Shareholder Agreements for the Real World
At their best, as with all legal documents, Shareholders’ Agreements are about creating successful business relationships based on clarity and understanding of each other’s rights and responsibilities.
As legal advisors, our role is to ensure that you have covered and provided for both typical and unexpected events that might alter or have an impact on your control of what is rightfully yours. The goal is to ensure that everyone involved is protected and that the balance of power is both fair to individuals and beneficial to the ongoing health and sustainability of the business itself.
Vanessa Challess outlines the scenarios your Shareholder Agreement needs to cover and how cross-options can and should form the main plank of your provision for dealing with both the routine and they unexpected occurrences in the life of a business.
& Downright Disasters
It’s difficult for a layman to predict all the scenarios in which a group of shareholders might want to revert to a legally binding agreement to resolve an issue, much less to determine appropriate courses of action in those events. By and large though, the scenarios your agreement should provide for would fall into two main categories: Routine Business Events – and Downright Disasters.
Typical routine areas might include:
Rights & Responsibilities
Simply put, what are the roles, areas of activity and influence, duties, privileges and voting rights in given circumstances of each director or member.
Significant business changes
What happens and who has the right to decide on changes in the nature or direction of the business.
Some members may be actively engaged in the decision-making and management of the business or in providing its services. Others may be completely inactive in routine matters, for instance a sleeping partner who has invested in or lent money to the business. What happens if this changes and someone wants to become more or less active?
Any loan agreement the company enters into will likely involve some restrictions on what the company can and can’t do. Who makes or contributes to the decision to borrow? If the lender is also a member or director it’s even more important to be precise about what his or her powers are. Alternatively, it may be that a director wants to borrow money from the company, what would the shareholders want in place to govern this?
What happens if a member wants to sell their shares or wind up the business? It’s advisable for your agreement to include precise provision for potential scenarios such as:
- The sale of the company
- Buy outs by one or more shareholders
- Public flotation
- Seeking further capital from a new/external source
- Sale of assets or winding up
Transfer of Shares
In the normal and non-contentious run of things, shareholders may want to sell their shares for a variety of reasons. Shareholder agreements need to contain clauses so that the other members have some control over who may purchase them and what role and powers they will have. It’s not necessarily ideal for the new owner to simply step into the same set of rights and roles that the previous one held.
Company Law restrictions
Shareholder Agreement scenarios and the requirements and limitations that you are able to define to deal with them are not a free range matter. Some shareholder rights are protected under UK Company Law and can’t be granted or withheld at will. If there is a shareholder who other members are prepared to accept but only on limited terms then an alternative route will need to be found, either by issuing a different class of shares or by having special clauses drawn up to deal with the matter.
The Sad, the Bad – and the potentially Dangerous
Of course, life doesn’t always go to plan and, when we are wearing our respectably lugubrious lawyer hats, it’s often our job to remind our clients that Death, Divorce, Dispute, Bankruptcy and assorted other disasters and general skullduggery can and do occur.
As gloomy as it makes us look we are really rather happy and cheerful when we can get people to put some thought in to these things sooner, when everyone’s still romping about bright-eyed and bushy-tailed, rather than later, when the you-know-what has already hit the fan.
In short, “Cheer up, it may never happen” is not something that you want to be saying to a lawyer. The amount of angst, distress and damage that can be averted by agreements that do a fine-tooth-comb job on possible future disasters is amazing. We know, because we’ve seen the alternative.
All contracts and agreements that are going to tie people’s fortunes and futures together need a dose of this lawyerly gloom but Shareholders Agreements, where a lot of money and people’s livelihoods are involved, really do need special care. When it becomes necessary for shares to be transferred at short notice due to unfortunate or unforeseen circumstances, you need powerful legal safeguards in place to ensure that one member’s sad or bad circumstances do not threaten everyone else’s wellbeing and the functioning and control of the business itself.
This is where Cross-Options come in.
What are Cross-Options?
Cross-options allow shareholders to retain control over their company whilst looking after the families of the shareholders. They can give the personal representatives of a deceased or shareholder the right to sell the shares back to the surviving shareholders (by “putting” their shares to them) and also allow the surviving shareholders the option to buy the shares of the deceased shareholder (by “calling” on them). This is set up as an option rather than a compulsory transfer for tax reasons. It means that if one of your co-shareholders in a venture meets with misfortune, which can include mental incapacity, then the others will be able to buy their shares whilst the family will receive a lump sum instead of share in a company that they may have had very little involvement with.
Essentially, the point is to prevent shares falling in to the hands of people not involved in the business. This might be family members of a deceased member who has no experience or particular interest in the business for instance.
All of these scenarios have huge potential to be detrimental to the business and the other shareholders’ interests. Cross-options permit them to exercise their right to buy and regain control of the business. In most circumstances it’s a good solution for whoever has become the new owner of the shares, such as the beneficiaries under a will.
Financing share purchases
Most scenarios in which a cross-option is exercised are unforeseen and therefore the necessary finance has to be arranged quickly, and often inconveniently.
To deal with this, an insurance policy can be taken out on each shareholder to cover the value of his or her shares. This is regularly reviewed and adjusted so that the money will always be available should it become necessary to exercise the cross-option.
There are a variety of different possible approaches to the type and structure of the insurances. There are tax implications too so devising and implementing a cross-option strategy really does require professional advice.