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  • Writer's pictureRajvin Singh Gill

Benefits of having a shareholders' agreement in place

It is common to discard the need for legal documentation to be in place when a joint venture is to commence on a friendly footing. We do not want to intimidate our 'friendly' counterparty now do we?

However, based on past observations, even the friendliest of relationships can break down when it comes to doing business. Hence it is often times best to introduce some formality into a supposedly friendly joint venture in the form of a shareholders' agreement.

Outlined below are a few reasons why it is essential to have a shareholders' agreement in place, preferably before the establishment of the joint venture company. Please note that this list is not comprehensive but serves to emphasize the numerous advantages of having a shareholders' agreement:

An interested investor can make a well-informed decision regarding their investment.

It should be noted that when there are multiple shareholders involved, there are inevitably certain discrepancies in their expectations and desires for the company. These discrepancies can arise in various areas, such as the exercise of management and control, the determination of dividends, ownership of intellectual property used by the company, procedures for exiting the company or valuing shares. By explicitly addressing these anticipated issues in a written agreement, all relevant shareholders can be on the same page and fully aware of the terms they are entering into. Finalizing the shareholders' agreement prior to or during the company's incorporation provides interested parties with the necessary knowledge they need before making investments in the company.

Minority shareholders or passive investors possess certain decision-making rights.

The board of directors typically holds the responsibility for managing the company's day-to-day operations, which can leave shareholders excluded from the decision-making process. However, some shareholders may believe that certain decisions should not be left solely to the discretion of the board. They may wish to have a say in matters such as implementing a change in business, approving significant financing or loans, incurring substantial capital expenditure, or approving the annual budget and business plan. This becomes particularly relevant when shareholders are not represented on the board of directors. In such cases, the shareholders' agreement can specify that certain decisions require special, unanimous, or supermajority (e.g., three-fourths/75%) approval to be implemented.

It is important to consider that if all decisions, especially those involving operational and management matters, require unanimous agreement, it could lead to complications and hinder the company's ability to carry out its daily business effectively.

Shareholders can have anti-dilution rights

The issuance of new shares to a specific shareholder or new shareholder without offering them proportionately to all existing shareholders can result in a decrease or dilution of the latter's ownership stake. To address this, having a restriction or pre-emption right in place enables shareholders to have a say in the creation and allocation of new shares before the company's directors can proceed with the proposal. This mechanism ensures that shareholders can make informed decisions regarding the issuance of new shares.

Shareholders have the ability to express their preferences regarding the selection of co- shareholders

In a typical shareholders' agreement, there are usually provisions that restrict who can become a shareholder. One such mechanism is the right of first refusal (ROFR), which requires a shareholder wishing to sell their shares to offer them first to the other shareholders. This serves the purpose of preventing unknown individuals, who may have no prior connection to the remaining shareholders, from acquiring shares in the company.

The underlying rationale for this restriction is that all shareholders have a vested interest in knowing who they are entering into a business partnership with, as they will be working together for the benefit of the business and the company. This is particularly relevant for startups or small businesses where the founders or initial shareholders may want to retain their shares, perhaps for a specific period, and prevent new and unfamiliar investors from entering the picture.

Additionally, this provision can prevent a departing shareholder from selling their shares to a competitor or someone else that the other shareholders do not wish to be involved with the company.

However, it's important to note that depending on the circumstances, these restrictions may not always be advantageous for minority shareholders. In fact, they may prove to be detrimental, as it can make it challenging for them to sell their shares and realize their investment.

Minority shareholders can tag along majority shareholder

The shareholders' agreement can include provisions that allow minority shareholders to "tag along" in case the majority shareholder decides to sell their shares. This means that if someone expresses interest in buying the majority shareholder's shares, the majority shareholder can only proceed with the sale if the same offer is extended to all minority shareholders who have exercised their tag along right. This provision ensures that minority shareholders receive an equal return on their investment as the majority shareholder.

Majority shareholder can drag along minority shareholders

The shareholders' agreement can incorporate "drag along" provisions, which come into effect when a buyer makes an offer to purchase all of the shares in a company, specifically targeting the majority shareholder. In such a scenario, the majority shareholder has the authority to compel the minority shareholders, regardless of their opposition to the sale, to accept the deal. This enables the majority shareholder to "drag along" any unwilling minority shareholders, ensuring they do not hinder the overall sale. This provision provides reassurance to the majority shareholder, as it allows them to realize their investment at a suitable time and price when a buyer is found.

However, in order to exercise this right, the majority shareholder must ensure that the price and other terms of the sale are fair and equal to all shareholders, ensuring that the minority shareholders are not placed at a disadvantage in the transaction.

Deals with the relationship between shareholding and employment.

