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:
john.kirkwood@heskethhenry.co.nz
