Key Issues for Shareholders’ when Starting a New Business.

Each Company will be different and there will rarely be an “off the peg” solution. However, it is worthwhile making the following general observations: –

(a) An institution investing in a new Company (perhaps in the context of a management buy-out or buy-in) will frequently be in a minority shareholder. Invariably they will seek for themselves undertakings from the other shareholders that certain ownership or management decisions (as listed in the annexures) will not be made without their written consent (or perhaps the consent of a Special Director appointment by them at a relevant Board Meeting). If the institution holds a strategic or “Balancing” shareholding the other shareholders may well be content to rely upon the decision of such institution to resolve any disputes between them. Indeed, an institution will be unlikely to agree to enter into a voting agreement to support other minority shareholders.

They might also be wary of voting agreements between other minority shareholders which for example, entrench a particular shareholder on the Board. Accordingly, the points made below will often only be relevant in the context of a Company without institutional shareholders.

(b) A deadlock structure can be devised for a “partnership” Company (even if shareholders do not hold shares equally) whereby shares are designated as “A” and “B” ordinary shares. Each class of shares has the right to appoint (say) two Directors (“A” Directors and “B” Directors). The Chairman’s casting vote is excluded, and it is stipulated that no meetings of the Board or General Meeting are quorate unless an “A” Director and “B” Director and “A” Shareholder and “B” Shareholder as appropriate are present. Similarly, no resolutions (or perhaps resolutions on certain key issues) are to be validly passed without the affirmative vote of “A” and “B” Directors or shareholders as appropriate.

The structure can be adopted for companies with three or more shareholders by creating “C” and/or “D” ordinary shares.

(c) A voting agreement can be entered into whereby certain shareholders will vote to ensure that they each have a nominated Director on the Board. Having the right to a Director on the Board (and accordingly access to confidential information) can be a powerful right.

(d) Voting agreement can be entered into whereby certain key (or all) ownership and/or management issues require the written approval of all or a specified majority of shareholders.

Essentially, the damages he can claim will be based on the salary and benefits to which he is entitled multiplied by the number of years unexpired on the service agreement. It should be noted, however, that the employee is under a duty to mitigate his loss. Accordingly, to the extent that the employing Company can demonstrate that another job could have been obtained within a reasonable period at the same or high remuneration the claim for damages will be reduced.

Nonetheless, as the starting point for compensation discussions is the salary and benefits for the unexpired period of the service agreement the existence of a long-term service agreement can provide the executive with a good degree of comfort.

(It should be noted that an agreement for a fixed term more than five years will not be effective unless approved by shareholders in general meeting. This provision was introduced to prevent Directors introducing protection for themselves without shareholders’ sanction.)

Recent case law suggests that failure to pay a reasonable dividend can form the basis of a claim for unfair prejudice by an aggrieved minority shareholder (see paragraph 3 above).

However, there will always be difficult questions of how much cash is required for the working capital purposes of the Company. Accordingly, a dividend policy may provide added protection for the minority shareholder. This might be fixed as a percentage of the after-tax profits.

A device sometimes incorporated in Articles (particularly for the benefit of institutional shareholders) is a stipulation that, if profits are available for distribution, dividends become payable whether declared by the Directors. This is linked to calls rights giving shares a fixed percentage profit. Provided distributable profits are available the minority shareholder is not then in a position where the Directors or the majority shareholders will not approve a reasonable dividend. If he is not paid in accordance with the Articles, he can sue for the dividend payments in question which become a debt due to him from the Company.

Restrictions of this type are prima facie unenforceable unless the party seeking to uphold them can show that they are reasonable as between the parties involved. The Court will look to the duration of the restriction, its scope and geographical limit in determining whether the restrictions are reasonable.

If written service agreements are to be entered into restrictions can frequently be included in the service agreement and dispensed with the Shareholders Agreement.