Navigating Pre-Incorporation Documents: Shareholders’ Agreement in nutshell.

INTRODUCTION

In the intricate world of corporate governance, various incorporation documents need to be established including a shareholders’ agreement. One may point out that with the ever-changing dynamics of business environments, having a robust agreement in place is more important than ever. Therefore, a well-structured shareholders’ agreement is a critical instrument that precautions the interests of all stakeholders and determines their relationship. This legal document

serves not only as a blueprint for decision-making but also as a safeguard against conflicts that may arise among shareholders. Before we go further, a shareholders’ agreement is a private contract between the shareholders of a company which sets out the rights and responsibilities of the parties in relation to the company.

Let’s navigate through the shareholders’ agreement and discuss the main provisions that should be included at the time of incorporation. Among others, hereunder some of the key provisions to be included in the shareholders’ agreement.

SHAREHOLDER RIGHTS AND OBLIGATIONS.

This defines the fundamental rights and responsibilities of each shareholder in the company. Initially, this provision indicates the “rights of the shareholders” within the incorporation which include (i) participation in management and operations basing on their voting rights on key issues at shareholder meetings, including election of directors, approval of major transactions, and changes to the company’s bylaws. A shareholders’ agreement has to indicate that a shareholder has right (ii) access to information and indicates allocation of (iii) dividends through the profit sharing.

Shareholders’ agreement has also to indicate the “obligations of shareholders,” which includes the (i) confidentiality obligations, and the most crucial part of obligations which is (ii) non-compete obligations. Shareholders may be restricted from engaging in or investing in businesses that directly compete with the company during their tenure and, often, for a period after they leave. This protects the company’s interests and helps prevent conflicts of interest.

SHARE CAPITAL AND OWNERSHIP STRUCTURE.

This provision is pivotal in the shareholders’ agreement because it outlines how the company’s share capital is organized and how ownership is distributed among the shareholders. In addition, it establishes the foundation for each shareholder’s financial stake and influence within the company.

This provision includes six key sections such as:

(i) Initial capital contributions. This provision specifies the amount of money or assets each shareholder has contributed to the company at the incorporation period. For example, it might list each shareholder and their corresponding contribution, such as cash, property, and others. Furthermore, it serves as a record of the starting investments and establishes the baseline ownership percentages based on each shareholder’s contributions.

(ii) Share classes. Companies often issue different classes of shares (e.g.: Class A, Class B, etc.), each with distinct rights and privileges. Typically, this part describes the types of shares issued at the time of incorporation and the rights attached to each class. The types of shares may include ordinary shares, preference shares, non-voting shares, redeemable shares, etc.

(iii) Ownership percentage and voting rights. This determines each shareholder’s shares in percentage ownership in the company. This provision often outlines the correlation between shareholding percentage and voting rights, which influences the shareholder’s power in decision-making processes.

(iv) Issuance of new shares. Practically, a company reaches to a certain point requires to issue new shares. In this regard, the shareholders’ agreement typically outlines the procedure in which a company shall abide by to issue the new shares in the future. It mostly includes the term which protects the existence shareholders from Share dilution. It also includes pre-emption rights, which give existing shareholders the first right to purchase new shares before they’re offered to external parties.

(v) Transfer of shares. This part includes basic restrictions or guidelines on how shares can be transferred among shareholders or to third parties. This may include references to Right of First Refusal or other mechanisms to control share transfer.

(vi) Buyback clauses. This section, briefly outline whether and how the company can repurchase its own shares. This can provide an exit strategy for shareholders and help the company control its capital structure.

SHARE TRANSFER RESTRICTIONS

Restrictions on share transfer includes provisions within a shareholders’ agreement that set out rules and limitations on how shares can be transferred. Clauses like these, are vital in order to maintain control over the ownership of the company, ensuring that shares are not transferred to the unwanted or unqualified third parties, and maintaining the protection of the rights of existing shareholders.

Outlined below are some of the most important share transfer restrictions to consider incorporating into the shareholders’ agreement.

(i) Right of First Refusal. This is the provision indicated into shareholders’ agreement which explain that, a shareholder intending to transfer his/her shares must first offer those shares to existing shareholders on a pro-rata basis. This clause gives existing shareholders the option to purchase shares that another shareholder intends to sell before they are offered to an external party.

(ii) Tag-Along clause. This is the provision which is also known as “co-sale rights and are set to protect the interests of minority shareholders.” When drafting a shareholders’ agreement, it is important to include this clause as it protects minority shareholders by allowing them to join-in a sale initiated by a majority shareholder. This provision details how the minority shareholders shall have the right to sell their shares under the same terms and conditions in case a majority shareholder sells their shares to a third party.

(iii) Drag-Along clause. Unlike tag-along clause, drag-along clause are set to benefit the majority. This provision allows majority shareholders to drag (i.e.: forcibly sell together) minority shareholders into a sale to a third party on a pro-rata basis. This is often applied in cases where the majority shareholders want to sell the entire company, and a third party is interested in purchasing 100% ownership of the company.

DISPUTES RESOLUTION

Dealing with shareholder disputes can be a challenging and stressful. Understanding how to prevent and resolve shareholder disputes quickly and effectively is key to ensuring that the underlying value in the company is impacted as little as possible. Therefore, establishing a shareholders’ agreement which provides for the procedure for handling issues is pivotal. Dispute resolution clause in the shareholders’ sets out the procedure to deal with shareholders’ disputes and deadlock situations.

CONCLUSION

In conclusion, while the provisions discussed above are foundational provisions of a well-constructed shareholders’ agreement, it is essential to acknowledge that they are by no means exhaustive. A comprehensive shareholders’ agreement should be tailored to the unique needs and goals of the company and its stakeholders.

For instance, other crucial clauses to consider include confidentiality clause, which protect sensitive business information from unauthorized disclosure, and non-compete clauses, which restrict shareholders from engaging in competing businesses. Additionally, provisions addressing dividend policies can clarify how profits will be distributed, while termination and exit strategies clauses outline the conditions under which shareholders can exit the agreement and the company.

Each of these clauses plays a significant role in fortifying the governance framework and providing clarity in areas not covered by the basic provisions. Drafting a tailored and dynamic shareholders’ agreement can help mitigate risks, protect shareholder rights, and contribute to long-term corporate steadiness.

Disclaimer: The information provided in this article is intended solely for informational purposes and should not be considered as legal advice. Although we have made every effort to provide accurate and reliable information, it is recommended to seek advice from a legal professional to address your unique circumstances and provide specific legal advice.