Shareholder Agreements: The Document Small Companies Miss Once

Most small companies in South Africa start with a handshake and a registration certificate. Two or three people who trust each other, a good idea, and a bank account. Nobody wants to be the person who insists on a shareholders agreement, because it feels like saying you do not trust your business partner.

Then the company grows. Someone wants to leave. Someone wants to bring in a family member. Someone wants a salary the others think is too high. That is when the absence of an agreement stops being an awkward conversation and becomes a lawyer’s letter.

What a shareholders agreement actually does

A shareholders agreement is a private contract between the owners of a company. It governs how they deal with each other. It sits alongside the company’s Memorandum of Incorporation, which is the public document that governs how the company itself operates.

The Memorandum of Incorporation is compulsory. A shareholders agreement is not, which is exactly why so many companies do not have one, and why disputes so often end up in court instead of being resolved at a boardroom table.

The clauses that earn their keep

A well drafted agreement covers the situations that actually arise in practice.

Decision making. Which decisions need unanimous consent and which can be taken by majority. Without this, a 51 per cent shareholder can make decisions that affect a 49 per cent shareholder’s livelihood, and the minority’s only remedy is litigation.

Dividends and profit sharing. When and how profits are distributed, and whether retained earnings can be used to fund expansion instead. Owners fight hardest about money, so it should be dealt with in writing while relations are good.

Exits. How a shareholder sells, at what price, and to whom. A pre-emptive right stops shares being sold to a stranger without the others being offered them first. A valuation mechanism stops a fight about what a quarter of a company is worth.

Funding and dilution. What happens if the company needs capital and only one shareholder can put it in. Does that shareholder receive shares, and if so, how many, and at what price.

Employment and remuneration. Whether shareholders must work in the business, what happens to their salaries if they stop, and whether they may run a competing business. A restraint of trade is enforceable in South Africa if it is reasonable in scope, duration and area.

Deadlocks. What happens when two equal shareholders disagree and neither will move. A properly drafted deadlock clause, and sometimes a buy-sell mechanism, is far cheaper than an application to wind up the company.

The disputes we see

A shareholding in a small company is often a person’s most valuable asset, and it is frequently the only asset they hold without any written terms. When a relationship breaks down, we see the same consequences: money locked inside the company, a director drawing payments others dispute, and no way to force a sale at a fair price.

The Companies Act gives minority shareholders remedies, including relief against oppressive conduct. Those remedies work, but they are slow and expensive. A shareholders agreement is quicker, cheaper and, most importantly, predictable.

Practical steps

• Put it in writing now, while your relationship with your co-owners is good
• Deal with exits, valuations and dividends first, because those are the clauses you will need
• Check that your agreement and your Memorandum of Incorporation do not contradict each other
• Update the agreement when a shareholder joins, leaves or dies
• Keep signed original documents somewhere you can find them in five years

How We Can Help

We draft and review shareholders agreements, memoranda of incorporation, buy-sell arrangements, restraint of trade clauses and share sale agreements. If you own shares in a private company and have nothing in writing, this is a small piece of work that prevents a very large dispute.