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Benefits of a Shareholders Agreement in 2022, or why you should have a SHA for your business.

In Business
In South Africa, a shareholders agreement is an agreement entered into by the shareholders of a private or public company.;Even without a shareholders’ agreement in place, shareholders of a company are bound by the provisions of the Companies Act, no. 71 of 2008 (also known as the “New Companies Act”). In addition to being bound by the conditions of the Companies Act, shareholders must comply with their obligations under the Memorandum of Incorporation (MOI). Although the Companies Act is unique to South Africa, most of the mechanisms discussed here are of global nature.

Shareholders agreements can become quite complex, the ideal SHA is both easy to execute and covers interest of all parties.

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What you can find in this blog:

  • 6 Reasons to have a Shareholders Agreement
  • Shareholders Agreement or Memorandum of Incorporation?
  • Written shareholders Agreement v Verbal Agreement or Handshake Agreement
  • Minority shareholder protections –
  • Appointment of Directors
  • Dividend Policy
  • Conflict Resolution
  • Valuation Methodology
  • Financing the Company
  • Tag Along
  • Come along / Drag Along

The Memorandum of Incorporation of a company prevails over the shareholders agreement.

In terms of the Companies Act, the MOI is a company’s most important founding document.The Companies Act states that any shareholders agreement must be in line with the company’s MOI and the Companies Act.

Although having a shareholder agreement is not mandatory, having a well-prepared agreement provides shareholders with a host of benefits. A well drafted shareholders agreement provides shareholders with guidance when it comes to voting, buying and selling additional shares, valuing the company, resolving disputes between the shareholders and much more. 

In this blog we discuss both the reasons to have a shareholders agreement in the first place, and we explain the basic elements of a well written shareholders agreement.

6 Reasons to have a shareholders agreement

Before we explain the legalities of the SHA, we’d to address the 6 reasons that could make the difference in your situation 

Control over valuing the shares.

The Shareholders Agreement contains provisions for how the shareholders are to  value or price the shares in the Company. The Shareholders Agreement can stipulate that the shareholders must either reach agreement as to the value of their shares or use a predetermined formula. Furthermore, the Shareholders Agreement can require the use of an independent expert if the Shareholders cannot reach agreement.

Regulate management of the Company

The Shareholders Agreement should contain provisions dictating how the Company should be operated which should include detail as to the Shareholders’ rights and obligations. It is also important to contain provisions in the Shareholders Agreement that regulate how the Company Shareholders are to appoint directors of the company.

Control the transfer of shares

Your Shareholders Agreement should contain mechanisms to prevent a Shareholder from selling shares in the Company without the consent of the remaining Shareholders. Therefore, such mechanisms ensure that both minority and majority shareholders are protected. These mechanisms are often described as come-along and tag-along clauses and are described in greater detail in this article.

Resolution of disputes

Your Shareholders Agreement must contain provisions as to how the shareholders are to resolve disputes that may arise between them as to the management of the Company. 

Can be used to secure funding and offer investors insight into your business

If you are looking to raise capital in order to start your business or you are looking to bring on investors or friends, a well drafted Shareholders Agreement can often seal the deal. Investors will often require a written Shareholders Agreement to ensure that their investment is secured and to ensure that there are certain protection mechanisms in place. With a well drafted Shareholders Agreement in place,

Can regulate a varied dividend policy

Your Shareholders Agreement must contain provisions which direct when and how dividend is paid out to the shareholders. Such a provision can include directions for the time and circumstances which need to be met before a dividend is paid out.

Breaking down the Shareholders Agreement more

Shareholders Agreement vs Memorandum of Incorporation

Every company requires a Memorandum of Incorporation (MOI). The MOI contains the rights, duties and responsibilities of shareholders, directors and others within a company. It is a public document and is submitted to the Companies and Intellectual Property Commission (CIPC). 

When deciding if you need a shareholders agreement, we suggest you ask yourself the following questions: 

Q – *Are there certain issues which we (as shareholders) would like to regulate privately? *

If you answered yes to the above, then you require a shareholders’ agreement. 

Q –  As a shareholder, do you want to prevent your fellow shareholders from selling their shares to third parties without your knowledge or consent?

If you answered yes to the above question, then you require a shareholders’ agreement.

Having a right to purchase your fellow shareholders’ shares, when they are looking to sell, is known as a pre-emptive right. Therefore, in order to ensure that you are first in line when your fellow shareholders are looking to sell their shares,  you need a “pre-emptive right” to make an offer on said shares, before any third party is able to purchase such shares. When you have a “pre-emptive right”, if your fellow shareholder wants to sell shares, such shares must be offered to the other shareholders in the company first (i.e. yourself).

