The Double Edged Sword

Shares A shareholder agreement is the preferred way of managing matters when the number of shareholders is not too large - trying to prepare an agreement that reflects the interests of more than ten shareholders will generally render the document unworkable. A shareholder agreement is a legally binding document that defines the shareholders’ obligations with regard to the company and to each other. It is usually prepared in accordance with contract law instead of company law. Courts in most, if not all countries, generally uphold the intentions expressed in the agreement as they would in any other contract, accepting that when it was written all parties had given adequate consideration to the issues covered. 1. Terms of employment Shareholder agreements are supplemental to the Articles of Association and can be made between some or all of the shareholders. The company itself can also be a party to the shareholder agreement in certain circumstances. As an instrument that regulates some aspects of a company, shareholder agreements offer the benefit of confidentiality as, unlike the Articles of Association, such agreements are not generally open to public inspection. "As organizations grow they need to know who they are going to need," says Alan Waring, head of risk management consultancy Alan Waring & Associates. "Typically, you might have three or four people start a company on the basis of their knowledge. When they reach a certain stage of growth it becomes apparent that they don't have enough knowledge of marketing and finance they are not very good as business managers - but they don't know how to give way…they can have a stranglehold on the business.” Shareholder agreements can act, in many ways, as a contract of employment for the shareholders of a business. They can specify compensation levels, outline a system of performance review and specify terms under which a shareholder’s employment can be terminated. They can state the conditions for selling the shares held by a shareholder, and can even contain the circumstances under which a director of the company can be removed. Shareholder agreements can specify how new people can be brought into the company. Bringing new people into a company can often open up dissent among shareholders – is the new person really needed; do they have the right qualifications; are they too closely aligned with one of the existing shareholders and represent a threat to another shareholder’s voting power and so on. And yet bringing in new talent is sometimes the only viable strategy for business growth. With an agreement in writing that covers the concerns and sets out the circumstances for an acceptable adoption of new shareholders those issues can’t become sources of shareholder dissent. Equally important is separation of shareholders from the business. A dispute between shareholders can be extremely disruptive and the damage caused by a disaffected shareholder who also happens to be an active employee can be considerable. Having the ability to terminate a shareholder who is also an employee of the business is often the only way to get a business returned to a focus on its normal activities. In some instances unhappy shareholders have sought legal redress, not as employees but as shareholders which gives them much more leverage. However, if the dismissal was conducted under the terms of their shareholder agreement it will usually be seen as lawful. 2. Stock disposition and valuation After termination a shareholder’s stock will be a matter of concern. This too can be covered by the shareholder agreement. It can require that the dismissed individual sells their stock back to the other directors of the business and contain a formula for determining a fair price for the buyback.