Do You Know Your Shareholders?

You probably can’t stop disputes, but you can diffuse them more easily.

It is a critical step for a business owner to understand the implications of an agreement with the people they own the business with and the rules, should they have a dispute.

Commonly, parties confirm how a company should be managed by the terms of a Shareholder’s Agreement.  However, often I find that people do not bother with such an agreement. They feel when times are good there is less chance of an argument, or they have a perception the costs of preparing this document are too high.

The reality is that, if the parties have a dispute, the costs will be enormous.

Here are a few tips and pointers in preparing a document and understanding its importance.

Directors

  • Directors should be carefully chosen to ensure that control and daily management of the company occurs in a way that reflects the understanding of all concerned.
  • There are very serious obligations on directors, including Workplace Health and Safety liability, tax liability and Corporate Act penalties for non-compliance. This includes keeping proper accounts, acting in the interest of the company as a whole and not obtaining a benefit where there is a conflict of interest.
  • The specific roles of each director should be set out clearly, whether it is finance, accounting, marketing, legal or management of staff.
  • The degree of delegation and authority to a director, including signatures required on cheque accounts or transfer of funds from a bank, should be clearly stated. Often small companies have at least two directors that must sign for the capital account and just one director or a secretary for a smaller operational account.

Limitations

  • A Shareholder’s Agreement should describe the limitations placed on directors in acting on behalf of the company. That might be the credit limits that apply for which they can commit the company and should state the maximum debt a single director can write off or compromise. It should also state how many directors must sign cheques and other negotiable instruments or contracts.
  • The quorum or number of directors required to form a valid meeting should be clearly outlined. The ability to appoint a proxy or alternate director in writing should be described. If there is a managing director with a casting vote, then that should be very clearly enunciated within the document.
  • The role of managing director should be described sufficiently including the process and frequency of appointment.

Voting

  • The equality of votes, or otherwise, by the directors appointed to the board should be clearly stated.
  •  If there is to be a casting vote on certain issues by a managing director, or if there is a deadlock, that should be included.
  • Whether a shareholder has the right to one vote at a shareholder’s meeting or whether votes are attributable to the number of shares held, then that should be clearly stated.
  • Whether the shareholders votes are affected by restricted issues should be included and it should identify the input of a non-shareholding director in the management of the company.
  • Any Shareholder’s Agreement should be resolved in general meeting to override the constitution, when appropriate, on specific issues.
  • Points such as a full sale of the business might need a unanimous decision of shareholders, as well as the admission of new shareholders or transfer of shares.
  • The events of default of a director or shareholder, including breach of agreement, insolvency, disability or perhaps death should be dealt with.
  • The process of meetings including how regular, where and agenda decisions should be included.
  • On exit of a shareholder there should be a reference to an independent valuation and perhaps a conditional grant of options subject to the event. A notice of retirement of director and whether that triggers a compulsory sale of their shares should be considered.
  •  The methods of dispute resolution should be canvassed including compulsory mediation and whether that appointment is by way of a professional expert.

Other issues

  • In reality, this Shareholder’s Agreement will be the document that is used if the parties cannot agree. It should have a positive emphasis, including the specific vision for the company and perhaps growth targets anticipated by the shareholders within an agreed time frame if they aim to grow the business or sell within a specific period.
  • If there are specific business planning issues, targets such as achievement of quality control or accreditation, then they should be included.
  • Specific qualities of a director or financial position of a shareholder should be specified as well.
  • Requirements regarding retirement of a director or exit of a shareholder by voluntary notice should be clearly stated in writing. This should take account of the position of the company and the financial framework.
  • If the shareholders are contributing capital then they should record any loans on the balance sheet.

If the directors require further loans from working capital or stock or plant and equipment, then each director and perhaps each shareholder should guarantee the loan equally in accordance with their shareholding to make sure there is fairness between them. If there are different levels of contribution of capital loans by shareholders or directors to the company then that should be recorded in formal loan documents and interest paid.

By having a clear checklist of these issues completed by the parties at the outset, it is less likely that a surprise or a point of dispute will occur in the future.

Independent accounting and legal advice should be obtained by each shareholder on a proposed Shareholder’s Agreement to ensure that all parties understand their obligations and requirements.

At the end of the day, people get together to create company value. It is, therefore, important to ensure that the rules are understood so that that value is preserved wherever possible.

ATC Digest Edtion #85

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