In certain cases, especially in start-ups, directors and senior personnel may be offered shares or equity stakes in the company as an incentive. To address potential issues that may arise if their employment or directorship terminates (through resignation or lawful dismissal), the shareholders' agreement can include provisions to handle the situation. These provisions may stipulate that their shares are returned or sold, or if unsold, the exiting director or employee may only exercise specific voting rights or receive certain benefits despite their departure. Some remaining directors or employees may be concerned about the exiting individual retaining their shares and continuing to benefit from the collective efforts of those who remain in the business.

Furthermore, the shareholders' agreement can incorporate mechanisms that establish different valuation methods based on the circumstances under which the relationship between the exiting director or employee and the company comes to an end. These mechanisms provide a framework for determining the value of their shares, taking into account the specific situation surrounding their departure.

Determines the value of shares through the assessment of the company's auditors.

The shareholders' agreement can include provisions that facilitate the valuation of shares when the remaining shareholders express their interest in purchasing them from an exiting shareholder. These provisions aim to prevent potential conflicts during the valuation process. For example, the agreement may specify that the shares offered for sale by the exiting shareholder to the remaining shareholders should be valued by auditors or another independent advisor. This ensures that the valuation is conducted objectively and independently, even if a third party has offered a higher price to the exiting shareholder.

Sets forth the guidelines and provisions regarding the distribution of dividends

A shareholders' agreement has the capability to establish a flexible dividend policy that permits varying dividends to be distributed to different shareholders based on the class of shares they hold.

Restricts competition

When a shareholder intends to leave the company, the remaining shareholders, especially the majority shareholder, might wish to impose limitations on the exiting shareholder's capacity to establish a competing business, invest in a rival company, or offer consultation services to a competing entity. These restrictions are crucial for safeguarding the company's interests, especially concerning intellectual property, trade secrets, and other confidential information, as it moves forward.

Reduces conflicts and establishes guidelines for resolving disputes

When a company has multiple shareholders, it is highly probable that disputes will arise among them. These disputes can involve various issues such as business management, dividend declarations, share transfers, and share pricing, among others. A well-drafted shareholders' agreement plays a vital role in clearly outlining the terms and procedures for resolving such disputes. By providing clear guidance, unnecessary and costly legal actions can be avoided.

In cases where some shareholders are located outside of Malaysia, it is crucial to explicitly specify the applicable law governing the shareholders' agreement. The choice of law to resolve disputes must be expressly stated or reasonably evident from the contract terms or circumstances. Parties also have the option to refer their disputes to either local or foreign courts or arbitral tribunals. However, it should be noted that even if the parties have agreed that foreign law governs any disputes in the agreement, it does not exclude the jurisdiction of Malaysian courts to hear a legal action arising from the agreement if the breach occurred within Malaysia. Furthermore, it is not uncommon for shareholders' agreements to include arbitration clauses specifying a seat outside of Malaysia or under a law different from that of Malaysia.

Assists in situations where two shareholders possess an equal 50% ownership stake in the company.

When two shareholders each own an equal 50% stake in a company, there is a potential for impasse or deadlock to occur, resulting in an inability to reach decisions at both the board and shareholder levels. Without a mutually agreed-upon procedure to resolve disputes or conflicts, the impasse can hinder the company's operations and potentially violate provisions of the Companies Act. In such cases, a shareholders' agreement becomes essential as it provides mechanisms to identify when a deadlock arises and outlines steps to address and resolve the situation, allowing the company to move forward and mitigate any negative consequences.

May have priority over the Constitution

If both the shareholder's agreement and the company's Constitution have been properly drafted, there should be no conflict between their respective provisions. It is common to include a provision in the shareholder's agreement stating that if a conflict does arise on the same subject matter, the shareholder's agreement will take precedence over the Constitution. In such cases, the parties involved are typically required to promptly take steps to amend the Constitution to align with the terms of the shareholder's agreement.

However, it's important to note that under the Companies Act 2016, if there is a conflicting provision related to an obligation of the company, the Constitution generally takes precedence over the shareholder's agreement. In such instances, the Companies Commission of Malaysia (SSM) may take action against any breach of the Constitution.

Furthermore, it should be emphasized that a shareholder's agreement is a legally binding contract enforceable only between the parties involved. If a provision in the shareholder's agreement is not also incorporated into the Constitution, the party seeking to enforce that particular term in the shareholder's agreement may not have the additional option of seeking intervention from the SSM.

Also take note

It is important to conduct regular reviews of the shareholders' agreement to ensure that it aligns with the company's and shareholders' current intentions and preferences. Any significant changes in the shareholding structure should prompt the agreement to be updated and re-executed.

At Rajvin Gill & Co the core of what we do pertains to joint ventures, startups, partnerships and investments. Please feel free to contact us to schedule a free consultation in structuring a proper shareholders'/joint venture agreement for your business.


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