Going into business with another person is often straightforward when everyone agrees. The real test comes when the shareholders disagree, somebody wants to leave, a new investor arrives, the company needs additional funding or one shareholder wants to sell their shares.
A well-drafted shareholders’ agreement can provide a clear framework for dealing with these situations before they develop into a serious shareholder dispute.
For Irish companies, a shareholders’ agreement can regulate the relationship between the shareholders and establish rules concerning the ownership, management and future direction of the company. It sits alongside the company’s constitution and the provisions of the Companies Act 2014.
There is no single shareholders’ agreement that will suit every business. The appropriate provisions will depend on factors such as the number of shareholders, their respective shareholdings, their involvement in the business, the company’s funding arrangements and their plans for the future.
However, there are certain provisions that shareholders should almost always consider.
Here are 10 important clauses to consider when preparing a shareholders’ agreement in Ireland.
One of the most important questions is: who controls the major decisions affecting the company?
Directors are generally responsible for managing the company’s business. However, shareholders may want certain significant decisions to require specific shareholder approval.
These are commonly referred to as reserved matters.
Depending on the company, reserved matters might include:
The required approval threshold is important.
For example, the shareholders might agree that certain decisions require 75%, 80%, 90% or unanimous approval.
Reserved matters can be particularly important for a minority shareholder, as they may provide protection against important decisions being made solely by the majority shareholder.
At the same time, requiring unanimous approval for too many decisions can make a company difficult to operate and increase the risk of shareholder deadlock.
What happens if one shareholder wants to sell their shares?
Without appropriate provisions, the remaining shareholders may have limited control over who ultimately becomes their new business partner.
A shareholders’ agreement will therefore commonly contain share transfer restrictions.
One important protection is a right of first refusal or pre-emption right.
This can require a shareholder who wants to sell their shares to offer them to the existing shareholders before selling to an outside party.
The agreement should clearly address matters such as:
Careful drafting can prevent disputes when a shareholder decides that they want to leave the business.
A shareholder deadlock can occur where the shareholders cannot agree on an important decision and neither side has sufficient voting power to resolve the issue.
This is particularly relevant in a 50/50 company.
Imagine two shareholders each own 50% of a successful company. Their relationship deteriorates and they can no longer agree on budgets, recruitment, dividends, investment or the future direction of the business.
Without a mechanism for breaking the deadlock, important decisions may become impossible to make.
A shareholders’ agreement can establish a process for resolving a deadlock.
This might involve:
The appropriate deadlock clause needs careful consideration. A mechanism that works well for two shareholders of broadly equal financial strength may be inappropriate where one shareholder has significantly greater resources than the other.
What happens to a shareholder’s shares if they stop working for the company?
This question frequently arises in owner-managed businesses, professional businesses and start-ups where shareholders are also directors or employees.
A shareholders’ agreement can include good leaver and bad leaver provisions.
These clauses can require a departing shareholder to sell their shares and can establish how the shares will be valued.
A “good leaver” might include somebody leaving because of circumstances such as ill health, retirement or another agreed reason.
A “bad leaver” provision may apply in circumstances defined in the agreement, potentially including serious misconduct or breach of contractual obligations.
The distinction can have significant financial consequences because the method used to determine the price payable for the departing shareholder’s shares may differ.
For this reason, good leaver and bad leaver clauses should be drafted carefully and should clearly define the circumstances in which they apply.
Suppose shareholders holding 80% of a company receive an attractive offer to sell the entire business.
The purchaser may only be prepared to proceed if it can acquire 100% of the shares.
What happens if the remaining minority shareholder refuses to sell?
A drag-along clause can allow the required majority of shareholders, when selling their shares to a third-party purchaser, to require the minority shareholders to sell their shares as part of the same transaction.
The precise threshold and conditions should be clearly specified in the shareholders’ agreement.
Drag-along rights can prevent a small minority shareholding from blocking a genuine sale of the entire company.
However, because these provisions can result in a shareholder being required to sell their shares, appropriate protections concerning price and sale terms should also be considered.
Tag-along rights approach the same situation from the minority shareholder’s perspective.
Suppose a majority shareholder has found a purchaser for their controlling interest in the company.
A minority shareholder may not want to remain invested in the company under an entirely new controlling owner.
A tag-along clause can give qualifying minority shareholders the right to participate in the sale and require the purchaser to acquire their shares, usually on corresponding terms.
Drag-along and tag-along clauses therefore perform different but complementary functions.
Broadly speaking:
Drag-along rights protect the ability to complete a sale of the company.
Tag-along rights can protect minority shareholders when control of the company is being sold.
