Managing Shareholders Agreements
In this article, we will discuss the purposes and functions of Shareholder’s Agreement. A Shareholder’s agreement is a formal contract made between the company and shareholders.
The major reason to make shareholder’s agreement is controlling the bond between the private limited company and the shareholders, and to conclude the duties and authorities. The scope of this agreement also differs very much. Some position only the mode of buy out another share and have one shareholder in case of dispute. On the other side, some deal with chances of a shareholder’s death. They put out with the rules in order to determine the management and company policy. Yet there are other people who give rights to certain shareholders in order to acquire out shares and dispose them in certain cases. Several or all of such aspects are combined in some agreements.
RESOLUTION OF DISPUTE
In case an argument occurs among the shareholders of the company, unfortunately there are some situations occur when shareholders may have to discontinue their partnership. However, making decisions on who will quit and who will see price departure is time-consuming and tedious. Additionally, the dispute among the shareholders may lead to loss of value in the business.
Only because of disagreements, it may lead to attention to business and customers may become familiar of the dispute and search for the replacement for which they think they have less volatile. As a result, patching up the shareholders has the chances to ask for litigation and/or negotiations. It will literally mean huge expenses on bills for business valuators, solicitors and tax specialists. This way, a lot of stress and time have been involved in the business.
Both the cost and time frame involved in future arguments can be reduced by the shareholder’s agreement. Shareholders’ agreement literally has points that can resolve disputes by having several options to enforce the sales of shares.
OFFERING SHARES TO THIRD PARTY
More often, third party shows the interest to buy 100% shares of the company, but other existing shareholders may disagree with the offer. Shareholder’s agreement includes a provision according to which, if shareholders don’t like the offer of third party, they can buy shares of the companies that can accept the offer in the terms of offer given by the third party.
DEATH OF A SHAREHOLDER
Usually, when an active shareholder dies, there are two business areas that cause problems. Firstly, the remaining shareholders will not enjoy the advantages of deceased contribution to their business and they have to appoint a new shareholder of the company in place of dead shareholder. Secondly, the deceased shareholder’s family will obviously want compensation for the interest that is deceased in the business. The best solution is that deceased shareholder’s share can be sold to active shareholders, the company or an upcoming shareholder.
The problem with the idea of selling the shares simply is arranging for the funds. Only because of the loss of a shareholder of the company, neither the company nor the existing shareholders have proper flow of cash to make payment of the shares. If the deceased shareholder’s family doesn’t want compensation at a time, the company can deal with the problem by paying in installments perhaps over specific period or several years. In that case, surviving shareholders have pressure that payment should be made completely.
SHORT TERM DISABILITY
In general, the shareholder’s agreement has provision to provide full salary to the shareholders who are working in the company in order to deal with the issue of short term disability for various months, even though they are unable to work. In this provision, temporarily disabled shareholder can has financial stability, but it can impose a load on existing and active shareholder(s).
Due to this reason, a lot of shareholders opt for disability insurance in order to get cover against the period of disability and to provide monthly salary to the disabled shareholder paid from the insurer. The compulsion of the company to keep giving temporarily disabled shareholder with regular salary will generally cease on the day when payments are commenced on disability insurance. In that case, a better alternative is that no disability insurance is taken on paying the reduced salary.
The provisions of disability should be designed for the assurance of avoiding the indefinite period for the coverage of short-term disability of the shareholder by getting back to work.
LONG TERM DISABILITY
In a shareholder’s agreement, providing continuous salary to a permanently or long-term disabled shareholder is quite uncommon.
Instead, shares of disabled shareholder(s) can be sold according to the provisions of shareholder’s agreement. This way, shareholder can turn the shares in cash and get the benefit of this provision. On the other side, active shareholder(s) can get the benefit by avoiding the profits to split with disabled shareholder or the one who is no longer giving his contribution to the success of the company.
In the case of having more than two shareholders or having minority shareholder, provisions that restrict the management might be an imperative mechanism of pretention for the shareholders who might be voted out. In general, according to the shareholder’s agreement, such decisions may include unanimous approval.
“Put” is actually explained as an option to sell out shares at a pre-defined price on an appropriate date. A “put” is granted to a shareholder according to which, one can involve more than one shareholder to buy all of their shares or a part of shares at either a cost calculated with a formula or at a fixed price, according to the shareholder’s agreement. A “Put” may consists of a time frame before which it can be ruled out or it can be expired when not ruled over a pre-fixed date.
“Call” is subject to less or more reverse. It is an option with which one can opt for shares at a pre-fixed rate within a given date. This way, right to buy shares of a certain amount can be granted to the shareholder by notice. The share can either be bought at the rate calculated by using the formula or a fixed price.
