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Owning shares in a company is a big commitment. It’s further complicated when you add other people into the mix. It’s human nature to focus on the positives at the outset of a business relationship and in fact that will be the key to forging a successful business. Unfortunately, if you neglect to consider mechanisms for what happens in the event shareholders disagree or one simply wants out then there can be costly consequences.
Grounds for divorce
Shareholders in a company effectively make a commitment to one another and have common ownership of an asset: the company. You don’t have to stretch the metaphor too far to see why the breakdown of relations between shareholders can occasionally be likened to a divorce. How many times have you heard someone refer to their company as ‘their baby’? Like all relationships, there may be communication breakdowns, unresolvable issues and unreasonable behaviour between shareholders that will be cited as ‘grounds for divorce’. There may also be one or more shareholders who might want to leave because the grass has suddenly become greener elsewhere, perhaps because they’ve received a better offer for their shares or they just wish to pursue new interests.
We think that drafting a shareholder agreement needs to be treated a bit like agreeing a “pre-nup” in some respects. All participating individuals should be conscious of what their rights and responsibilities are should the relationship end, however unnecessary it might seem at the start. While it isn’t possible to eliminate the risk of a dispute entirely, if you have a properly drafted shareholders’ agreement to refer to, it can make the resolution of disputes much more straightforward.
Points of contention
Common issues we would address when drafting a shareholder agreement include:
- Restrictions and/or rights on transfers of shares
- How to resolve disputes between shareholders and/or directors
- Whether shareholders should receive a discounted amount for their shares if they leave for a “bad” reason, for example, they were dismissed from their position as director or leave to work for a competitor
- Restrictions on the shareholders outside business interests
- What the exit process (or processes) should be
Making an exit
Exit provisions in particular may outline a specific agreed process (if the business or venture is to be limited in time), and/or what happens if one or more (but not all) shareholders decide to exit the business by selling their shares.
For example, it may be the case that when a majority shareholder wants to sell his shares, he will want to be able to compel any minority shareholders to sell their shares to the same buyer, literally dragging them along (these are called ‘drag’ rights). Buyers may not be interested in buying shares in a company where they can’t control the whole company – it’s not often that a buyer will want to have to deal with an unknown ‘partner’ in the business, who might be able to stop them taking it in the direction that they want. Conversely, minority shareholders might want to have rights to ‘tag along’ with any sale by a majority shareholder to a third party, so that they get value for their shares and are not left behind (unsurprisingly these are called ‘tag’ rights).
It is worth noting that, save for a legislative procedure which only applies to a minority of shareholders and requires certain conditions to be met, there is no way to force a shareholder to sell his or her shares unless you have included relevant provisions in a shareholders agreement. This can present a real problem when shareholders fall out.
Working out the issues
It is important to ensure that exit and disputes provisions are drafted as clearly as possible, as invariably they will be heavily scrutinised in the event of shareholder conflict or exit. The mechanisms which govern these provisions can sometimes be unwieldy and, if not drafted correctly, contradictory. It can therefore be a helpful exercise to run through hypothetical problem scenarios and check that the provisions ‘work’ (and be comfortable with how they work) before finalising a shareholder agreement.
Thinking about the realities of what could happen on dissolution of the shareholder relationship may later reduce any exit scenario to more of a ‘conscious uncoupling’ than a messy divorce.
Click here to download our detailed guide on what to consider when entering into a shareholder agreement.
If you have any questions about the above article or would like some advice about how a shareholders’ agreement might benefit you, please get in touch with one of our specialists for a friendly chat today.
Call 01622 759 900 or email firstname.lastname@example.org