A shareholders agreement will normally address the situation where one or more parties wish to exit the venture, or where there is a falling out between shareholders. This article explains some of the more common provisions.
A shareholders agreement will normally prohibit a shareholder from selling their shares without first giving the other shareholders a reasonable opportunity to buy them. These provisions are known as 'pre-emptive rights'.
The basic idea is to ensure that the existing shareholders cannot be forced to accept an unwanted new shareholder.
Usually the existing shareholders will have the right to buy the exiting shareholder's shares:
in proportion to their existing shareholdings (unless the agreement gives priority to a particular shareholder or shareholders); and
at a price that is not lower than the price offered to any potential third party buyer.
A tag along provision is a clause that allows minor shareholders to 'tag along' with a larger shareholder or group of shareholders if they find a buyer of their shares.
The purpose of a tag along provision is to ensure minor shareholders are not left behind in the event a major shareholder decides to exit the venture. (You can read more about protections for minority shareholders here.)
Whereas a 'tag along' clause provides protection to small investors, a 'drag along' provision protects the interests of the major shareholder(s).
A 'drag along' clause allows a large shareholder (or group of shareholders) to 'drag' the other shareholders into a joint sale of the entire venture.
It means that if the controlling shareholder(s) find a buyer of the entire venture, the smaller shareholders may be forced to join in the sale even if they would prefer not to.
Sometimes drag along provisions will be coupled with a pre-emptive rights clause, so that the minor shareholders have the right to buy the entire venture rather than being forced to work with a new third party buyer.
Shareholders agreements usually contain a mechanism to address the situation where there is a deadlock or a falling out between shareholders. (A deadlock is a situation where the company is unable to do something because the Board or shareholders cannot agree on the best way forward.)
The most common mechanism is one that results in one shareholder buying out the other(s). These clauses can be structured in different ways. The most common are as follows.
Although these types of provision can be effective in resolving impasses quickly, they also have the potential to produce unfair results - particularly where there is a material disparity between the parties' financial positions. Consequently, when these clauses are used, they are usually tailored to suit the specific circumstances and contain checks and balances to ensure they cannot operate unfairly.
5. Other deadlock and dispute resolution provisions
There are various other ways that shareholders agreements deal with deadlock and disputes, including:
As will be apparent from the above, there is no 'one size fits all' approach.
A mechanism that works well for one company may be completely inappropriate for another, taking into account differences between the relationships, businesses, financial resources of the parties and other relevant considerations. There are a number of reasons why should be wary of a shareholders agreement template.
The only way to get it right is to give careful consideration to the various options (some of which may not appear above), and to tailor a solution to suit your circumstances.
If you would like to know more about what is usually covered by a shareholders agreement, read our separate post here or check out our FAQs on shareholders agreements. If you would like more detail, we would encourage you to download our comprehensive guide.