Shareholders’ Agreement: What Is It and Why Does a Company Need One?
If your startup has grown into a company, then in order to clearly define the rights and obligations — no longer just between co-founders, but between the owners of the company — to establish the decision-making procedure, profit distribution, and everything else that relates to the company’s activities and may affect its fate, it would be appropriate to conclude a Shareholders’ Agreement.
Shareholders’ Agreement: What?
A Shareholders’ Agreement (hereinafter — SHA) is an agreement between the shareholders of a company (shares — shares, holders — their owners).
The first thing that comes to mind is that such agreements are only for large joint-stock companies or holdings. However, this is far from the case. If your company is registered abroad, it will most likely operate in the form of an LLC (Limited Liability Company) — the equivalent of a Ukrainian limited liability company.
Abroad, this is the most common type of company, characterized by the fact that the share capital of the company is divided into shares, each of which has a certain price (more on this later). That is, our LLC, but with shares. The liability of the participants for the company’s obligations may be limited to the price of the shares (company limited by shares) or to shares and personal guarantees (company limited by guarantee).
And such owners need to agree in a Shareholders’ Agreement how to run their business, so to speak. Since UK corporate law is extremely flexible, in order to demonstrate its capabilities in the area of regulating company management, we will cover the main provisions of a Shareholders’ Agreement developed under English law.
Where to Begin in a Shareholders’ Agreement?
First of all — the definition of the key terms that will be used in the Shareholders’ Agreement.
For example, if the SHA states that attracting investment into the company will be done through a convertible note, then it is necessary to define what a convertible note means within the context of the Shareholders’ Agreement.
One of the most important sections — the Ownership Structure — provides for the distribution of the company’s shares among the owners.
For example: Shareholder 1 — 30%, Shareholder 2 — 20%, Shareholder 3 — 50%.
In accordance with this distribution, the SHA will define the shareholders’ right to receive dividends proportionally to their stakes in the company (for example, if the ownership stake is 20%, the shareholder will receive 20% of the company’s profit).
This structure will also determine the number of votes for each shareholder at the general meeting. For example, if a decision to issue shares for a new investor requires a vote by shareholders who collectively hold 50% of all shares, then the consent of the shareholder with a 50% stake is sufficient.
This section should also provide for the size of the company’s share capital in shares (for example, 100,000 shares) and the price of 1 share (for example, £10). A feature of the corporate law of foreign states (including the UK) is that the share capital does not have to be paid in full immediately. It is sufficient for shareholders to contribute to the capital, for example, the price of one share — £10 — and pay for the remaining shares later.
Company Management — Board of Directors
The Board of Directors (Board of Directors, or simply the board) is the main executive body of the company. In the SHA, several sections are usually devoted to the organization of the board, covering the procedure for appointing and electing directors (for example, each shareholder may appoint 1 director for every 10% of the votes they hold in the company, or may only nominate a candidate who will then be approved by the General Meeting of Shareholders).
It is also appropriate to set out in the SHA all matters for the resolution of which the Board of Directors must seek shareholder approval — Important Board Matters. For example, in order to conclude an agreement with another company for an amount exceeding $10,000, a resolution of the general meeting is required.
However, so that the board’s hands are not completely tied, the SHA may provide that the organization of activities within the Board of Directors is left to the Board itself, but must be recorded in a separate document — Board Regulations. This will make it possible to avoid constant updates to the SHA itself due to changes in internal board procedures.
General Meeting of the Shareholders
Shareholders may express their will at the general meeting. And so that all owners of the company are familiar with the procedure for convening general meetings, the voting procedure, and the approval of resolutions, these provisions must be included in the SHA.
It is particularly important to record the quorum required for a general meeting to be held and the number of shareholder votes required for resolutions to be approved. English law allows for particular flexibility here, as it is possible to establish that a quorum of the General Meeting requires the presence of, for example, only 2 shareholders.
This section should also describe which resolutions — ordinary (requiring, for example, a simple majority of votes) or special (requiring, for example, 70% of the votes of all shareholders) — govern shareholder voting, who should chair the general meeting, and even that shareholders may attend the meeting by means of a video conference.
How to Attract an Investor — Further Funding
Current shareholders always seek to ensure that investors, venture funds, and others wishing to join their company become shareholders through a transparent mechanism. Therefore, one of the key pillars of an SHA is the provisions relating to further investment in the company and its mechanisms.
It is essential to specify how a new investor will join the company — through the conclusion of a convertible note, an SPA (share purchase agreement), or in another manner that the shareholders may decide upon.
Exit — Every Shareholder’s Dream
No less important is the question of a participant’s exit from the company — the very thing they dream about almost daily. Here, English law opens up a whole trove of methods from which shareholders can select the one that suits them. It must be remembered that when a shareholder exits, the question of who will receive their shares remains open. The right of pre-emption by the other participants has not been abolished, but the manner in which this will occur must be decided by the founders in the Shareholders’ Agreement.
The following are typically used:
Right of First Refusal: a shareholder who wishes to sell their shares to a specific person (not necessarily a shareholder) must first offer each of the existing shareholders the opportunity to purchase them. If none of them wishes to purchase the shares, the shareholder may sell them to anyone.
Tag Along Right: shareholders who hold a small stake (minority shareholders) have the right to sell their shares together with a shareholder who holds a significant stake (majority shareholder) and has expressed a wish to sell. The majority shareholder cannot refuse to allow them to sell their shares alongside their own. At the same time, the buyer is obliged to purchase all of the shares offered to them.
Drag Along Right allows majority shareholders to require minority shareholders to sell their small stake alongside their own. For example, one shareholder holds 50% of the shares and wishes to sell them. They have the right to oblige another shareholder who holds 10% of the shares to sell their shares together with their 50%.
The procedures for exercising the right of first refusal, tag along, and drag along must be recorded in the SHA.
Profit Distribution, Liquidation, Shareholder Rights
The SHA may also typically set out how and when profits will be distributed (for example, before the New Year in accordance with each participant’s stake), as well as what will happen to the company if the participants decide to liquidate it. This question also comes back to each participant’s stake, in accordance with which the shareholder will receive those company assets that remain after its debts have been repaid. It may also be specified that such assets will first be distributed among the holders of, for example, preferred shares, and only then among the holders of common shares.
It is also worth including in the SHA a section stating that each shareholder who holds a certain stake (or indeed every shareholder) has the right to information regarding the company’s activities. For example, they may request the accountant to provide them with the accounting books or even appoint an auditor (but also pay for their services).
Can a Shareholders’ Agreement Be Concluded for a Ukrainian Company?
In Ukraine, shareholders may also conclude a Shareholder Agreement, but such an agreement will have little practical value. Firstly, our participants will not be able to depart from Ukrainian law in the agreement (because the personal law of a legal entity is Ukrainian law, and if foreign law is chosen, the agreement will be void), and secondly, the Law of Ukraine “On Joint-Stock Companies” sets out clear percentage requirements for the adoption of a number of important decisions by shareholders.
For example, pursuant to this law, the general meeting of a joint-stock company has a quorum if shareholders who collectively own more than 50% of the voting shares are registered to participate, whereas pursuant to the Companies Act 2006, which governs corporate relations in the United Kingdom, the presence of 2 participants is sufficient for a quorum.
A Brief Conclusion
We have made an attempt to outline the most important aspects that an SHA makes it possible to regulate and that enable shareholders to avoid many risks in the company’s activities. If you have established a company and need an SHA — you know who to contact.
