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Six vital issues to consider when preparing your shareholder agreement

What is a Shareholders Agreement?

Shareholder Agreements are referred to as constitutional documents. That is, they constitute and document the relationship between the parties entering a business endeavour together.

shareholders meeting

What part do finances play in a shareholders agreement?

Before entering into a shareholders’ agreement, the parties should consult with their accountant or business adviser to prepare a business plan. This plan should consider the projected cash flows of the company, over say 5 years, with those projections reviewed annually.

By preparing cash flow projections, shareholders can identify the proposed activities of the company, the time it may take for the company to turn a profit and the funding required to ensure its success.

Funding the Company

Generally, it is up to the shareholders to fund a start-up company, either from:

  • personal funds;
  • personal loans to the company; or
  • loans provided to the company by a financial institution under a directors guarantee.

An average funding period is for at least the first 5 years.

Once you understand the maximum projected funding requirements, each shareholder can assess whether they are willing to take the risk of establishing the business.

Dividends

Cash flow is the lifeblood of any business. The shareholders should establish a policy for paying dividends so that the business can flourish.
In some cases, the shareholders may agree to forgo dividends for a number of years, unless a certain level of profitability exists.

It is crucial that the projected cash flow and dividend policy underpin and become part of any shareholders’ agreement.

Cash flows and budgets

It’s very important to monitor and review the projected cash flow and budgets on a regular basis. The shareholders’ agreement should stipulate that the projected cash flows will be recalibrated at least annually and put before the board and the shareholders. In this way, the parties can monitor the liquidity of the company and take corrective action as required.

Business cash flows are calculated by sales less expenses, but projections mean nothing unless goals are set and targets achieved. To this end, it’s recommended employees and directors enter into employment contracts that clearly set out Key Performance Indicators (KPI’s) such as sales and/or expense targets. KPI’s determine how the directors and employees will maximising sales and cost control, thereby contributing to the profitability of the company.

When is it time to sell?

Generally speaking, all shareholders will eventually want to sell their interest if the right opportunity presents itself. But what happens if one group of shareholders want to sell and others want to hold out for a better price? A comprehensive shareholders agreement will include “Come along” and “Tag Along” clauses.

Come Along rights protect and confer rights upon a majority of shareholders that compel a minority group of shareholders to sell their shares and facilitate the sale of the company without the consent of the minority shareholders.

Tag Along rights have the opposite effect because they protect minority shareholders. Tag Along clauses give minority shareholders the right to participate in any sale of the business if a majority shareholder or group of shareholders want to sell to a 3rd party.

What if a shareholder or business partner dies?

As they say, nothing is more certain than death and taxes. So, what would you do if one of your fellow shareholders died?

Answer; include provisions in your shareholder's agreement that compel each party to take out a life insurance policy nominating the remaining shareholders as beneficiaries. This provides funding for the remaining shareholders to buy the deceased parties interest from his/her estate, so you don’t finish up with a partner/s that contribute nothing to the business.

This article by Jim Wilson.

jim wilsonJim Wilson B.Com,. LL.B from Wilson Haynes Solicitors Tweed Heads has decades of experience helping clients establish their businesses and ownership structures.  

Last updated: 25 February 2019

Resources

Plan for the unexpected - how a Shareholder Buy / Sell agreement safeguards your companies future

When do you need a Shareholders Agreement?

 

 



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