Institutional lenders like trusts, banks, credit unions, etc. are the major source for the company to borrow funds according to the shareholder’s agreements. In case conventional sources of funds are unable to lend money that is required by the company, each shareholder may agree to lend a share of desired amount in proportion to a company in person.
In case shareholder(s) cannot or disagree to make contribution to the desired amount of shares, the agreement is subject to notify that shareholder(s) are defaulted. This way, other active shareholders may be allowed to pressurize the default shareholder to sell their share, even at reduced amount. Otherwise, shareholders can provide a loan to the company and defaulter can be charged with high interest rate, according to the shareholder’s agreement.
In case institution lenders lend money to the company, shareholders might have to sign the unlimited “joint and several” guarantees. According to this guarantee, every shareholder is responsible for 100% of loan amount personality that a company owes the lender. It may denote very little if a shareholder lives virtually with no assets and other existing shareholders are required to be familiar with. In a proportionate share is not covered in the guarantee, other shareholders will have to make payment of more as compared to fair share, which is one major reason for concern. However, shareholders can negotiate to bear various guarantees which are not added or at the price whichever is less as compared to the whole indebtedness, with the lender. And each shareholder will be solely liable to get a share in proportion.
In general, some omissions or acts of a shareholder are deemed as a breach of shareholder’s agreement. As a result, special rights of the shareholder are granted to other shareholder.
As discussed earlier, the financial defaults are resulting in high rate of interest to be charged off the default shareholder. High rate of interest is charged due to two reasons. First one is to force the default shareholder to fulfill the fiscal obligation, even when one has to borrow funds to do it. Second reason is to provide compensation to the existing shareholders in spite of sharing extra money than proportionate company share.
Next most sought-after default consequence is the option with which other shareholder can buy the shares of defaulter. Normally, the price of share is calculated with a formula that is structure to find fair market value. However, it is, then, minimized by the portion of a percentage. On the basis of considering the defaulter who created the problem, one can justify the reduction.
Shareholders also play the role of active employees in some small-scale companies. When written agreements are cautious for the employment of key members (due to reasons like restricting the disclosure of dismissal wrongful suits or protecting classified information of the company like income tax etc.), the ground rules are often established by the shareholder’s agreements related to benefits and salaries. There are some advantages included in the contract like provisions of non-competition in shareholder’s agreement, instead of including in employment contract.
The principals are not the owner of any shares in most small scale companies. However, they can control family holding or personal companies that have shares which are very important to run the business successfully. This is so because of estate planning or for tax implications. Expert advice regarding tax will always be crucial for the small company.
As per the corporate viewpoint, a certain layer of complexity has been added by the management companies in the shareholder’s agreement. In this agreement, holding companies, as shareholders, will become the parties. Parties can also be the principals. For instance, all the major references of shareholder’s disability or death are required to be replaced with principal’s disability or death.
In addition, there are several provisions came into existence. In every holding company, shareholding’s restrictions are some of the foremost restrictions. If this type of restriction is not present in the company, a principal may sold all the holding company’s shares to a third party. As a result, the shares could be defeated in the holding company. With having the absence of existing players, no change will occur in other players of the company. Due to this reason, key players can take over the position of leaving player in the company.
The key individuals who are involved in forming the shareholder’s agreement are the following:
A lot of agreements made to face the chances of disability or death of a shareholder are mostly subject to insurance policies that cover such events. Hence, it is mandatory to seek the help of insurance agents when it comes to preparing the parts of agreement and to confirm that agreement and policies of the insurance are correlating with one another.
LEGAL CONSULTANTS AND LAWYERS
A shareholder cannot draft the complete shareholder’s agreement due to the complexities involved. It can be done only by an expert professional who possesses years of experience in drafting these types of agreements.
With the experience in taxation, an accountant is required to prepare the shareholder’s agreement. This way, one can correctly add tax implications on it. It also has an added advantage. Since accountant knows the agreement terms very well, one can notify the company when agreement has to be changed because of amendments in tax laws.
As discussed earlier, necessary changes in the agreement can be done when tax laws change. If company adds a new shareholder, it will require one to sign the document on the basis of which one can become the party according to the agreement. A view to shareholder’s agreement can be justified by changes in size or business of company, shareholders’ financial status and various internal changes.
When shareholders have to fix the agreed-upon company’s valuation every year (especially when they have to declare the sales price in case of death or disability of the shareholder in the consequent year), it is important to have a diary system to ensure that they can perform the task on regular basis.