A shareholder’s agreement is contract that regulates the management of the company. It essentially supplements the articles of association and will include clauses that may not be included in the articles. It outlines rights and obligations, company operations, shareholder roles, regulates share transactions, and governs dispute resolution.
Unlike the Articles of Association, the shareholders agreement is private document which does not require registration at the Companies Registry therefore safeguarding confidential information.
The following are salient terms in a Shareholders Agreement:
1. Capital contribution
The shareholder agreement should outline the obligations and the processes by which additional capital can be raised.
2. Company operations
The shareholder agreement should specify the frequency for meetings, quorum to vote on issues, and how meetings can be called when special issues arise. The agreement should also provide the rights and responsibilities of Shareholders and Directors and rules on appointment of Directors.
3. Share Transfer
a. Good and bad leaver rights
This is a provision that governs how shares are treated depending on the circumstances of departure of the shareholder, normally an Employee who has been offered shares as an incentive for working in a Company.
A good leaver refers to a shareholder who departs from the company due to circumstances beyond their control such as death, retirement, permanent disability or permanent incapacity through illness, or redundancy. In this case the shareholder may retain their shares if they are able to. A bad leaver is a shareholder who departs from the company within their control or through an agreement, such as resignation, dismissal, breach of contract or bankruptcy. A bad leaver is obliged to sell their shares on exit to the other shareholders and will in return get simply the nominal value of the shares.
b. Pre-emptive rights
As the name suggests, pre-emption rights allow existing shareholders to acquire shares prior to those shares being offered to third parties. This means that existing shareholders have the opportunity to preserve their proportionate ownership in the company, even if new shares are issued.
c. Tag-along and Drag-along rights
Tag along rights enable minority shareholders to have their shares bought on the same terms and for the same price as shares of majority shareholders. Tag-along rights provide minority shareholders with a potentially viable exit route as they will not be forced to remain in partnership with a new and unfamiliar partner. In the context of share transfers, a tag-along right will often afford minority shareholders with a greater degree of protection as compared with a right of pre-emption, especially in situations where the minority may not have the financial resources to acquire a majority stake.
Drag along rights require the minority shareholders to sell their shares to a bona fide purchaser, on the same terms and for the same price as a majority shareholder. A drag-along right enables the selling majority shareholder to procure an exit by forcing the remaining minority shareholders to similarly sell their shares to a bona fide third-party purchaser on the same terms.
4. Dividend Policy
The shareholder agreement should provide guidelines for distribution of profits among shareholders.
5. Non-Compete
The shareholder agreement should contain a non-compete clause, prohibiting shareholders and Officers from participating in competitive business to the company while they remain Officers of the Company and for a period of time afterwards. It includes the dos and don’ts, the scope and the period of these restrictions. On the flipside, such a covenant may prohibit shareholders from luring key customers, employees or suppliers of the company after exiting as shareholders from the company.
The aim of this clause is to ensure that internal knowledge, which is crucial for the company to stay competitive, stays confidential.
6. Dispute resolution
There must be a procedure outlining how disagreements should be resolved. Differences in the views of shareholders of a company can occasionally become problematic especially with respect to critical business matters. Such disagreements may lead to deadlock situation which ends up hampering the execution of critical business decisions. To mitigate this, a shareholders’ agreement must define what constitutes a deadlock and the process to follow if this situation occurs. There are various types of deadlock resolution clauses, each bearing its own set of implications.
The shareholders should only include important matters in the deadlock clause to avoid the process being triggered for matters which do not have a significant impact on the company’s business.
Conclusion
A shareholders' agreement establishes a structured framework for company operations. It safeguards the Company’s interests and creates transparency, promoting stability and confidence among shareholders.
It is important to note that the shareholders’ agreement and the articles need to work cohesively. If there are contradictions, it can be complex to make decisions.
How we can help
At CM SME Club, we provide valuable legal advice and guide businesses on the incorporation of Companies including advising on the documentation required to protect the interests of the Company. Contact law@cmsmeclub.com for assistance.
Related blogs & news
What is a Power of Attorney (POA)?
Power of Attorney (POA) is a formal instrument by which one person empowers another to represent him or act in his behalf in many matters including transactions for sale of land, registration of intellectual property, filing of lawsuits, signing off on documents, and opening of a bank account among many others. ...
