Most SMEs don’t give much thought as to how their shareholding should be structured apart from the number of shares to be held by each shareholder.
One problem with this is what happens if there is a disagreement between shareholders. The majority group will always be able to out-vote the minority group and therefore effectively control the company. Whilst the courts may intervene if the minority shareholders are being unfairly prejudiced, it is far better to limit the possibility of such a situation arising in the first place.
The way to deal with this is to organise the structure of the shareholders, either through issuing separate classes of shares, or through a Shareholders’ Agreement, or a combination of the two.
Different classes of shares
The default position is that all shares are equal; each share comes with the same voting rights and the same entitlement to a share of dividends and the proceeds of any sale. In practice, this means that any single shareholder, or group of shareholders, with more than 50% of the company’s shares controls the company. They can do this by exercising their powers to dismiss directors they don’t agree with and/or to make decisions that bind the directors on important matters.
Whilst many companies are happy with the default position, this does not suit all, particularly small companies with few shareholders or where shareholders fall into distinctive camps.
For example, you might have three groups of shareholders: one consisting of the company’s founders, another consisting of investors, and perhaps a third containing employees who have been given shares as part of a reward package. With such a structure, the motivation of each group of shareholders could be quite different.
One way to deal with this is to grant different classes of shares where each class has different rights. For example, one class could have full rights whereas another can have rights to, say, dividends and a share of any sale price but no voting rights at a general meeting. This might be appropriate for example for employee-shareholders. Investors may require rights to dividends and sale proceeds and a say on overall strategy but are content for most decision making to be decided by the founders.
Another way to structure a shareholding is through a shareholders’ agreement which may for example state that more than a simple majority is needed to make certain decisions or that certain decisions require the agreement of certain named shareholders.
Shareholders’ agreements can also set out the procedure to follow in the event of deadlock to prevent a debilitating stalemate from arising. They can also place restrictions on the right to sell shares, either to protect the other shareholders or to prevent the shares being sold to a party who may not be best for the company.
Each company is different and there are many ways in which to structure the shareholding. The important thing is to consider the needs of the company particularly when there are likely to be competing groups of shareholders with different interests. At the same time, it is important to protect the interests of each group of shareholders. Usually this can be achieved through creating different classes of shares and/or entering into a formal Shareholders Agreement.
Don’t forget the board
At the same time as considering how the shareholding should be structured, thought should be given to how the board of directors is structured.
Particular thought should be given as to what should happen in the event of deadlock. One possibility is to create a permanent chairperson who has a casting vote. Another is to direct that certain decisions can only be made by the shareholders or can be delegated to a particular director or committee of directors. All this should be documented to avoid problems later on. If, certain tasks are delegated to a director or committee of directors, then it should be agreed how often they should report to the full board as it is important that all directors know what is going on in the company.
Having agreed upon the structure, you then need to get the paperwork in place. This will often consist of amended Articles and a Shareholders’ Agreement. These are important documents and it is vital to get them right.
Get in touch with us for an informal chat about how we can help in getting the right documentation in place, and advise on any questions you may have on the right structure for your company.