A shareholders’ agreement, or ‘business will’, is an agreement that attempts to regulate the conduct of those starting a new business venture. It is essential too for those seeking funds from new investors.
I wanted to focus this week on seven must-have terms for any shareholders agreement. To do this I spoke to Kristie Piniuta from Kubed Legal in Melbourne. A big thanks is due to Kristie who put together the list of seven based on her broad depth of experience as a corporate lawyer. This has included time spent working in-house for Boost Juice alongside Janine Allis. The seven must-haves include:
1. Only shareholders that hold more than a certain threshold or % of shares, say 20%, should be entitled to appoint a director.
You don’t want a new shareholder exerting too much control on the direction of your business if they are only a minority shareholder. A condition like this also increases the stakes for new investors and ensures that a larger investment is rewarded with greater authority via more seats on the board.
2. When a shareholder exits there should be an obligation on the director appointed by that shareholder to resign.
If an independent director has been appointed by a shareholder who later exits their investment then it would make sense for the director appointed by them to stand down. Their representation may no longer be justified if they represent the interests of someone who is no longer invested in your business.
3. Director decisions versus shareholder decisions.
You need to carefully consider what decisions are at the mercy of directors and those at the mercy of shareholders. For example, you don’t want to have to call a shareholder’s meeting to make a decision on the appointment of a new CEO. At the same time you don’t want to let a board of directors veto any important decisions made by shareholders. Jurisdiction on capex, business plans, budgets, asset purchases also need to be considered.
4. If a shareholder or director of a shareholder entity dies or suffers permanent disability, other shareholders should have a right to buy their shares
This situation occurs more often than you might think and can be overlooked very easily. If there is a clause in your contract that addresses this situation then it makes a traumatic event a lot less ambiguous. Ambiguous in the sense of what happens next for shareholders of the business.
5. Carefully consider events of default
A shareholder in breach of a shareholder agreement is said to be in default. It is important to include a right for non-defaulting shareholders to purchase the defaulting shareholder’s shares which if appropriate, may be discounted from fair market value (up to 20% in some cases).
6. Consider including drag-along and tag-along rights
Drag-along rights enable a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller. This ensures a clean sweep of of minority shareholders in the event of a full sale or acquisition.
Tag-along rights are used to protect minority shareholders. If a majority shareholder sells his or her stake, then the minority shareholder has the right to join the transaction and sell his or her minority stake in the company.
7. Include non-compete and confidentiality provisions.
This is especially important for businesses with a lot of intellectual property. That’s not to say it is any less important for other businesses who have lots of cash flow and very little IP. Non-compete periods have to be reasonable in scope and duration to ensure enforce-ability. A confidentiality clause is obvious for a number of reasons and it is a commonly used for other contractual agreements like employment agreements and non-disclosure agreements.
The cost of a full shareholder’s agreement “starts at about $A2,000-$A3,000″ according to Kristie from Kubed Legal. This is the bare minimum and the cost will increase depending on the complexity and number of shareholder requirements.
Hopefully the terms above highlight a few key points for business owners embarking on a capital raising mission for the first time. If all parties are fully informed and provisions are drafted appropriately, a shareholders agreement should be able to sit in the bottom drawer gathering dust until a situation arises where it needs to be consulted. The cost of the agreement pales in comparison to the cost of a legal dispute if an agreement is not put in place.
Please feel free to contact Kristie at Kubed Lawyers at firstname.lastname@example.org if you have any further questions or if you need a shareholder’s agreement drafted.
This article is general in nature and cannot be regarded as legal advice. It is general commentary only. You should not rely on the contents of this article without consulting professional advice from a corporate lawyer or adviser.