Both should be considered when drafting a shareholders’ agreement.
Growing companies often require additional capital.
The shareholders’ agreement should consider what happens when the company needs more money.
Questions may include:
This last issue is particularly important because issuing additional shares can potentially dilute an existing shareholder’s percentage ownership.
Pre-emption rights on the issue of new shares can give existing shareholders an opportunity to maintain their proportionate interest by participating in a new share issue, subject to the applicable legal and contractual arrangements.
Disputes concerning money are a common source of tension between shareholders.
One shareholder may want profits reinvested to grow the company while another may expect regular dividends.
This can become particularly contentious where some shareholders work in the business and receive salaries while others do not.
A shareholders’ agreement can establish principles concerning the company’s dividend policy.
It is important that any provisions operate consistently with applicable company law, including the legal requirements governing distributions.
A clear policy can nevertheless help manage expectations and reduce the potential for disputes about whether profits should be retained or distributed.
Shareholders can gain access to valuable information about the business, including customer relationships, pricing, intellectual property, suppliers, strategy and other commercially sensitive information.
The shareholders may therefore want the agreement to contain confidentiality provisions.
Depending on the circumstances, the agreement may also contain restrictive covenants addressing matters such as competition with the company, solicitation of customers or employees and involvement in competing businesses.
Restrictive covenants require particularly careful drafting.
Their enforceability can depend on their scope and the circumstances in which they operate. An excessively broad restriction should not simply be assumed to be enforceable.
The provisions should therefore be tailored to the legitimate interests of the particular business rather than copied from a standard template.
Even the best shareholders’ agreement cannot guarantee that shareholders will never disagree.
It can, however, establish what happens when they do.
A shareholder dispute resolution clause might provide for an escalation process before court proceedings are considered.
For example, shareholders might first be required to meet formally to attempt to resolve the dispute and, if that fails, proceed to mediation.
The agreement can also address what happens if the relationship has broken down completely.
An agreed shareholder exit or buyout mechanism can sometimes be far more valuable than attempting to devise a solution after a dispute has arisen.
The agreement should consider issues such as:
Disputes over share valuation can become substantial disputes in their own right, so the valuation provisions deserve particular attention when the agreement is being negotiated.
Many Irish companies operate without a shareholders’ agreement.
This can work perfectly well while the shareholders’ interests remain aligned.
Problems often emerge when circumstances change.
A shareholder may want to leave. Another may stop contributing to the business. The shareholders may disagree about dividends. A founder may die. A relationship may break down. One shareholder may receive an offer for their shares. The company may need additional funding.
Without a shareholders’ agreement, the parties must rely on the company’s constitution, applicable company law and whatever other contractual arrangements exist.
If a serious dispute arises, remedies may potentially be available under the Companies Act 2014, including, in appropriate circumstances, relief in cases involving oppression or disregard of a member’s interests under Section 212.
However, agreeing sensible rules while the relationship is good is generally preferable to trying to establish those rules after a shareholder dispute has begun.
A shareholders’ agreement downloaded from the internet may appear to offer a simple and inexpensive solution.
The difficulty is that the most important questions are usually specific to the particular company.
Consider a company owned 50/50 by two founders compared with a company where one founder owns 70%, an investor owns 20% and several employees hold the remaining 10%.
Their requirements concerning control, deadlock, funding, share transfers and exit arrangements are likely to be very different.
The real value of a shareholders’ agreement is not simply having the document.
It is identifying the situations that could create problems and agreeing in advance what should happen if they arise.
Ideally, shareholders should agree the terms of a shareholders’ agreement before or when they go into business together.
However, an agreement can also be considered later.
Common trigger points include:
The best time to negotiate difficult issues is usually while the shareholders still have a good working relationship.
There is no universal list of clauses that should appear in every Irish shareholders’ agreement.
A two-person family business may require very different protections from a venture-backed technology company or a company with numerous minority shareholders.
The agreement should reflect the ownership structure, management arrangements, funding requirements and commercial objectives of the particular business.
The ten areas discussed above provide a useful starting point:
Taking the time to address these issues when relationships are good can help reduce uncertainty and provide a clear framework if circumstances change.
Sherwin O’Riordan Solicitors advises companies, founders, investors and shareholders on the preparation and negotiation of shareholders’ agreements in Ireland.
We also advise on shareholder disputes, including disputes concerning share transfers, minority shareholder rights, shareholder oppression, 50/50 shareholder deadlock, company management and shareholder buyouts.
Whether you are establishing a new business, bringing in an investor, reviewing an existing shareholders’ agreement or dealing with a dispute between shareholders, obtaining advice at an early stage can help protect both your investment and the business.
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