When you are starting out a company or a business for that matter with others, it helps to have a working outline of what the business is about, how future changes to the business will be made, what each person’s input, expectations, and role or responsibility in the business is going to be. This implies having a robust discussion about these issues including amongst other things; how new people may join the business; how existing shareholders may exit the company; how disputes will be resolved when they occur, and how the relationship between the shareholders can come to an end. A Shareholders’ Agreement is essentially the working document that helps co-founders do this. It lays out for everyone involved the agreed upon structure for the direction, management, ownership and financing of the business including means of dispute resolution and the effects of termination of the business relationship. In a sense then, drafting one is simply the process of setting out in clear, binding terms the foundational structure of the business.

Too often, people who set out to start a business together get caught up with the process of developing and marketing their business concept, product or service that they often forget the fact that there are legal implications of their business relationship and that it is people who are in one way or another responsible for the development of the business.

This neglect often manifest as an intractable dispute between the founders much later down the road. Therefore, it is imperative that once a particular business idea will involve more than one person, and the founders are going to set up a company, then there should be a sit-down to discuss elements of their shareholders agreement. There are a few advantages to doing this.

Advantages of a Shareholders’ Agreement

Clarity

In my opinion, the one singular overarching and compelling reason why parties starting out a business venture together should invest in a Shareholders’ Agreement is clarity and all the tremendous benefits that come with it. Every other benefit is simply secondary or a corollary of this. Having a clear written down agreement that details your co-ownership relationship ensures a couple of things:

It ensures that everyone is clear about what each one's roles and responsibilities are.

It ensures that everyone is clear about what each one is contributing to the venture, on what terms, and what each one is expecting to get out of it. It also helps to clarify the rights of each party to the game.

This clarity naturally cascades into better protection for the rights and interests of shareholders.

For example shareholders agreement can help minority shareholders (shareholders with less than 50% of the shareholding of the company) ensure that they have a guaranteed means of successfully selling their shares if they are unhappy with the management of the company and want to leave. They can also helps to ensure that they have a say in the management of the company by entrenching in the SA a seat at the board for minority shareholders and or by reserving some matters for unanimous decisions of the Shareholders. This protection is especially useful in private companies where the shareholders usually function as the directors and control of the company is usually vested in the hands of one or two majority shareholders.

SAs are equally beneficial for majority shareholders in ensuring that their interests are adequately represented at the board or in curbing the powers of the directors if they do not have majority representation on the board or if they are not actively involved in the running of the company. They can also help to ensure a greater purchase price for the shares of the Majority shareholder through the provision of drag along rights.

One of the reasons why people choose to incorporate a private company is because it allows for restricted membership, that is, membership is open only to such persons as the founders allow. However, in situations where one of the shareholders dies the shares of the deceased would automatically pass onto his estate ensuring that the spouse, child, relative of the deceased becomes a member leaving the remaining shareholders in an unwanted relationship. Shareholders agreements can prevent such situations from occurring by providing for the transfer of such shares back to the remaining shareholders. It helps to ensure that in the event of the decease of a shareholder, membership of the company remains restricted to founders by providing for the transfer of shares of the decease back to the remaining shareholders.

Through the entrenchment of information rights they provide a means of keeping tabs on the management of the company especially for shareholders who are not actively involved in the management of the company.

Additionally, through carefully worded provisions, shareholders agreements can help protect the trade secrets and industry contacts of the company for the remaining shareholders. This helps to ensure that disgruntled employees or shareholders who leave the company do not sabotage the company.

Dispute resolution

Because different parties with varied and similar interests are involved in the ownership and management of a company there is bound to be some disagreement between the owners of the company at some point in time. Though it is not mandatory, it is common in Shareholders’ agreement to provide for means of resolving disputes between the shareholders when they arise. This helps parties to proactively address issues that may become divisive in the future and to agree on the means of resolving these disputes when they occur.

The presence of a shareholders’ agreement shows prospective investors that the founders of a company are clear and serious about their commitment to the future of the company.

Usually, it is suggested that another very important document, the company’s articles of association be reviewed in conjunction with the Shareholders’ agreement. In fact, in many instances, you will often find a clause in the shareholders agreements that stipulates that if there is any contradiction between the provisions of the shareholders agreement and the company’s articles, the provisions of the shareholders agreement will prevail and that the shareholders will use their powers as shareholders to amend the provisions of the articles to bring it into conformity with the Agreement. The reason for this is simple. At the point of incorporation, many people (registering a company through a lawyer, accountant or secretary simply) adopt the CAC’s model articles of association without a clear understanding of its contents and provisions and without an understanding of what a company's articles are. This is rather unfortunate because a company’s articles of association is one of a company's constitutional document and it deals with issues pertaining to the internal management of the company; how it is to be run. Specifically, the Model Articles contain provisions which deal with:

