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A shareholders agreement allows a company to clearly outline its rules and procedures concerning decision-making at both the board and shareholder levels. While you might think these agreements primarily look after majority shareholders and the company, they can also be critical to protecting the interests of minority shareholders. This article will outline some ways a shareholders agreement can benefit minority shareholders.
Clear Rules and Decision-Making
Having a shareholders agreement helps clarify how a company’s decisions are made. The default rules under the Companies Act 1993 (the Act) provide that the directors are responsible for managing the company’s business and affairs. Notably, the default rules do not contain any specific approval requirements for how directors should make decisions. Likewise, it does not mandate whether certain decisions require a higher level of approval than a simple majority.
Accordingly, a shareholders agreement can specify which types of decisions the board needs to make by special or unanimous resolution, giving comfort to shareholders as to the alignment of their board on key decisions.
A shareholders agreement can also address the types of decisions shareholders are responsible for beyond what is mandatory under law. Typically, directors will run the business and its operations. However, certain key decisions are more appropriate to go to shareholder approval. These include:
- any proposed change to the nature of the company’s business;
- adopting or altering a company constitution;
- issuing new shares or other securities; and
- entering into a major transaction. A major transaction involves, for example, the acquisition of assets, the value of which is more than half the value of the company’s assets.
Some of these thresholds for shareholder decisions are mandatory under the Act. Still, the shareholders’ agreement will often look to expand the list depending on the company’s specific needs. Such decision thresholds may be set at a level high enough for certain minority shareholders to have “negative control.” This is the ability to vote against a decision, resulting in the resolution not being passed. More commonly, however, they may simply result in minority shareholder buyout rights (allowing a shareholder to require their shares to be sold).
A shareholders agreement will typically outline an exit process for any minority shareholder wishing to exit the company. It would also include any ability for them to either require the company to:
- buy back their shares; or
- tag-along to a potential sale of the entire company.
A robust shareholders agreement should also include a clear valuation process in the event of a share buyback. Notably, the default rules do not outline these requirements.
The mandated process for the sale of company shares by a minority shareholder moves away from the default position under the Act which allows shareholders to freely sell their shares to a third party at any price. Instead, the shareholders agreement will typically restrict the ability of a shareholder to sell their shares to a third party via pre-emptive rights.
In these situations, it is common for a company or its shareholders to buy back and cooperate with the minority shareholder for selling its shares. Still, the minority shareholders are unable to freely sell their shares to any third party once signing the shareholders agreement. This is often a key reason a company drafts a shareholders agreement in the first place. Notably, founders of small, closely-held private companies want some control over their shareholders.Continue reading this article below the form
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Intellectual Property and Confidentiality
The other key benefit of signing a shareholders agreement is to protect the company’s intellectual property. A shareholders agreement will usually acknowledge that the company retains ownership of any intellectual property a shareholder develops for the company.
Of course, you can also include intellectual property provisions in employment agreements. However, these may or may not be signed by the same people. Instead, the shareholders agreement captures, for example, founder shareholders who may not have a formal employment agreement with the company. Often, intellectual property is the key asset of (and therefore driver of value in) the company. So, ensuring the company legally owns it is critical.
Similarly, confidentiality obligations also require any exiting shareholder to keep confidential any key company information obtained in their role. From the perspective of a minority shareholder, having these company protections put in place adds a sense of security to their investment in the company. Additionally, these rules usually benefit all company shareholders, as they seek to protect all investments.
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Having a shareholders agreement can benefit a minority shareholder by outlining a clear process for the company’s governance. It is also helpful to acknowledge intellectual property and confidentiality. For a minority shareholder, having these rules in place for all shareholders can provide a sense of comfort, knowing that a clear set of rules governs how a minority shareholder’s investment into the company will be managed and maximised.
However, a minority shareholder should still seek individual legal advice to check that the shareholders agreement aligns with their expectations and usual commercial practices. Nonetheless, a well-drafted shareholders agreement will work towards protecting the interests of all shareholders involved in the company.
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