The Business Prenup – The Importance of a Shareholders Agreement

Introduction

No one goes into a marriage already expecting the worst, but even the most seemingly stable couples can hit bumps in the road that tear them apart. Prenuptial agreements have the power to protect both parties when entering a marriage. The whole idea being to minimize the uncertainties of the law and litigation, if something does happen and the marriage ends in divorce or death.

Similarly, a shareholders’ agreement (business prenup) would be extremely handy in the event of a dispute or a breakdown in trust between the shareholders of a company i.e. disagreement on the business of a company, or the methods of carrying out the same, or their decision making powers etc. A lack of certainty created by not having a shareholders’ agreement in place can often lead to disputes amongst the shareholders which can be costly to deal with.

What is a Shareholders’ Agreement?

A shareholders’ agreement is an agreement between the shareholders of a company which generally sets out the shareholders’ rights, privileges and obligations along with the foundation of how the company will be set up, managed and run. Having a shareholders’ agreement is a cost effective way of minimizing any issues which may arise later on by making it clear how certain matters will be dealt with. It also provides a forum for dispute resolution should an issue arise down the road. Taking the time to sit down and discuss certain issues from the beginning can help eliminate disagreements between shareholders and ensure that everyone is on the same page.

In Kenya, there is no statutory requirement for shareholders of a company to enter into a shareholders’ agreement. Accordingly, a shareholders’ agreement can be quite flexible in terms of what provisions are contained in the agreement and what issues are specifically addressed.

Essentials of a Shareholders’ Agreement

Shareholders’ agreements usually cover issues that are similar to those covered in a company’s Articles of Association. However, within the confines of the law, said agreement can cover whatever the parties to the agreement wish. A Shareholders’ agreement is also considered a private document and is therefore not required to be filed with any public registry in Kenya unlike a company’s Articles of Association.
Although each document will vary from another, a typical shareholders’ agreement will deal with some or all of the following:-

a) Outline each shareholders’ right to hold a seat on the board of directors.

b) Set out the powers of the board vis-a-vis the shareholders in general meeting.

c) Determine who the chairman of the board of directors is to be and whether that chairman will have a second or casting vote in the event of an equality of votes on an issue.

d) Whether the consent of certain shareholders is required before a company can take certain actions such as disposing of the company’s assets, issuing new shares, or winding up the company. This is particularly relevant for shareholders holding a minority of shares in the company as it allows them to “punch above their weight”.

e) Define a company’s policies on funding, dividends, profits and losses.

f) Whether the intellectual property created by the shareholders is to be vested in the company. This is particularly relevant in industries where intellectual property is an important asset of the company e.g. the IT industry.

g) Provide for methods of resolution of disputes between shareholders including how to handle a deadlock situation.

h) What procedure is to be followed if a shareholder wishes to sell his shares. This is a highly important issue, particularly in private companies. Remaining shareholders will often be working very closely together and do not want to be dealing with just any third party whom the selling shareholder decides to sell his shares to. Often a pre-emption process is followed under which the selling shareholder is obliged to first offer the shares for sale to the remaining shareholders before (if that is what the shareholders agree) a sale can take place to a third party. The shareholders’ agreement will usually also deal with the mechanism for deciding on a price for these shares to be sold.

i) The process to be followed in the event of the death, incapacity or insolvency of a shareholder.

j) Reserved matters which are matters that are specified as requiringthe agreement of all shareholders, or a certain majority, in order to be done or undertaken.

k) Borrowing powers and policies.

l) Rights of veto.

m) Restrictions on who can become a shareholder.

n) Situations where changes in one shareholder’s personal circumstances can have an adverse effect on the company or other shareholders (e.g. divorce) and how to deal with them.

All the defined policies and procedures of the shareholders must be spelled out and require the signature of all parties. Any future investors will also need to agree to and sign the shareholder agreement.

In terms of decision making by the shareholders’, although many actions will require a majority vote, other decisions may need to be unanimous. As a general rule, corporate law gives the upper hand to the majority shareholder(s) as decisions can typically be made with the positive vote of a simple majority (i.e. 51%). In most jurisdictions there are a limited number of exceptions which require what is called a “special majority”, meaning two-thirds (i.e. 66.67%) of votes, in order to make decisions regarding the fundamental aspects of the company. The Companies Act 2015 provides for a 75% majority for special resolutions (special majority). However, in drafting a shareholders’ agreement, the shareholders can decide what percentage is required for certain decisions. For instance, fundamental decisions pertaining directly to the business, financing or business structure may require a unanimous decision by all of the shareholders, while other less important decisions may simply require a majority vote. This is especially important where one shareholder holds a majority of the shares in the company as without a shareholders’ agreement, most shareholders’ decisions could be made by the sole majority shareholder leaving the minority shareholder(s) with little or no voice.

Benefits of a Shareholders’ Agreement

Some of the major benefits of having a shareholders’ agreement can be summarized as follows:-

1) The agreement is supplemental to a company’s Articles of Association, but will give shareholders greater protection than can be provided by the Articles alone, not least because companies are often set up quickly and cheaply just with standard Articles that will not include much detail regarding protective provisions for shareholders or define the limits of their responsibilities.

2) Generally, companies registered in Kenya are subject to control by the provisions and statutory requirements of the Companies Act 2015. However, a shareholders’ agreement can contain any arrangement agreed between the shareholders, which are within the confines of the law.

3) Determines the basis for important decision making, to restrict the power of the directors where necessary and to provide protection for the parties involved in the ownership of the company against the actions of the others, whether minority, majority or equal shareholders.

4) Articles of Association are public documents that require filing at the Companies Registry offices in Nairobi. A shareholders’ agreement will remain private and confidential and will not be open to view by others such as creditors or non-member employees.

5) Minimizes any potential for business disputes between owners by making it clear how certain decisions are made and also by providing a framework and procedures for dispute resolution.

6) Can assist in raising finance from banks or creditors and also demonstrates the stability of the business to other potential partners.

7) It prevents situations where changes in one shareholder’s personal circumstances can have an effect on the company or other shareholders within the company, safeguarding each shareholder’s financial interest in the company, and the interests of the shareholders’ families in the event of the death of a shareholder.

Conclusion

Reality is that business partners will have arguments and not always see eye-to-eye on all issues. Companies that have more than one shareholder should always consider having a shareholders’ agreement in place in order to set out the expectations of each of the shareholders from the beginning. Having these discussions from the get-go and spending a little bit of money to have a shareholders’ agreement drawn up can save much time, money and effort down the road.

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