholders’ conduct in relation to the running of the company. Although there is no legal obligation under the Companies Act, 2015, it is best practice and highly recommended to have a shareholders’ agreement as it provides certainty and consistency within the business by setting out a framework of rules, responsibilities and procedures that the Articles of Association may not have provided for.
2. Do sole proprietors and SMEs need a shareholders’ agreement?
Now whereas single member companies do not necessarily need a shareholders’ agreement, seeing as all the voting rights vest on the sole proprietor, it is equally important to have one in limine if you are intent on adding shareholders, changing the amount of shares.
For Small and Mediums enterprises, as long as the business has a number of key individuals such as directors and shareholders, it is important to set out their arrangement with each other to ensure that in the event of disputes between shareholders and other unforeseeable circumstances, the business of the SME is disrupted as little as possible.
There is no limit to the clauses/provisions that a SHA should incorporate. However, a well drafted SHA should sufficiently provide for the most critical aspects of the relationship between the company and the shareholders, e.g.
- What are the powers of the Shareholders?
- How will shareholders acquire and dispose of shareholding?
- How will the business will be funded?
- What happens if shareholders breach the terms of the agreement?
- Can shareholders transfer their shares?
- What is the procedure for exiting as a shareholder?
3. What are some of the key considerations in developing a shareholders’ agreement?
In drafting, developing and reviewing your shareholders’ agreement, some of the salient features you should consider include:
- The business, capitalization, working capital and financing structure: the agreement must be clear on the shareholders’ contribution to the company’s share capital.
- Board/Shareholder issues.
- Management structure: there should be agreed procedures and methods of taking decisions.
- Deadlock Procedures: these are procedures to follow and the steps to be taken where no decision can be reached on a particular matter.
- Minority Protection.
- Dividend Policy: The rights of individual shareholders to receive profits and/or dividends.
- Transfer of shares.
- Addition of new shareholders: you should consider whether a new shareholder will be able to join the company.
- Exit strategy/Monetization policy.
- Dispute resolution procedures
4. Does the shareholders’ agreement give shareholders control / management powers over the Company affairs?
Generally, shareholders (who are not directors) do not have control over the day to day running of the company by being shareholders. However, it is necessary to involve these shareholders in several decision making powers as they have a vested interest in how the company is run and have the right to vote on certain matters within the company. The SHA may provide for the right to appoint directors broadly proportionate to shareholding in the Company and address other issues and decisions which the shareholders consider sensitive to be classified as shareholder matters.
The agreement also clarifies whether there are matters usually reserved to a Board resolution but which will instead be made subject to approval of shareholders.
The consent and approval of a proportion of shareholders is necessary:
- When resolutions are sought to alter the Company’s business;
- For identifying new opportunities for the company and expansion; and
- In appointing signatories to the bank accounts
5. Can shareholders contribute to the financing options of the Company?
There are various financing options available to a company such as: calls on unpaid share capital, unsecured normal overdraft, secured financing facilities from financial institutions and licensed commercial banks- to be secured using the Company’s assets.
Shareholders can contribute by:
- giving personal guarantees for the financing issued by banks or borrowings from third parties. The cap/ limit of such guarantee should be negotiated by the parties and included as a value contribution in assessing the entitlement of the guaranteeing shareholder.
- issuing shareholder loans or equities.
- subscribing to additional shares.
6. How restrictive is a shareholders’ agreement?
A shareholders’ agreement can restrict shareholders from competing with the business of the Company whilst they are shareholders and/or within a certain time frame after they cease to be shareholders.
A well drafted SHA incorporates a Non-compete clause that clarifies on the company’s position in regard to a shareholder’s competing businesses.
Further the agreement should clarify what happens if new opportunities within the business of Company arise and the Company decides not to pursue it. The Agreement may allow or deny a shareholder to pursue such an opportunity.
Other restrictive covenants in a shareholders’ Agreement include:
- Non-solicitation clauses – prohibits a shareholder from utilizing the company’s clients, employees, and contact lists for personal gain upon ceasing to be a shareholder.
- Non-disparagement clauses – prohibits a shareholder from making negative comments about the business in any form of communication while a shareholder and including upon ceasing to be a shareholder.
Prior to execution of the SHA, each party must seek independent legal advice as to the operation of these restrictive covenants. Failure to observe these covenants would be a breach of contract entitling the innocent party to seek redress in law.
