Introduction – Decision Making in a Shareholders Agreement
In our earlier article we set out some of the details about why a Shareholders Agreement is useful and some of the key reasons to set up a Shareholders Agreement. This article will be focused on the issue of decision making under a Shareholders Agreement.
The key purpose of the Shareholders Agreement is to assist shareholders in determining the type of decisions that require shareholder input and the manner in which that input is treated.
What Decisions Should A Shareholder Make?
The starting point is to consider what issues are decided by the directors of the Company (the ‘board’) and those which require the concurrence of the shareholders. Ideally, there should be an assessment of the type of issues in terms of importance that should involve the shareholders (called ‘control’ decisions). That is, what type if issues are important enough to fetter the decision making of the board.
Typically, it is the bigger issues rather than day to day management decisions that are referable to the shareholders. Changes that affect the nature of the business, important transactions that affect the business (such as the sale or purchase of other businesses), the funding of the business especially if the funding will require shareholder contribution or a dilution of their shareholding are the type of issues that are often referred or otherwise reserved to shareholders.
When considering the list of ‘control’ decisions, it is important to allow for some flexibility in re-calibrating the trigger points for control decisions so as to reflect the nature and scale of the business. In particular, where dollar thresholds are specified for requiring shareholder agreement, for example, where the Company wishes to acquire an asset above a certain threshold or otherwise borrow funds above a certain threshold, those thresholds whilst once appropriate may be too low to remain workable for the effective operation of the business by the board. Without that flexibility there is a risk that the Company will be caught up in a cumbersome process of seeking shareholder approval. If so, there is a risk that rather than aiding the proper and effective operation of the Company, the shareholder approval process is inhibiting effective management and governance of the business and is otherwise straining or impacting what could be a strong and productive business relationship between and among the board and the shareholders.
How Are Shareholder Decisions Made?
The next issue to consider is for those ‘control decisions, how do shareholders consider and deal with the issue. Depending on the nature of the shareholder group consideration will need to be given as to whether decisions are pass by a simple majority, special majority (and at what percentage) and/or by way of unanimous decision.
For shareholders with a smaller holding, the risk of majority and even special majority decisions is that the majority shareholders will control all decision making. On the flip side, by requiring unanimous decision making, there is a risk of decision making be unduly restricted where a hold out or disgruntled shareholder (irrespective of size of the holding, effectively ‘vetoes’ the will of the other shareholders.
Clearly, calibrating the type of decision that require approval and the manner in which such approval can be passed is an important issue to consider when making a Shareholder Agreement.
For smaller companies with two (2) shareholders, in practice everything will need to be decided unanimously. In this instance, the chance for a stale mate in decision making is a very real likelihood which may affect company performance and shareholder value. It is strongly recommended that for your two shareholder set up, that appropriate ‘deadlock’ mechanisms be incorporated into the Shareholder Agreement (this issue will be the subject of a later article).
Once a decision has been made to create a Shareholders Agreement, it is important to carefully consider how, when and why shareholders will be upon to make decisions. When properly considered, it will sharpen the focus of both board and shareholders as to how they see the Company operating and how they want each party to be involved in that process. This will not only help in structuring a well thought out shareholders agreement but also will tease out any difference of views before the shareholders agreement (and perhaps the venture) are made.
If you would like to discuss a Shareholders Agreement or require more information please contact: Heath Adams Director-Lawyer.
Written by Heath Adams.