Why You Need a Shareholders Agreement

Pre-emptive rights on a transfer of shares

The term "Pre-emptive rights" describes the right a shareholder has to purchase another shareholder's shares if that shareholder is wishing to sell. These rights require the selling shareholder to first offer their shares to the other shareholders in the Company. There are no pre-emptive rights on sale of shares in the Companies Act 1993. However, these rights are commonly contained in a Company's constitution, if the Company has adopted one. See below for more information. Pre-emptive rights may also provide that even where a shareholder did not want to purchase the other shareholders shares, that they could have a say in who the purchaser is.

Exit rights

There are a number of reasons why you as a shareholder may wish to no longer own shares in the company. It could just be because it does not suit your personal circumstances any longer (e.g. due to illness or you no longer have a desire to be involved the Company) or because you are no longer getting on with the other shareholder/s and or directors (due to actions they have taken or want to take). While the Companies Act 1993 does provide shareholders with some rights – these can be difficult to instigate and extremely expensive and time consuming to enforce.

Tag Along Rights

If a majority shareholder(s) is intending to sell their shares to a third party – tag along rights provide minority shareholders with the right to require the majority shareholder(s) to ensure that the third party also purchases the minority shareholder's shares on the same terms and conditions on which they are purchasing the majority shareholder's shares.

Greater protections/rights for minority shareholders

Under the Companies Act 1993, shareholders which own less than 25% of the total shares issued in the Company have very limited rights. They do not have the right to participate in any decisions about whether the Company should proceed with a "Major Transaction" or not. A "Major Transaction" is essentially any transaction which involved the purchase or sale or incurring of liabilities which exceed more than 50% of the Company's assets. They also do not have the right to appoint a director which could mean no say in the day to day operations or the Company and no say in whether distributions (i.e. dividends) are declared or not and limited rights to information about the Company.

Dispute resolution process

A dispute resolution process will typically require shareholders to engage in a formal process to attempt to resolve a dispute before they can proceed to court etc. Without an agreement which provides for such a process there is no mandatory requirement on parties to engage in dispute resolution. This means that the only way to resolve a dispute may be to proceed to court which would be extremely expensive and time consuming.

Forced collaboration and agreement

One of the most important benefits of having a Shareholders Agreement is that it forces the shareholders to work together to agree on their respective rights and obligations in relation to the Company. If the parties are unable to reach agreement on their rights and obligations which are to be contained in the Shareholders Agreement, then maybe they should seriously consider if becoming a shareholder in the Company is a good idea. Conversely, the process of negotiating the agreement could be very beneficial and assist the relationship between the shareholders in the future.

Minority shareholder protections

A Shareholders Agreement can provide a minority shareholder with rights they would otherwise not have, for example:

• Decision making rights – which give the shareholder the ability to have a say in certain decisions. It would be standard for the agreement to specify how many shareholders must agree before the Company can take certain actions;
• The ability to appoint and remove a director(s);
• The right to approve a new shareholder;
• The right to receive any information about the Company;
• Tag Along Rights (see information above);
• The automatic right to receive a dividend in certain situations.

Exit mechanisms

The agreement can contain various mechanisms to enable a shareholder to exit in certain situations, e.g.:

• For any reason whatsoever – the agreement could provide a shareholder with a put option which means that it can require the other shareholders to purchase their shares at anytime or on the occurrence of a certain event or date;
• Due to death or permanent incapacitation – in this situation the agreement may contain provisions regarding the obtaining of insurance by shareholders to enable them to purchase the other shareholders' shares if that shareholder dies or becomes permanently incapacitated;
• Due to default – if a shareholder breaches the Shareholders Agreement (for instance, breaches the non-competition restrictions), the Shareholders Agreement could require the defaulting shareholder to sell their shares or alternatively buy the other shareholder/s' shares;
• Deadlock provisions – if the shareholders are unable to reach agreement on a certain decision, deadlock provisions can provide a process to resolve the deadlock which may involve shareholders buying each other out or selling the business of the Company;
• Drag Along Rights - if a shareholder receives an offer from a third party to buy its shares but that third party requires all of the shares in the Company, drag along rights allow the selling shareholder to require the other shareholders to sell their shares to the third party on the same terms.

Confidentiality

Because the Shareholders Agreement is not publicly available this means that it can contain provisions which are confidential between the parties – for example details regarding dividend and borrowing policies, payments to directors and shareholder advances.

Shareholder obligations

Under the Companies Act 1993, shareholders do not have obligations to each other or to the Company. However, it is standard for a Shareholders Agreements to create obligations between the shareholders and the Company, for example:

• Non-competition provisions – these provide that a shareholder is not to compete with the Company while they are a shareholder and/or for a period after they cease to be a shareholder;
• Non-solicitation provisions – these provide that a shareholder is unable to "poach" the Company's customers, employees and/or suppliers for a certain period after they cease to be a shareholder;
• Confidentiality provisions which provide that any information about the Company and the Shareholders agreement is confidential;
• Provisions which provide for the protection of the Company's intellectual property.