Are you thinking about incorporating a company, or perhaps you have recently done so? No matter the size of the company, consideration should be given to adopting a constitution and a shareholders agreement from the outset.
In our September 2018 article, we talked about constitutions for small businesses. A constitution is a document that sets out the rights, powers and duties of a company, the directors and the shareholders. It governs the way a company is run and can include operative provisions not provided for in the Companies Act 1993. There is no requirement for a company to have a constitution but if adopted it can be accessed by the public on the Companies Register.
In contrast, a shareholders agreement sets out the rules between shareholders, and their dealings with each other and the company. A shareholders agreement is not registered with the Companies Office, therefore, offers a greater degree of confidentiality. An agreement can provide a framework for the “what if” moments that are sometimes overlooked. It also provides a level of certainty for the shareholders as to how those situations will play out.
A shareholders agreement can be as complex as the shareholders wish but would usually include, among other policies, the following:
• Decision making: the agreement should reflect how decisions will be made, what matters require a shareholder resolution passed by 50% or 75% of the shareholders entitled to vote, and what matters require a unanimous decision.
• Structure and management of the company: this covers who the directors and shareholders are, the shareholding and allocation of shares, appointment and removal of directors and shareholders, shareholders remuneration, whether a managing director will be appointed, who will prepare financial and management reports for the shareholders, and general rules of the company which are not included in the Constitution due to being sensitive information.
• Pre-emptive rights: if the company issues more shares or a shareholder wants to transfer their shares, those shares must first be offered to the existing shareholders in proportion to their shareholding. This is to ensure the shareholders can have some control about shares being owned by unrelated third parties.
• Exit strategies for shareholders: if a shareholder wishes to sell their shares and the non-selling shareholders have waived their pre-emptive rights a mechanism can be included in the agreement whereby the shares to be sold are valued and the shareholder is paid out accordingly.
• Drag option: this allows a majority shareholder to ‘drag’ a minority shareholder to sell their shares to a bidder who wants to purchase all the shares.
• Tag option: this option protects a minority shareholder in the event the major shareholder wishes to sell their shares. The minority shareholder may wish to ‘tag along’, meaning the majority shareholder can only sell their shares if the bidder also purchases the shares held by the minority shareholder.
• Buy-Sell Policies: A stakeholder may hold buy-sell insurance policies on behalf of the shareholders that provide the funds to enable surviving shareholders to purchase the shares and any current account of a deceased shareholder. This ensures the remaining shareholders are not left in business with the trustees or beneficiaries of the deceased shareholder’s estate.
• Funding: this covers whether contributions by the shareholders are in exchange for shares or whether the contributions are loan advances. This can also cover the possibility of additional funding by way of bank borrowing and whether the shareholders need to provide personal guarantees.
• Dividends: the company may have a policy that no dividends or distributions to shareholders are made until the company has repaid any outstanding loans, or achieved an agreed level of growth. The amount of profits to be allocated as dividends each year should be set out in the agreement.
• Non-competition provisions: this is to prevent a shareholder from competing with the company and the business while being a shareholder. It is also prudent to have restraint of trade provisions for a shareholder exiting the company.
• Dispute Resolution: There would be standard mediation and arbitration clauses in the agreement but another way of resolving a deadlock is by way of ‘Russian Roulette’ where all shareholders put forward a price for the other’s shares and the party who puts forward the highest price has to purchase the others’ shares at that price.
• Imputation credits and offsetting losses: an agreement can promote continuity of shareholding to ensure the company can benefit from the credits and losses.
The above is a brief summary of policies that can be included in a shareholders agreement. Each agreement will be substantially different and tailored to suit each company. We see a lot of disputes between shareholders that could have easily been resolved if they had received advice at the outset.
If you would like to discuss this further please contact Solicitor Natasha McClure on DDI 03 343 8586 or Natasha@mmlaw.co.nz.