If you have any questions regarding shareholders' agreements or other corporate and commercial contracts, please contact Simon Wong at [email protected]
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「Hi, this is Simon Wong, a partner at the corporate commercial department at Oldham, Li & Nie.
I specialise in corporate finance securities M&A joint ventures, PRC related transactions, and IPOs. In this episode, I want to share with you the basics of a shareholders agreement. First of all, what is the shareholders' agreement?
A shareholders agreement is an essential agreement between the shareholders of a company and the company itself, is used to govern the company's management and operation and sets out all the rights and obligations between the shareholders and the company. A shareholders agreement is particularly important for third-party investors investing in an existing company or business or when unrelated parties come together to form a new company.
Why do you need a shareholders agreement? When people come together to form a company and run a business it is more often than not that the question of whether a shareholders agreement is needed pops up. A shareholders agreement is to safeguard interests of the shareholders and if disputes arise between the parties, there is an agreement that can fall back on setting out clearly what the parties can or cannot do, and shall or shall not do. Of course, people will say that they're not worried about getting into disputes because it will never happen. The business partner is a long time good friend, a family member, a trustworthy person, etc. Maybe in an ideal world, it could be the case. But we all know things are not perfect in reality, and business partners do find themselves disagreeing on different matters from time to time. When this happens, well-drafted shareholders' agreement could save you from trouble, and even save the business so a shareholders' agreement is important.
What does it include? A typical shareholders agreement includes terms such as the business of the company, the composition of the Board of Directors’ frequency procedure for convening, and holding board meetings and general meetings, reserved matters, restriction on transfer of shares, anti-dilution mechanism, minority shareholder protection for the financing needs of the company, and non-competition undertaking etcetera if investments are to be made in stages. The shareholders' agreement would normally include a timetable for capital contribution, share subscription by the shareholders, shareholding structure, and other typical clauses in a share subscription agreement. If you are a minority shareholder in the company, minority protection would be extremely important to protect your interests as you wouldn't want the company to do anything to jeopardise your interest or investment in the company.
Typical minority protection clauses will include tag-along rights and certain reserved matters that would require a super-majority approval from shareholders. And certain resolutions can only be passed with the approval of the minority shareholders' nominated director. There are many ways to work around the minority protection and how much you are going to get depends on your level of investment and of course, your bargaining power.
A restriction on the existing management or majority shareholder to engage in similar or competitive business as the company you invested in, is also a way to protect the minority shareholders' interest, as you wouldn't want that while you have invested so much in a company, the management goes out and sets up their own business which directly competes with the investor business. Often, when an investor invests in a business as a minority shareholder, the investor is in fact investing in the experience expertise, and knowledge in the industry and business operation of the company's management team, who are normally the majority of founding shareholders of the company. In case the majority shareholders decide to divest and sell the shares, the investor could also consider selling the shares as they may be uncertain as to the management, operation, and profitability of the business once the company changes hands. Hence, the investor will almost invest inevitably request a tag-along right to be incorporated into shareholders agreement, giving the investor right, but not the obligation to co-sell its shares on the same terms to the prospective buyer of the majority stake.
While there are minority protection clauses, if you're on the other side of the table as the majority shareholder, you would definitely want to have some clauses to protect your interests as well. A potential nightmare for a majority shareholder could be when they have found a prospective buyer willing to buy 100% of the company, but the minority shareholder refuses to sell their shares. What happens next is the entire deal falls through. To avoid this. The shareholders' agreement should include a clause whereby if the majority shareholder decides to sell all of their shares in the company to a third-party buyer, they will have the right but not the obligation to request the minority shareholders also sell the shares in the company on the same terms once requested by the majority shareholder, the minority shareholders will be obliged to sell their shares. This is called a drag-along right of the majority shareholder, which is the exact opposite of the tag-along right of minority shareholders, as we often hear about.
In addition, a majority shareholder would not want any information relating to the business operation prospects, customers suppliers will trade secrets to be disclosed to any third party, especially competitors or shares in the company, so to competitors. Therefore, specific clauses that deal with the use and disclosure of confidential information and under restrictions on transfer of shares will need to be incorporated in the shareholders' agreement to address the majority shareholders' concern. Let's discuss more about other clauses in the shareholders' agreement next time. My name is Simon Wong. I'm a partner at Oldham, Li & Nie. If you have any questions about shareholders agreement or any other types of corporate commercial agreements, please do not hesitate to contact me at [email protected].com. Thank you!」