Employee Consultation Before Redundancy
The requirement of consultation is not expressly provided in section 40 of the Employment Act, 2007. However, by dint of Article 2(6) of the Constitution, treaties and conventions ratified by Kenya form part of the law of Kenya. Kenya is a state party to the International Labour Organization (ILO) since 1964 and is therefore bound by the ILO conventions....
Employees Right To Information
The Employment Act, 2007, does not have an express provision on the employees’ right to information. However, Article 33(1)(a) of the Constitution of Kenya, 2010, provides that every person has the right to freedom of expression, which includes freedom to seek, receive or impart information or ideas. Article 35 (1)(b) of the Constitution 2010, further provides that every Citizen has the right to access information held by another person and required for the exercise or protection of any right or fundamental freedom. What information do employees have a right to? 1. Organizational goals and objectives Organizational goals and objectives are easily overlooked in the day-to-day business of getting the job done, but they should be provided, not just to new employees at induction, but to everyone regularly. Reinforcing an understanding of organizational goals and strategy helps employees feel like they are part of the business, which in return leads to improved job performance and engagement. Apart from the emphasis being made by the human resource manager, the line manager too should regularly remind his/her team of the goal and objective of the firm. The line manager together with his/her team may develop their department goals that align with the overall goal of the company. When a department has established its departmental goal, then it means they understand the goal and objective of the company. This in return leads to improved output and increased production. 2. Organizational policies and procedures Most organizations have rules, policies, and procedures that guide how they do things which is important for employees to know and understand. Depending on the company, the policies and procedures may be incorporated in the employee handbook or the human resource manual. How you collate this information is a matter of considering what works for you and the team, but the key is that you must make sure employees are aware of and understand all rules, procedures, practices, or policies with which they are expected to comply. This means they need to be written down somewhere and easily accessible. 3. Organization structure An organizational structure is the way that a company, organization, or team is set up. Every company and team has an organizational structure, even if it’s not formally defined. Organizational structures are important because they help businesses implement efficient decision-making processes and provide a clear org chart that helps businesses keep track of their human resources. Thus, the employees need to understand the organizational structure of the company because it guides all employees by laying out the official reporting relationships that govern the workflow of the company. A formal outline of a company's structure makes it easier to add new positions in the company, as well, as providing a flexible and ready means for growth. An employee who understands the organizational structure will be motivated to know that the company has a growth plan. 4. Feedback on performance Employees need to understand how well they are doing in their roles and what they can improve on. Regular constructive feedback is essential here, and the temptation to only pick them up on things they are doing wrong should be avoided. It is hard for you to do your best without information, and the same is true for your employees. If you withhold information unnecessarily, you will lose your talent. Maybe not today; but eventually those with choices will leave you. What information can be withheld from employees? Never use information withholding as power. If you are given 'secret' information, don't tell people you have it unless they ask you. If people ask you if you have information, be honest. Don't tell them you don't have information if you do. Tell them that you are not at liberty to share, and tell them why, e.g. "I've been asked to keep it confidential and I need to honor that request." If you establish a track record of early, honest information sharing, you will have more room to occasionally withhold information when the situation dictates. Information that should be kept confidential includes any information that could damage a company's reputation or ability to do business if that information becomes public. Such information is proprietary or sensitive. This information includes information whose disclosure is likely to: a. Impede the due process of law and procedures of the company; b. Endanger the safety, health, or life of any person; c. Involve the unwarranted invasion of the privacy of an individual; and/or d. Substantially prejudice the commercial interests, including intellectual property rights, of the company or third party from whom information was obtained. In the words of Sam Walton, Wal-Mart Founder: I guess our greatest technique and our greatest accomplishment is the commitment to communicating with employees in every way that we possibly can and listening to them constantly…you've got to put their interest first, and eventually, it will come back to the company....
The legality of Non-Compete Clauses in Kenya
A non-compete clause is a contractual agreement between two parties, typically an employer and employee, where the employee agrees not to engage in certain business activities that would be considered competitive with the employer's business. The purpose of a non-compete clause is to prevent the employee from working for or starting a business that would compete with the employer during and after their employment....
Why SMEs should use documents drafted by an Advocate for their Businesses
Here are some reasons why SMEs should use documents drafted by an Advocate: 1. Compliance with the Law. SMEs are subject to various laws and regulations. An Advocate can help SMEs navigate the complex legal landscape and ensure that they comply with all relevant laws and regulations. Non-compliance can lead to significant penalties, which can be detrimental to the business....
Share this blogLinkedIn Twitter Facebook Print