2. Negotiation of a shareholders’ agreement
2.1. Take the right stance
The successful negotiation of a shareholders’ agreement requires, in the first instance, a firm understanding of the desired objectives to be achieved, and the terms which are required to achieve those objectives. This is particularly relevant when the primary reason for forming a company is to establish a vehicle for the commercial exploitation of intellectual property.
Having “best case” and “worst case” scenarios formulated ahead of time, along with a clear understanding of one’s mandate and bargaining position, will focus negotiations on commercially realistic proposals.
Although it is not always possible, a healthy bargaining position must include the possibility of declining to proceed with the proposed transaction if expectations cannot be accommodated. If the venture is started while the negotiations are still underway (which is often the reality), the possibility of such a withdrawal without this entailing negative consequences, which may include legal action, becomes more remote.
2.2. Get the right people around the table
If at all possible, one should insist that the parties to participate in the negotiations must have a firm mandate to negotiate. When this is not the case, for instance where subsequent board approval is required, this fact should be noted at the start of negotiations. Too often negotiators find themselves in a corner, use the convenient tactic of pleading a limited mandate.
Decide upfront on whether to include a legal practitioner to assist in the negotiating process. Introducing new parties or personalities later in the process of negotiation may change the dynamics and could necessitate the renegotiation of key points, which could in turn lead to a breakdown of the negotiating process.
3. Drafting a shareholders’ agreement
3.1. Start with a “deal sheet”
Before drafting of the shareholders’ agreement is to commence, the parties should ideally agree upon what has become known as a “deal sheet”. This is a short, bullet point document that outlines the salient points of the envisaged shareholders’ agreement.
Since the shareholders agreement will embody the terms agreed in the deal sheet, the risk of material issues derailing negotiations later in the process, is limited.
3.2. Be express
Be sure to state the specific purpose of the company and the mandate of the directors in the pursuance thereof.
Expressly state how pre-existing and new intellectual property rights will be dealt with. Be sure to state clearly the intention of the parties regarding where new rights will vest, and when such rights will vest.
Where registered intellectual property rights are involved, stipulate clearly who will be responsible for the maintenance thereof, and how the cost associated therewith will be dealt with.
3.3. Be careful with “sweat equity”
It is not uncommon for shareholders to start a company on the basis that one of the parties will pay for its shares in the company by rendering certain services, hence “sweat equity”. The parties are typically excited to get the venture underway, and neglect to state precisely in their agreement the scope, milestones, timelines and performance criteria for the services to be rendered.
“Sweat equity” arrangements are often encountered in the context of software enterprises, where a software house or developer may become involved in a company on the basis that it is to earn its shareholding by undertaking the development of certain software.
Situations such as the aforementioned should be handled with no less attention to the deliverables than would have applied had the software company been retained on an arms-length basis as an external consultant or contractor.
3.4. Funding
Parties often use standard form shareholders’ agreement which have unintended consequences when it comes to the funding of companies. The funding provisions should be carefully considered, since they could hide suretyships, obligations to make available funding at the discretion of the directors and, coupled thereto, draconian share dilution provisions should a shareholder not be able to comply. The funding provisions should be tested against a realistic cash flow budget of the proposed venture.
3.5. Exit plan
Consider and agree upon an exit plan, should the venture not succeed.
Where the agreement envisages the exclusive right to commercially exploit certain intellectual property, care must be taken to ensure that sufficient checks and balances have been provided to prevent the intellectual property from being tied up indefinitely in a dysfunctional entity.
3.6. Get it signed!
More than often operational issues of a new venture dominate structural issues (“paper work”) with the result that the shareholders agreement is not signed. An unsigned agreement complicates the enforcement of rights and places a heavier burden of proof on a party who has to fall back on the agreement to enforce its rights.
4. Amendments to the Companies Act
Readers may be aware that a new Companies Act 2008 has been signed into law. Although it is expected that the new act will not come into force for a period of at least another twelve months, it is noteworthy to consider some of the implications thereof. Although a detailed review of the act falls outside the scope of this article, there are a couple of key points to take cognisance of.
Where a company’s authorised scope of business was previously limited to that stated in its public documents of incorporation, this will no longer be the case. Shareholders accordingly need to be specific about the mandate of directors and other officers of the company.
Previously shareholders’ agreements contained a standard clause that simply stated that, to the extent that the memorandum of association and articles of association were in conflict with the shareholders’ agreement, the latter would prevail and the parties would do what was necessary to make it so. Under the new act, the memorandum of association of the company will supersede the shareholders’ agreement, i.e. the shareholders’ agreement may not be in conflict with the memorandum of incorporation.
As an aside, close corporations will continue to exist under the new act, although it will not be possible to incorporate new close corporations after the new act comes into effect.
5. Conclusion
The above considerations will hopefully provide negotiators and drafters of shareholders’ agreement with some pointers. The comments are not intended to be comprehensive as shareholders’ agreements are complex transactions. The terms of each prepared agreement are to be carefully considered against the specific facts of any proposed company structure and initiative.