Therefore, ensuring that you have a pre-emptive right in respect of your fellow shareholders’ shares, ensures that you retain a certain level of control over who could potentially purchase shares in your company.

In terms of the Companies Act, pre-emption rights only apply to a fresh issue of shares and not to the transfer of existing issued shares. Therefore, the default position is that you as a shareholder are not automatically, by virtue of your shareholding, entitled to a pre-emptive right to your fellow shareholders’ shares.

In order to ensure that you have the above-mentioned pre-emptive right you need to include provisions in your shareholders’ agreement which deal with such pre-emptive rights. This provides existing shareholders with greater certainty and protection. 

If there are any differences between the MOI (Memorandum of Incorporation – the statutory document which per the Companies Act “sets out the rights, duties and responsibilities of shareholders, directors and others within and in relation to a company”) and the shareholders' agreement, the MOI will prevail.

Written shareholders Agreement vs Verbal Agreement or shareholders agreement versus Handshake Agreement

Before exploring the benefits of a shareholders agreement, it is important to understand the benefits of having a written agreement in place (as opposed to a handshake or verbal agreement). Here are the three main benefits of having a written shareholders agreement:

  1.     there is a single source of truth, one document which all the parties can turn to when a dispute or confusion arises;

  2.     having a single source of truth provides clarity in instances of disputes; and

  3.     the written agreement can be shown to third parties, such as investors when attempting to raise capital for your business.

Minority shareholder protections

Where a company has minority shareholders, their rights can be protected through a variety of mechanisms in the shareholders agreement to prevent abuse and oppression from a majority shareholder.

If you are looking to get into business as a minority shareholder we suggest that you insist on entering into a written shareholders agreement, which contains provisions that protect your interests as a minority shareholder.

Appointment of directors

A shareholders agreement can be used to regulate the appointment of directors by the shareholders. This allows you as a shareholder to have even greater control over the business and who makes decisions in the business.

Remember, as a shareholder, you aren’t responsible for the day to day running of the business. Therefore, this gives you the opportunity to have your say in the business.

Dividends policy

As a shareholder it is important to remember that dividends are not guaranteed. When starting out with your business it is often important to ensure that early dividends are used to reinvest in the business. Deciding when and how dividends are paid out is often a point of contention between shareholders.

The shareholders agreement provides shareholders with an opportunity to decide when and how dividends are to be paid out to shareholders.

One’s shareholders agreement is the perfect place to determine when you and your fellow shareholders are to receive dividends. For example, you can stipulate that ordinary dividends will be paid 100 days after the financial year end of the Company. 

Conflict resolution and a reduction in conflict 

A well drafted agreement has the ability to reduce the amount of potential conflict between shareholders. This is important because disputes are hugely distracting, and ultimately can affect the company and its viability. Clear mechanisms should be included in your shareholders agreement for the swift resolution of the disputes between the shareholders. 

Valuation methodology

When looking to sell your business or entice investors to invest in your business it is important to ensure that you know how to value your business. Valuation of a business is often determined by the industry you are in or the type of business you run. However, it is  important to agree on a valuation methodology with your fellow shareholders, to avoid unnecessary disputes and to avoid your fellow shareholders attempting to sell their shares for below market value.

The shareholders agreement will include a valuation methodology in order to regulate how the shares are to be valued in the event of a sale of any shares for whatsoever reason. 

Financing the Company

Your shareholders agreement can also contain provisions dealing with when and how the business is to be financed. You can stipulate the requirements for financing by shareholders and financing by third parties, banks etc. 

It is important to agree with your fellow shareholders as to when shareholders will be expected to loan money to the business.

Tag Along

A tag along provision is a clause in your shareholders agreement that provides for minority shareholders to ‘tag along‘ with a larger shareholder if they find a buyer for their shares. The tag along provision provides minority shareholders with some security in that they are afforded an opportunity to not be left behind should a major shareholder decide to exit the business.

Come Along, or Drag Along

A come–along clause allows a select number of  shareholders, usually majority shareholders, the right to force other shareholders to sell their shares when those certain shareholders decide to sell theirs.

Insurance, Tax and Licences

The shareholders agreement should also contain provisions dealing with insurance for the company, tax obligations of the company and any licences which the company will need to maintain and update. 

Over to you

A Shareholders agreement is an absolute necessity in many situations. At Hello Contract we aim to provide you with the tools to take control of your contracts.  You can find our fully customisable Shareholders Agreement for South African law here