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  Club rules
What have you and your co-shareholders agreed?


When I was a kid growing up in provincial New Zealand, a bunch of mates from my street and surrounding area decided one weekend to form a secret club. It was a club so secret that even several decades later I am loathe to disclose its membership. Having settled on a name, secret handshake and passwords we then turned to discussing rules. There were a few fundamental ones that everyone agreed on, like "no girls" and that sort of stuff. We then wrote them down (we imagined they were signed in blood) and buried it in a box. So far as I can recall we never looked at them again and nor did we need to. We knew what we stood for, and still do (although we did drop the silly handshake).

I often think of the shareholders' agreement as the rules of the business club.

Some basic agreements between the parties that will operate as a touchstone in their daily operations and a key document in the event of a later dispute. I am not suggesting that the shareholder agreement be pinned to the wall and all actions measured against its terms. On the contrary, it is generally filed away and never seen again until something goes wrong! However, it is just as important that right from the outset, the parties have discussed and agreed key issues, contributions and desired outcomes.

The Companies Act 1993 and the company constitution (if it has one) provide some general rules for the incorporation and ongoing operation of a company. Shareholders' agreements, on the other hand, are about the specific relationships between the shareholders and between those shareholders and the company and its directors.

So what do you include in a shareholders' agreement? Remember, other than in certain limited circumstances, the directors control the operation of the company. A shareholding in a company, in the simplest kind of ownership structure, generally entitles the shareholder to vote on any resolution, the right to an equal share in dividends authorised by the Board and the right to an equal share in the distribution of surplus assets of the company. Those rights may of course be negated, altered or added to in the constitution itself or in a shareholders agreement.

Some fundamental (but far from exhaustive) points include:

  • Shareholding Structure - Who will hold the shares? Consider whether it is appropriate to have trusts or other entities as shareholders. Tie those entities to the shareholder agreement.
  • The Core Business - What is the core business of the company going to be? This is an important provision. Any material deviation should require the unanimous consent of shareholders.
  • Allocation of roles - A clear outline of the expected contributions and roles of each of the shareholders.
  • Death or Disability - What happens if one party becomes ill and cannot function within the business in the way originally anticipated? If a party dies, do you want to be in business with their relatives? Include provisions to deal with these circumstances.
  • Buy/Sell Insurance - Consider obtaining buy/sell insurance to enable the remaining shareholders to buy out shares in the event of the death or disability of a shareholder.
  • Key Person Insurance - Consider obtaining key person insurance for the benefit of the company to cover the death or disability of a key person in the business.
  • Funding - What are the initial funding requirements of the company and how will any new funding be provided?
  • Appointment of Directors - How are directors appointed and removed? What limits are to be placed on their ability to make decisions?
  • Unanimous agreement of shareholders to certain matters - Some matters are so fundamental that any change should require the unanimous consent of shareholders. For example, changing the scope of the business, buying another business, selling all or any part of the business, issuing further shares, acquiring capital items over certain specified amounts, etc.
  • How profits will be distributed - An agreed dividend and reinvestment policy.
  • Termination Events - Other circumstances which will lead to termination and the obligations of the shareholders upon termination. For example, the material default of a shareholder triggering buyout rights for other shareholders.
  • Dispute Resolution - Include mediation and arbitration provisions.
  • Valuation of Shares - Include a clear mechanism to value the shares in the event of a shareholder exit.

    The best time to think about a shareholder agreement is right at the beginning of the venture. However, all is not lost if this has been overlooked. Deal with it now! A bit of time spent on the "rules" of your business will pay enormous dividends

    - literally!

    JOHN KIRKWOOD is a partner with Hesketh Henry.

    Contact John at:

    ASB creating futures.