The article is the first in a series of four articles.
This first article will focus on the advantages and disadvantages of shareholders’ agreements.
The second article will deal with the issues for consideration by promoters and investors in the context of third party investment in private companies and the advantages of having a detailed subscription and shareholders’ agreement in place.
The third article will concentrate on avoiding costly and public legal shareholder battles.
Finally the fourth article will deal with employee / shareholder disputes.
The author of these articles, Alan O’Driscoll, partner in Flynn O’Driscoll, a business law firm will be giving a detailed presentation in relation to the aforementioned topics, which will have the aim of assisting accountants giving advice to clients who are bringing investors into their business or becoming an investor in another business. The presentation is part of ‘The Practising Accountants’ Seminar’ which we will be hosted around the country in December 2011.
Advantages and Disadvantages of putting a shareholders’ agreement in place
A shareholders agreement is an agreement or a contract between, in most cases, the shareholders in a company. The agreement, generally, will regulate the relationship between the shareholders and detail how the company will be managed. As we will see a shareholders agreement provides an opportunity for shareholders to obtain additional rights or expand upon their existing rights. Each shareholders agreement should be tailored to suit the particular circumstances of the company and its shareholders.
The following briefly sets out particular advantages, for various parties, of entering into a shareholders agreement:
A minority shareholder may be able to obtain extra rights that it would not otherwise be entitled to; these include, but are not limited to:
- Increased access to information relating to the company. Many people are unaware of how little information they are entitled to by law when they are simply a shareholder in a company.
- A contractual right to nominate and have appointed a director to the board of the company. Parties can often agree to appoint someone to the board of a company at the outset of the relationship without realising that the company, usually acting through the majority shareholders, may remove that director by special resolution or appoint additional directors and have a majority for board decisions.
- Pre-emption rights on new share issues. If the company decides to issue new shares, the minority shareholder shall be entitled to be allotted additional shares pro-rata to its existing shareholding so as to ensure its shareholding is not diluted.
- Offer-round rights on a share transfers. If any shareholder is selling shares in the company, the minority shareholder shall be entitled to purchase a portion of the shares on offer pro rata to its existing shareholding, again so as to ensure its shareholding is not diluted.
- Tag along rights. If another shareholder is selling his shares in the company, the minority shareholder shall be entitled to have his shares also purchased by the purchaser. This is a significant protection to a minority shareholder who is generally less likely to find a buyer for his minority shareholding and may also not be in a position to purchase the majority shareholder’s shares at the price that they are being sold to a third party.
A shareholders agreement can be drafted significantly in favour of the majority shareholders depending on relationship between the parties. One advantage of shareholders agreements is that they are completely flexible and can be tailored to meet the objectives and concerns of any party.
A significant advantage for majority shareholders to enter into a shareholders agreement is the benefit of what is referred to as the drag along provision. Where this provision is included and the majority shareholder receives an offer for all of the shares of the company, the majority shareholder can force the remaining shareholders to also sell their shares to the purchaser. This is particularly useful where the purchaser only wants to buy 100% of the company, which is usually the case. Otherwise the majority shareholder may have to negotiate with the remaining shareholders to sell their shares to the purchaser, which could be costly, time consuming and might jeopardise the sale.
Majority shareholders can also benefit from the inclusion of certain default provisions. This would allow the majority shareholders the opportunity to purchase the shares of any shareholder (or just minority shareholders) who commits an event of default which can include for example, being in material breach of the shareholders agreement, being declared bankrupt or ceasing to be employed by the company if the shareholder is also an employee who holds shares.
When investors are considering investing in a company, they will be concerned about how the company will be run. To address these concerns, suitable covenants can be entered into in the agreement which set out in detail how the company will be managed.
Investors will also be interested in the options available to realise their investment from the company. Suitable exit mechanisms can be included in the shareholders agreement.
Investors can also seek to insert veto provisions where certain company actions can only occur where the investors have given their prior written consent. Investors will not want to unduly hamper the day to day running of the company but they will be concerned that no action is taken which could reduce the value of their investment in the company, for example buying another business, repayment of directors’ loans or declaring a dividend.
The above only mentions particular provisions that can be included in a shareholders agreement that would benefit certain shareholders. The following provisions can be a benefit to all shareholders:
- Privacy. A private company must file their articles of association with the Companies Registration Office, which is then available to the public to obtain. The advantage with the shareholders agreement is that it does not have to be filed with the Companies Registration Office and so the contents are private.
- Dispute Resolution. The shareholders agreement can set out in detail how disputes are to be dealt with. The shareholders may wish to firstly use mediation before going to court or arbitration, both of which can be very costly. Companies that are held 50/50 between two shareholders who are also the company’s only directors should have a shareholders agreement with deadlock provisions, to allow either shareholder buy the other shareholder’s shareholding in the event of a serious dispute which prevents the company continuing to function.
- Non-Compete. It is to the benefit of all parties that a shareholders agreement contains non-compete provisions preventing a shareholder setting up a competing business while they are a shareholder in the company. This would also usually extend for a period of six to twelve months from which a shareholder no longer hold shares in the company.
- Death. The shareholders agreement can provide in the event that a
shareholder dies the company and/or the shareholders have the option to purchase the deceased shareholders shares. This avoids the situation where the remaining shareholders are forced to deal with a shareholder’s estate or a beneficiary in a shareholder’s will, who has no interest in the business. It can also provide certainly and comfort to the shareholders to know that their estate will benefit from arrangements being put in place where the company/ the other shareholders will be in funds to purchase the deceased shareholder’s shares in the company at market value.
There are really no disadvantages to putting a shareholders agreement in place. In almost all instances shareholders, whether they hold a majority or minority shareholding, will be in a better position than if they were only to rely on a company’s articles of association to regulate the affairs of the company and the relationship between the shareholders.
In any negotiation of a shareholders agreement between an investor and a promoter there will be give and take on both sides. The commercial bargaining power of the parties will generally decide what controls and protections are put in place for each party.
Where the provisions apply to shareholders holding a very small minority of shares, they are generally given greater rights than would otherwise be the case.
To change the memorandum and articles of association of the company, only a special resolution (75% of the members) is required. Generally when parties wish to change a shareholder agreement, all the parties that signed up to the original agreement need to agree to the proposed change.
The foregoing is merely a guide and is not a substitute for professional legal advice which should be obtained should you have any queries in relation to any aspect of the foregoing.
If you have any queries in relation to the content of this article please contact Alan O’Driscoll whose contact details can be found below.
No.1 Grant’s Row,
Lower Mount Street,
Tel: +353 1 6424220
Fax: +353 1 6618918
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The Practising Accountants' Seminar
Alan is presenting on the Practising Accountants' Seminar details for which can be found below.