One of the functions of a shareholders agreement is to set out clearly the differentiation in roles between shareholders and directors. Shareholders are not responsible for the day to day running of the company, but will want say on decisions that affect the value of the company, the risks it takes and loss of control. As such, the agreement between them should set out what decisions shareholders make, the process that is followed, and the power each of the shareholders has in the process for any particular matter.
Background information about the share structure
The start of a shareholders agreement usually states the background to the agreement. Information given here such as the number of classes of shares, the number of shares in each class, and total share capital is for memorandum purposes.
Transfers of shares clauses
Shareholders may want to restrict transfers of shares in certain circumstances in order to keep control of the company between known people. Restrictions may include:
- to trusts, where the trustees who are not necessarily “qualified” to make shareholder decisions gain power to do so
- to a family member, where again in the view of other owners, that person may not be suitable to vote or maintain the obligations he or she must
- to associated companies, where control of the associated company cannot be influenced by the shareholders
Transfers may be allowed, but the rights associated with the shares (or some of them) are not transferred, or are delayed in transfer, or are transferred in certain conditions. For example the owners may agree:
- that if any other of them wants to place shares in a trust for family members in order to reduce the value of his or her estate for inheritance tax purposes, voting rights on certain matters are lost, but other rights remain
- that a shareholder must have been employed in the business for at least two years before he or she can vote on certain matters
Note that shareholders have certain statutory rights (i.e. rights given by law) that cannot be reduced. Thus restrictions may not be completely effective.
Similar to restrictions of transfers, situations in which a transfer may arise may be restricted. The most common of these is prohibiting a charge over shares, i.e. offering the shares as a guarantee for a loan or a mortgage, where non-repayment would mean that the borrower becomes a shareholder.
Owners between them should agree what each commits to do in relation to the business. These can include:
- a commitment of time, such as to attend in person or by telephone a certain number of shareholder meetings each year (so as to ensure that at least a minimum number of shareholders vote on each issue)
- the maintenance of payment of life insurance policies required in order to pay for the exercise by the others of cross option agreements and similar arrangements
- to notify all the other shareholders as soon as possible of any material event such as litigation against the company
- the obligation to disclose management level information to the other shareholders
You should agree how many shareholders need to attend a meeting, and whether attendance must be in person or could be via telephone or video conference. Decisions for a small start-up ideally need to be made by all founders.
It is common to appoint a chairman to manage the meeting and ensure that every member is able to speak and be heard. The chairman also usually has a casting vote, which gives him or her superior power over certain decisions. There is no requirement in law for this position however.
Within the shareholders agreement, you may want to agree that the position of chairman will be rotated between shareholders, such that no founder can hold the position again before all others have held it, unless one agrees to waive his or her right.
You are also likely to want to remove the right of the chairman to a casting vote, and instead replace it with another mechanism for resolving deadlock. For example, if you cannot agree on a matter, you may decide to vote on a different basis (such as a show of hands, rather than share ownership) or eliminate one of the possible choices in subsequent rounds of voting.
One of the functions of the shareholder meeting is to make sure that all owners are aware of what is happening in the company. One of the directors is likely to present an update to trading compared to the plan agreed at the last meeting. Documents such as management accounts should be circulated in advance.
The chairman may also ask shareholders in advance for questions or matters to raise at the meeting in order to have a timetable and give each owner the opportunity to address important matters to him or her.
You should consider having policies in place that determine how decisions about the following are made:
- the business plan (remember an exit plan is likely to be important to at least some owners)
- debt financing matters – short term working capital, longer term loans (particularly those secured by company assets), and debt investment by third parties (such as convertible debt)
- equity investment by new shareholders (when venture capital is raised)
- payment of dividends
- remuneration of directors and other senior employees
You may also want to have policies regarding directors:
- how directors are appointed and removed, and who has power to do so
- whether an executive director must also be a shareholder, and if so, what holding is required as a minimum
- whether there will be a limit to the number of directors (so as to balance thorough consideration of matters with the ability to make decisions)
Common matters for shareholder decisions
The decisions that shareholders are likely to make are fairly limited, since the day to day running of the company should be left to the directors.
Matters that are important to vote on usually are those where:
- there could be a significant operational risk to the business
- there could be a change of control of the business
- value could be transferred from shareholders (usually to another shareholder, or a party connected with another shareholder) unknowingly otherwise
Votes at shareholder meetings may be on:
- issue of new shares or other alterations to share capital
- buy back by the company of its own shares
- change of accounting reference date
- change in the nature of the company’s business, or the start of a new business
- expansion into a new market
- purchase of sale of assets of significant value, or the disposal of a business
- entering into major contracts
- formation, disposal or acquisition of subsidiaries
- acquisition of shares or debentures of another company as part of a joint venture
- loans guaranteed against company assets
- authorisation of loans in excess of the limit that directors may take out
- loans made by the company
- factoring of debt (selling rights to receive debts to someone else)
- capital expenditure in excess of the limit that directors may make
- transactions involving intellectual property
- unusual transactions
- changes to bank signatories
- legal action by the company
- transactions with “connected persons”
- political donations
- appointment and dismissal of directors
- directors’ remuneration
- alteration of the articles of association
- winding up the company