The shareholders’ agreement is an essential legal document that provides a framework for relations between shareholders and sets out certain rules governing the operation of the company.
Whenever the shareholder structure changes, whether as a result of the arrival of a new shareholder, a reconfiguration of capital, a fund-raising operation or a partial sale of capital in which the initial shareholder remains in the minority, it is essential to draw up a shareholders’ agreement.
AKCEAN can help you negotiate the clauses of a shareholders’ agreement, to protect your interests, prevent conflicts and establish sound governance.
What is a shareholders’ agreement and why is it important?
A shareholders’ agreement is a private law contract between the shareholders of a company. Its role is to establish clarity in shareholder relations and define rules for the smooth running of the company. In particular, it enables shareholders to anticipate and agree in advance on measures to be taken in the face of potential divergences.
The exact name of the pact varies according to the legal form of the company: it is called a shareholders’ pact for joint-stock companies (Société Anonyme, Société par actions simplifiée) and a partners’ pact for partnerships (Société à responsabilité limitée, Société civile).
Although optional, a shareholders’ agreement is essential to ensure coherent management of the company, and is strongly recommended when there are several shareholders.
Distinction between articles of association and shareholders’ agreement
It should be noted that the company’s Articles of Association and the Shareholders’ Agreement are two separate documents, with the Agreement supplementing the Articles of Association. Unlike the Articles of Association, the Shareholders’ Agreement is neither mandatory nor public, and enables you to set down rules that you wish to keep confidential.
However, it is essential to ensure that the two documents are compatible, to avoid any possible contradictions.
What clauses does it include, and why are they essential?
A shareholders’ agreement includes a number of clauses categorized according to their purpose, such as those relating to governance, presence, exit and financial rights. The following is a non-exhaustive list of some of these clauses:
GOVERNANCE CLAUSES
Board of directors
Shareholders define the structure and composition of the Board of Directors, including their representativeness, as well as the frequency of meetings. The main role of the Board of Directors is to guide and validate the company’s major strategic decisions.
The shareholders’ agreement specifies the responsibilities of the Board of Directors. In particular, its role is to guide and approve the company’s key strategic choices. This includes appointing senior executives, supervising executive management, drawing up remuneration policies, establishing internal governance principles, approving financial statements, validating financing requests, monitoring and managing risks, making investment and M&A decisions, and approving the annual budget.
To avoid deadlock, it’s a good idea to opt for a moderately sized board, with an odd number of the main shareholders represented.
Voting rights
Shareholders may wish to impose an obligation to vote for or against certain resolutions, benefit from enhanced voting rights or a right of veto on certain decisions, or require consultation before each meeting.
Mediation
In the event of persistent disagreements between shareholders, it may be useful to provide for a simple obligation to consult or mediate, or to envisage more binding solutions.
Right to information
Shareholders define the content and frequency of the reporting they wish to receive, to ensure optimum transparency and communication
ATTENDANCE CLAUSES
Exclusivity
Directors are forbidden to become involved in other companies, including non-competing ones. The aim is to ensure total commitment to the company and prevent any potential conflicts of interest.
Non-competition and non-poaching
Directors and shareholders undertake not to compete with the company, either directly or indirectly. This may involve a prohibition on investing in a competing company. This clause, which must be circumscribed in its geographical and temporal scope, may continue to have effect even after the persons concerned have left the company.
Non-transferability (or inalienability)
Shareholders undertake not to sell their holdings in the company’s capital for a certain period, thus ensuring stability in the capital structure.
EXITCLAUSES
Pre-emption
If a shareholder intends to sell his or her shares, he or she must inform all other shareholders. The shareholders, or some of them, have a priority right to acquire the shares before any outside third party. The price of these shares may be fixed in advance or determined according to certain conditions.
Approval
Shareholders may control and approve the entry of new shareholders. Any intention to transfer shares to a new entrant must be approved by the shareholders’ meeting. If approval is not granted, the shares may be acquired by the other shareholders or by the company. It is also possible to provide for the appointment of an independent expert to estimate the value of the shares.
Good/Bad Leaver
The “Bad Leaver” refers to a shareholder who decides to leave the company prematurely, or is excluded as a result of misconduct. Under these circumstances, the shareholder’s shares can be bought back at below market value. This provision is designed to penalize departures deemed detrimental to the company.
