B P Collins’ corporate and commercial team recently prepared a general overview of articles of association and shareholders’ agreements which you can read here. This time, we focus on 10 key questions to consider when preparing your articles and shareholders’ agreement:
1. If there is a deadlock or disagreement, how should this be resolved?
If there are disagreements between the shareholders or between the directors, you may choose someone who should be given a final casting vote in such cases. Alternatively, you may want to set up a process where a facilitator or mediator is appointed to help your board of directors or shareholders to resolve the issue.
2. What protections should minority shareholders have?
By default, shareholders’ power is usually based on the proportion of shares held. Therefore, a majority shareholder can pass decisions against the minority shareholders’ wishes. One way of protecting minority shareholders is to set out key decisions that would require consent of all the shareholders such as changing the nature of the business or amending the Articles. They could also benefit from pre-emption rights (enabling them to maintain their percentage shareholding on an issue of new shares), tag along rights which give them a right to sell their shares alongside the majority and/or share valuation rights that remove the risk of minority discount.
3. What controls should there be over director decision-making?
As the directors are responsible for day-to-day running of the company, there are many decisions that the directors would ordinarily be able to take themselves. However, the shareholders may want certain important matters that affect the value of the business to require shareholder oversight. These matters could include: the company making substantial borrowings, entering into mortgages and charges over the company’s property and entering into high-value contracts.
4. How should income and capital benefits be shared?
The shareholders can agree a dividend policy that will describe how dividends can be paid and whether there needs to be shareholder oversight over dividends declared by directors. Similarly, it is possible to set out how proceeds of the sale of the business are to be shared and that minority shareholders can secure similar terms of sale as majority shareholders.
5. Should there be any restrictions on share transfers?
If shareholders are looking to exit or reduce their shareholding, other shareholders may want a right of first refusal before shares are offered to external investors.
On the other hand, if a majority shareholder is looking to exit the company, a buyer may want the ability to purchase minority shareholdings in order to own the entire share capital.
6. Do you want different shares to have different rights?
Many companies choose to create different share classes. The share classes would have differing rights that may be appropriate for the various shareholders of the company. For example, an investor who does not want to be involved in company decision-making may want to have non-voting shares that have preferential dividend and return of capital rights.
7. Should there be restrictive covenants on shareholders and directors?
If the shareholders and/or directors have access to valuable information or relationships regarding the company’s customers, suppliers, products or services, it may be worth considering whether the shareholders should be subject to restrictive covenants prohibiting them from competing with or damaging the company. Similarly, it may be appropriate to impose restrictive covenants on the directors so that they cannot set up a competing business.
8. Have you taken on senior employees whom you want to incentivise with equity?
If you are considering issuing shares to employees, you may want to limit their entitlement to the future value they create. If those senior employees leave their role, perhaps they should be required to sell their shares or if they are ‘bad leavers’ (a term sometimes used to describe employees who are dismissed for gross misconduct or fraud but could also have a wider definition e.g. cover circumstances where an employee leaves without the agreement of the board of directors), their shares could convert to deferred shares that have limited rights. Alternatively, consider the use of share option schemes and arrangements.
9. Does an incoming investor want additional protections over their investment?
An incoming investor may seek warranties to be given by existing shareholders and/or directors of the company so that if those warranties turn out to be false, they can seek damages. They may also want the right to appoint an investor director that must be present at all board meetings so that they have an input on board level decisions.
10. Do you want to record and have oversight of the overall business strategy?
There could be an agreed business strategy between the shareholders and directors. In order to ensure that the business strategy is being followed, the shareholders may want the right to request certain information and require the directors to meet reporting requirements.
For further advice please contact B P Collins’ corporate and commercial team at enquiries@bpcollins.co.uk or call 01753 889995.