The classes of shares and the rights and restrictions thereto
Restrictions on transfer of shares
Pre-emptive rights of the shareholders of the company to the issuance of new or unissued shares
Notices and the conduct of meetings of the company
Voting rights of members of the company
Many of these issues are also contained in a shareholders’ agreement. Therefore, when preparing a shareholders’ agreement, it is usual for, and advisable that the shareholders amend the articles to bring it in line with their shareholders agreement because in many cases, the shareholders simply assented to those provisions without being adequately aware of its contents

This conjunctive review is also important considering the fact that the articles is one of the constitutional documents of a company and is a public document registered with the Corporate Affairs Commission, when a contradiction arises between the provisions of the Agreement and that of the Articles, the Courts are likely to uphold the provisions in the articles. especially in disputes (such as a transfer of shares) involving a third party not privy to the contents of a shareholders’ agreement.

Even in situations where there is opportunity to draft rather comprehensive articles of association, a shareholders’ agreement (in addition to the articles) might be preferred for the following reasons:

a.

A company’s articles of association is a public document and therefore open to inspection by members of the public whilst in contrast, a shareholders agreement is generally speaking a private document open only to the parties to it. As a result, members of a company might feel better including certain sensitive matters such as remuneration of directors, intellectual property, etc in the shareholders agreement than in the articles.

b.

Additionally, even if certain matters contained in the shareholders agreement are provided for in the articles, as a shareholders’ agreement is a contract, it may afford aggrieved parties contractual remedies in the event of a breach of any of its provisions.

c.

While modified or bespoke articles are now being allowed by the Corporate Affairs Commission (CAC) at the point of incorporation, articles which are devoid of lengthy details or provisions are still favoured. As such, it is much better to include provisions dealing with dispute resolution in a shareholders’ agreement than in the articles as such provisions can be especially detailed or lengthy.

d.

Even if the articles provide comprehensive protection to the shareholders, they can be amended by 75% majority of the shareholders passing a special resolution, in contrast, a shareholders’ agreement in most cases can only be amended by unanimous consent of the shareholders.

Some common provisions found in a shareholders’ agreement include

Management rights: Entitlement to appoint and remove directors, board composition and structure

Matters requiring unanimous consent of all the directors/shareholders. Certain issues are fundamental to the interests of all the shareholders that they require unanimous consent before they can be acted upon. It is important that a shareholders’ agreement clearly outline what these issues are.

The dividend policy: Most people set up companies in order to enjoy a steady stream of income or to share in the profits of the company via distribution of dividends. It is therefore important for the SA to outline for the benefit of all shareholders, the agreed upon decision regarding the distribution of dividends. It is however, important to note that as per the provisions of CAMA dividends whether interim or otherwise can only be distributed if the company’s directors recommend it to the shareholders. Where there is no recommendation by the board of directors it is nearly if not completely impossible for distribution of dividends to occur. However, the essence of agreeing on a dividend policy is so that the directors of the company have an idea of the expectations of the company’s shareholders where distribution of dividends is concerned.

In many early stage companies, a common provision is to forbid the distribution of dividends until the company is well established and profitable. A clause could be drafted indicating what percentage of the post-tax profits should be paid to the shareholders as dividends each year.

Tag along and drag along rights: These are rights that ensure that a minority shareholder(s) is not left in the company with an outside purchaser of a significant portion of the company. A tag along right ensures that a majority shareholder who is selling his shares procures that the purchaser buys the shares of the minority shareholder on the same terms as that of the selling majority shareholder.

A drag along right on the other hand, ensures that a majority shareholder who is willing to sell his shares is able to deliver the entire shares of the company to an outside purchaser by dragging the other shareholders along with him thereby effectively commanding a higher purchase price for the shares. It is also a favourable provision especially for third party purchasers who may not want the other shareholders to be involved in the running of the company. It should be noted that in Nigeria, the operation of a drag along right is dependent on the majority shareholder being able to drag the remaining shareholders to a connected outside party as there must be at least two shareholders in a company.

Non-competition rights; restrictive covenants: Shareholder agreements also contain restrictive covenants preventing ex-employees or ex-shareholders from competing with the company. It is generally believed that restrictive covenants are more enforceable between shareholders than between employees and employers. However, care should be taken when drafting restrictive covenants as in many cases, shareholders in early stage companies are also employees of the company.

Financing: Adequate financing is an important issue that needs careful consideration by the shareholders. Provisions could include obligations on shareholders to provide further financing when needed or to serve as guarantors of a bank loan. In such cases, the shareholders usually agree among themselves to split the cost according to their respective shareholding. Provisions could also specify what form the financing should take

If you have questions about this topic or would like an agreement prepared for you please send an email to newslettersng@gmail.com