The absence of shareholders’ agreements among New Zealand’s
mid-sized companies is a stumbling block that often results in costly disputes
over how private companies are run, valued or funded. Lack of agreements also
hamper growth of these companies by preventing them raising finance from investors.
For the benefits they provide, shareholders’ agreements are an extraordinarily
cheap way to minimise business disputes between owners. They can also cut down
the uncertainty and cost of a business break-up.
Evidence of an agreement can assist in raising finance from banks or creditors.
It can also be used to demonstrate stability whenever the company has to undergo
due diligence, such as when entering a large tender contract.
Shareholder agreements are a time-saving tool for owners to plan retirement
and exit the business, including grooming a business for sale and appointing
a successor. Although the best time to implement a shareholders’ agreement
is during the early days, it is possible to construct a pact around existing
business structures in an established operation.
The following 10 items should be included to ensure your shareholders’
agreement is legally binding:
1. Overview
The agreement should provide guidelines about how the ownership of the company
will operate, including an outline of the funding of share transfers, management
rights, dividend policies and details of how equity will be provided to employees.
As well as setting parameters for company operations, the overview helps guide
shareholders through issues not dealt with elsewhere in the agreement.
2. Voting thresholds
Specify the percentage of shareholder votes required to approve major decisions.
Common issues include the sale of the business to an outsider; bringing in new
shareholders; and the hiring or firing of senior executives or directors.
3. Valuation method
Without a public market, private companies need an agreed method for valuing
shares. This price will underpin a wide range of actions, including issuing
new shares and shareholder sales. There are several valuation methods such as
capitalisation of earnings, discounted cashflows and net tangible assets. All
are subjective – different external valuers can come up with different
valuations of the same company, so the agreement should specify an agreed methodology.
One approach reducing the number of valuations needed is to have a notional
valuation undertaken at the end of each financial year and use this for any
transactions during the next year.
4. An ‘out’ for business partners
Setting out formal processes that govern how shareholders can exit the business
and at what price, can remove a major source of contention in private company
ownership. The sale process should give existing shareholders pre-emptive rights
to purchase the stake before it can be sold to an outsider using the valuation
method set out in the agreement. This requirement is often a standard clause
in the company constitution, if there is one.
5. Life insurance
The shareholder agreement can ensure shareholders are able to afford to purchase
the stakes of co-owners in the event of death or disability, by funding such
a sale through linked life and trauma insurance. The death of an owner can cause
problems for private companies – relatives may wish to realise inherited
company shareholdings, thus requiring other shareholders to raise finance or
face the prospect of the stake being sold to an outsider. The shareholder agreement
can stipulate that each owner should take out life and trauma insurance to the
benefit of other shareholders, which then provides finance to buy the stake
in event of death.
6. Employee shareholders
Employee shareholder schemes can be an excellent way of attracting, motivating
and rewarding staff, but the fine details must be worked out in the shareholder
agreement. The agreement should ensure existing shareholders do not lose control
of the company unless they are willing to. This could be achieved by issuing
shares with fewer voting rights, or issuing an entirely new class of shares.
The agreement may help employees finance share purchases through loans and dividend
reinvestment. It should grant shareholders rights to repurchase shares held
by employees who leave the company to prevent former staff releasing confidential
information they would be entitled to as shareholders, or to prevent dealings
with a shareholder now considered an “outsider”.
7. Dividend policy
Set out how often dividends will be paid and how their value will be determined
(e.g., as a percentage of net profits). The agreement should say when they are
not to be paid – such as when working capital is required and liquidity
ratios have fallen below a threshold.
8. Confidentiality
These clauses aim to protect the company from the release of commercial information
to competitors or other outsiders. As all shareholders are entitled to privileged
information about the company through financial reports, the agreement should
restrict how this information can be used. This is particularly salient when
shareholders have a range of business interests and some are more actively involved
in the company than others.
9. Family issues and succession
This should govern how and when family members can take on a shareholding; whether
they can transfer their stake to a non-family member; and entitlement to directorships
or executive positions within the company. Typically, family members believe
it is their birthright to own or acquire shares in the family company, but a
sound business case should be evaluated and a commercial decision made as to
ownership regardless of family ties.
10. Mediation
Although the agreement should stem most possible sources of conflict between
shareholders, it should also anticipate that owners may disagree occasionally
and provide a mechanism to resolve differences. The most common approach is
to nominate a third-party mediator who is held in esteem by all shareholders,
e.g., the head of a professional association or industry body. As a last resort,
the agreement should identify the circumstances for termination.