On the other hand, a “Good Leaver” is a shareholder who separates from the company under conditions that respect the terms of the agreement, whether by achieving pre-established objectives or respecting a commitment period. In this case, the shareholder may benefit from favorable conditions for the sale of his shares.
Good/Bad Leaver clauses are generally intended for key individuals with a significant operational role in the company.
“Buy or Sell
In the event of a major disagreement likely to compromise the company’s future, a shareholder may offer to buy the shares of another shareholder. The shareholder receiving this proposal then has the choice of selling his or her shares at the proposed price or, if he or she refuses, buying the shares at the same price. This mechanism prevents the company from being paralyzed by a conflict between shareholders.
Liquidity
After a defined period, or following a particular event, a coordinated exit strategy can be planned, involving all or some shareholders. For example, after a certain period, the shareholders may agree to jointly mandate an investment bank to explore either the sale of the company, or its flotation on the stock exchange.
The pact may also include a commitment by the founders or historical shareholders to acquire the shares of the other shareholders at a set price.
Preferential sale/liquidation
In the event of a sale of the company, the distribution of the proceeds does not necessarily correspond to the share invested by each shareholder. Some shareholders may wish to take priority in receiving the proceeds of the sale, sometimes up to an amount equivalent to several times their initial investment, before the other shareholders receive their share.
Tag long (joint exit)
When majority shareholders plan to sell their shares, they are obliged, under the “tag along” clause, to include minority shareholders in the negotiations. This mechanism offers minority shareholders the opportunity to sell their shares on the same terms as the majority shareholders, ensuring that they benefit from the same terms and conditions of sale.
Drag long (forced exit)
In the event of a full sale of the company’s shares, the “drag along” mechanism enables majority shareholders to require minority shareholders to sell their shares as well. The purpose of this clause is to facilitate a global sale of the company by ensuring that minority shareholders cannot oppose or hinder the process.
Change of control
When a corporate shareholder undergoes a change of control (i.e. a change in his or her main shareholder base), the other shareholders have the option of acquiring his or her shares.
CLAUSES RELATING TO FINANCIAL RIGHTS
Distribution of profits
The covenant may stipulate how profits are to be distributed, generally in the form of dividends. Minority shareholders may receive a dividend if the company’s financial situation allows.
Anti-dilution
In the event of a capital increase, an historical shareholder may subscribe to part of the increase and maintain his percentage holding.
Ratchet investor
The “ratchet investor” mechanism offers protection to a shareholder against a potential fall in the value of his or her shares. If, in a subsequent round of financing, the company’s value falls, this shareholder has the opportunity to strengthen his position, generally at the expense of other shareholders, notably the founders. The shareholder concerned can thus acquire additional shares at a symbolic cost, compensating for the devaluation of his initial investment.
Ratchet management
Ratchet management is a mechanism designed to reward management for performance. If defined objectives are met, or if the company’s valuation increases during a new round of financing, the managers have the opportunity to acquire shares at a preferential rate, below their real value.
It is possible to modify a shareholders’ agreement. The prior agreement of all signatory shareholders is required. The amendment must be unanimously accepted. The shareholders’ agreement may also be terminated on the basis of its terms or in the event of a breach of its clauses. Should this be the case, as with any contract, a civil action may be taken by one or more shareholders who feel they have been wronged.
What are the pitfalls to avoid?
Drafting a shareholders’ agreement is a complex task requiring the expertise of a legal professional. The pact must maintain a balance between all signatories to prevent potential sources of tension. Its major role is to reconcile and harmonize the interests of shareholders, which may sometimes diverge.
Here are a few essential recommendations to consider when negotiating a covenant:
- Balance between precision and flexibility: Avoid vague clauses that could cause conflicts, but bear in mind that excessive rigidity in clauses can hinder flexible management of the company.
- Anticipation of different situations: Anticipate the various situations and challenges that may emerge over time.
- Precise expectations : The covenant should accurately represent the objectives and aspirations of each shareholder.
- Conflict resolution mechanism: It’s crucial to establish clear procedures for resolving disagreements.
- Deterrent mechanisms: Be sure to incorporate sanctions to ensure compliance with the covenant’s provisions, which may include a forced exit.
- Periodic revisions: Consider periodic updates of the covenant to align it with the company’s evolution.
A solid, well thought-out shareholders’ agreement is essential to ensure healthy, productive collaboration between shareholders throughout the life of the company.
Last update: October 2023