7. How can a shareholders’ agreement resolve Deadlock?
The agreement may include options to resolve deadlock arising as a result of tied voting at board or shareholder level such as; cooling off period, arbitration, mediation, put/call option, gunshot clause provision.
8. Can existing shareholders transfer their shares?
The SHA provides for the procedure and conditions for transferring shares. A shareholder can transfer their shares if:
- they obtain the consent of all other shareholders;
- they give a transfer notice to the company stating the number of shares they propose to transfer, as well as the price and identity of the transferee of the shares (if any);
- a shareholder, or the key person of a shareholder (if the shareholder is an entity), dies; it is crucial to clarify whether the deceased shareholder can be bought out by either the remaining shareholders/ company (maybe through insurance) or should the estate take over the shares?
- an insolvency/ financial bankruptcy event occurs in relation to a shareholder that is not remedied, or a shareholder commits a breach of any material obligation under the agreement which is not remedied;
- a third party offers to purchase all of the shares of a shareholder with more than a set % of shares and that shareholder requires all of the other shareholders to transfer their shares to the third party purchaser.
A private company must have pre-emptive right / Right of first refusal. This gives existing shareholders the right to purchase any new shares the Company may issue before they are offered to third parties also requires shareholders of the company seeking to sell their shares to first offer them to existing shareholders to purchase.
9. What are Drag-along and Tag along Clauses?
Shareholders agreements may contain tag-along and drag-along rights if a certain proportion of shares are being transferred?
Drag-along clause – This serves to protect a majority shareholder’s interests in a future merger or acquisition or sale of shares to a third party, allowing them to force minority shareholders to sell off their shares to the purchaser at the same price and terms as they had negotiated. This prevents a standoff with minority shareholders, who may want to delay or frustrate such a deal.
Tag-along clause – This serves to protect minority shareholders in a future merger or acquisition or sale of shares to a third party, giving them the right to be included in a proposed transaction negotiated by another shareholder. It works to the benefit of minority shareholders by giving them an opportunity to benefit from a good deal a majority shareholder negotiated. It also gives minority shareholders the opportunity to exit at the same time as a majority shareholder and to avoid having to deal with a new shareholder.
10. What happens if there are new shareholders?
A shareholders’ agreement is executed by and between the existing shareholders and the company. In the event that shares are allotted or transferred to new shareholders, all they need to execute is a Deed of Accession which signifies their agreement to be bound by the terms of the already existing shareholder’s agreement. The Deed also allows the new shareholder to acquire benefit of the rights given to the other shareholders under the shareholders’ agreement.
11. Can shareholders create security over their shares in the company?
Shares in a company are personal property of the shareholder. The shareholder may deal with them in whichever way they wish (provided it is not restricted by the SHA or the company’s articles of association) including creating a security over the shares to secure personal financial obligations. The Shareholders agreement may restrict such securitization including imposing conditions that must be met to effect it.
12. What are exit events and Exit strategy?
Common exit events include: where the company sells a substantial number of shares or assets, merges with, or is acquired by another company, or it goes into liquidation.
The shareholders’ agreement should typically address the shareholders exit strategy upon exit events such as a lock-in period for the directors and shareholders among others.
13. How does the Agreement resolve distribution of profits and dividends to shareholders?
It is imperative to agree on the broad parameters of the Company’s dividend policy. It is important to agree whether profits are distributed based on shares only? The Agreement needs to avail options if the parties are unable to agree on whether to distribute profits or reinvest in business such as cooling off period or mediation.
14. What happens if a shareholder breaches the shareholders’ agreement?
Material breaches will usually occur in the event of a failure by a shareholder to provide capital where required under law or the agreement, a failure to comply with any particular provision of the agreement or where a shareholder commits fraud.
Some steps to take if a shareholder defaults in fulfilling their obligations in the agreement include; issuing a period to comply, valuation of shares, making buy out provisions. A shareholders’ agreement also enables an aggrieved shareholder to bring a cause of action against another shareholder that materially breaches one of their obligations under the agreement.
Please click here to download the article.
How can we assist you?
At CM Advocates LLP, we have an experienced team of lawyers who can offer you legal assistance in drafting, developing and reviewing your Software License Agreements for your business. Please contact us for our services at firstname.lastname@example.org for more information on our services.
Contact Persons & Contributors
Victorine Rotich- Senior Associate & Head of Unit
Ivy Mburu- Associate
Beverly Tracy- Associate
This article is for informational purposes only and should not be construed as legal advice.