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What Is a Shareholders’ Agreement?
A Shareholders’ Agreement refers to a formal agreement done between the shareholders of a private limited company. This formal agreement is used to govern the relationship between the shareholders so as to determine the rights and obligations that need to be adhered to.
Depending on the circumstances, the scope of the Shareholders’ Agreement can differ considerably. Shareholders’ Agreements are generally a combination of several different aspects. Some agreements would deal with the consequences of the death of a shareholder, while others simply outline the method of how one shareholder can buy out another should a dispute occur.
Some agreements cover the rules and regulations which determine the company’s policy and management, while other agreements give certain shareholders the right to acquire or dispose of the shares in the event of certain circumstances.
What Happens During a Dispute Resolution?
Sometimes when a dispute happens between the shareholders of a company, it could get to a stage where the shareholders may no longer be able to continue doing business together. Resolving conflicts can be very costly and time-consuming, sometimes requiring either an extended litigation, negotiation or even both. Big lawyer bills, tax specialists and business valuators can be a very costly affair for the business.
Having a Shareholders’ Agreement can help to minimize both the time and the costs involved should a dispute arise. The agreements help to resolve shareholder disputes by implementing one of several possible methods of enforced share sales, which involve:
- When the sale takes effect
- What the price point of the sale is
- Who does the buying and the selling
The “shot-gun” provision method is one of the known used methods which involve the first dissatisfied shareholder giving notice to the others while naming a price per share. The other shareholders must then either buy the shares at the price, or sell their shares at the same price to the first shareholder.
Other methods implemented may also involve one shareholder either having the right or the obligation to acquire the shares of the other shareholders. This can either be done at a price set based on a formula (which must include a percentage of gross or net revenue in previous financial periods, or a percentage of book value assets), or by a third party. The third party in question could be the company accountant who oversees determining the value based on some pre-set criteria.
In the case of a small private company, the identity and involvement of the shareholders is considered a very important matter. Shareholders’ Agreements in this instance should contain provisions that appropriately deal with partnership matters, and one such method which is used is the right of first refusal.
The right of first refusal means that if a shareholder were to obtain a commitment from an outsider to purchase the shares, the shares must be offered under the same terms to the existing shareholders for a specific duration. This will give the other shareholders the opportunity to match the price and the purchase of the shares, which prevents any unwanted third party from being able to acquire the shares of the company.
Another method which could be enforced is when complete prohibition of on the sale of shares to any third party is put into effect. Due to the restrictive nature of this method, it is viewed as unattractive to the minority shareholders.
What Happens When There Is a Third-Party Offer?
In the event that this happens, the third party will offer to buy 100% of the company. However, not all the shareholders may be agreeable to this option. The Shareholders’ Agreement should include a provision which allows those who reject the third party’s offer to then purchase the shares of those who do want to accept, based on the same terms of agreement as the third party offer.
What Happens in the Event of a Death?
The death of a shareholder could pose some problems, as the remaining shareholders no longer have the benefit of the deceased contributing towards the business, and that the family of the deceased will want compensation from the business.
In the instance where the family of the deceased shareholder is unable to wait for their payments, life insurance could be used to resolve the problem using one of two methods. The first method is criss-cross insurance, and the second is insurance owned by the company. Tax consequences of the two schemes would differ as they are not considered one in the same.
What Happens in the Event of Short and Long Term Disability?
In the Shareholders’ Agreements, short term disability would provide for the shareholders who are employed by the company, meaning they would still be entitled to receive their full salary for several months even if they are unable to work. Many shareholders prefer to purchase disability insurance in this instance because should a disaster strike, the disabled shareholder will still be able to receive monthly payments from an insurer.
For long term disability however, it is considered unusual for a Shareholders’ Agreement to provide for continuing salary payments if a shareholder is disabled for a long period. Instead what is provided in the agreement would be a forced sale of the disabled shareholder’s shares.
Shareholders’ Agreements & Management
When there are more than two shareholders involved, or even in the case of minority shareholders, there should be provisions in place which restrict the management prevent out-voting. A Shareholders’ Agreement will ensure that there are certain decisions which require unanimous approval, while others just require a specific percentage for approval.
What Is a Put and a Call?
A “put” is referred to the selling of shares at a fixed price on a specified date. In the Shareholders’ Agreement, a shareholder may be granted a put which allows them to require one or more of the other shareholders to buy part of or all their shares at either a fixed price or a price which has been determined by a formula.
A “call” is the opposite of a put. In a “call”, the option to buy shares at a fixed price on a given date is allowed. One shareholder may be allowed the right to buy a certain quantity of shares from one or more of the other shareholders via notice at a price which is either fixed or determined by a formula.
Shareholder Agreements & Financing
Shareholders’ Agreements states that the primary source of borrowing funds for the company will be institutional lenders. The institutional lenders can either be banks, credit unions, and/or trust companies.
If a shareholder is either unwilling or unable to contribute the necessary amount, the Shareholders’ Agreement may stipulate that the shareholder is in default, and other shareholders may force the defaulter to sell their shares, which most likely will be sold at a discounted value.
If loans are made to the company via institutional lenders, the shareholders could be required to sign “joint and several” unlimited guarantees. Each shareholder would be personally liable for 100% of the amount owned by the company. Concern arises when one shareholder is unable to cover the proportionate share of the guarantee, as this would force the other remaining shareholders to fork out more than their fair share of payment.
Shareholders’ Agreements & Defaults
Under normal circumstances, a Shareholders’ Agreement would stipulate that certain acts or omissions by a shareholder may be considered a breach of agreement. The resulting effect here could be that special right among the other shareholders be conferred.
Financial defaulting could result in the defaulter being charged with a high interest rate, caused by two reasons. The first reason would be that the defaulter has more of an incentive to repay the financial obligations, and the second reason would be as a means of compensating the other shareholders who have to step in to pick up the financial burden.
Defaulting events could include:
- Unable to carry out the obligations set forth in the Shareholders’ Agreements
- Ceasing to be a Singapore resident
- Permitting of any creditors to attempt to seize the shares
- The spouse of the shareholder is applying under the Family Relations Act for a portion of the shares.
Shareholders’ Agreements and Employment
Agreements are used to establish the ground rules when it comes to the terms of employment laid out in the contract. This is because is a lot of small companies, some of the shareholders could also be active employees.
Who Are the Key Players in A Shareholders’ Agreement?
The people involved in the agreement would include the following: