For those setting up a business in South Africa it is important to consider the merits of whether or not you require a shareholders agreement. Please note the information below uses the term ‘shareholders agreement’ in a generic sense as it will equally apply to those involved in a Close Corporation, the only change being it would be referred to as a ‘members agreement’.
1. Where does a shareholders agreement fit into the picture?
A shareholders agreement is used to govern the relationship between the various parties in their capacity as shareholders and often also in their positions as directors of a company.
Any aspect not covered by the Memorandum of Incorporation (MOI) needs to be covered by the shareholders agreement. Any aspect not agreed on in this way often has to be settled by way of litigation which becomes very expensive, time-delaying – something that could have been avoided.
2. When is it needed?
As soon as two or more people decide to be involved in business together, the shareholders agreement should be the first document that should be prepared and signed. Often working through this document right in the beginning or start-up of the business forces parties to discuss and finalise aspects relating to their relationship which would maybe not have been covered at all otherwise.
Common errors in thinking that cause the delay in setting up shareholders agreements include:
- Shareholders tend to think that because they know each other and have a good business concept, they would be successful in a joint business.
- Shareholders think that when they start out there is no major value in the business – so they will get to the shareholders agreement once there is value in the business. The problem often is that once there is value and people have their shares already, there is no incentive to compromise to ensure everybody’s interest is being taken care of.
- Although all statistics proof otherwise, the default person starting a business thinks that his business will be successful and nothing will go wrong.
3. What to cover in a shareholders agreement?
Some of the aspects to be covered in the shareholders agreement, should include:
- Implications in case of death of a shareholder.
- Share valuation methodology; Loan account treatment.
- Options to minorities when majority of shareholders sell their shares.
- BEE Requirements and implications if they cease to be met.
- Dividend policy.
- Working capital requirements.
This is by no means an exhaustive list but only some of the items.
4. How does the shareholders agreement interact with the new MOI (Memorandum of Incorporation)?
The MOI is the higher ranking of the two documents. This is however a public document, so some items that the shareholders want to govern more confidentially have to be done in the shareholders agreement. Any item in the shareholders agreement that conflicts with the MOI will be null and void. It is therefore important that the two documents be prepared simultaneously.
5. What are the implications of not having a shareholders agreement?
In case of the death of a shareholder, their shares could form part of his estate and a family member could become your new partner in the business.
When the business splits up, and the principles of first taking care of the business and shareholders that remain in the business has not been established, the business could be destroyed by parties leaving.
The practical reality is if principles have not been decided and documented from the beginning and then differences occur, it is often too late and could well end up in court. Causing further conflict, neglect of the business and huge amounts spent on legal fees – all of which could have been avoided.
If a valuation methodology has not been determined in the agreement it is often impossible to get two parties to agree to a value at a later date. This is particularly pertinent when one existing party is selling to another existing party, as the buyer and the seller are standing on opposing sides. Legal battles between shareholders with various experts involved to determine the value is unfortunately common.
6. Cost-effective solution
A shareholders agreement can be prepared at fairly reasonable prices and will save a substantial amount of legal fees and disputes down the line.