A well-drafted Shareholders Agreement sets out how the business will be conducted and also what happens if one of the shareholders wants to sell its shares.
When dealing with the sale of shares, a Shareholders Agreement will usually include a “first right of refusal” clause – this essentially gives other shareholders the right to have “first dibs” when it comes to purchasing another shareholder’s shares. A standard “first right of refusal” clause will require the shareholder who wishes to sell its shares i.e. the selling shareholder, to provide notice in writing to all the other shareholders in the company. The other shareholders then have the first opportunity to purchase or refuse the shares. The clause should also set out how notice will be given and the time period within which a shareholder may respond to the notice – this is usually a 30-day period.
The first right of refusal clause also needs to address the different circumstances of the sale. For example, what happens if only some shareholders want to purchase the shares and what happens if every a shareholder wants to purchase a portion of the shares? The answer to this is to require the selling shareholder to sell its shares on a pro-rata basis, based on the proportionate shareholdings of each shareholder.
It is extremely important to include the “first right of refusal” clause in your Shareholders Agreement, as it prevents a shareholder from selling its shares without first reverting to the existing shareholders. This could be particularly problematic if a majority shareholder wishes to sell their shares. Without giving notice to the other shareholders to provide them with an opportunity to purchase the shares, any third party could obtain a controlling interest in the company.
The “first right of refusal” clause also needs to include the procedure for the transfer of shares. Once the remaining shareholders have agreed to purchase the shares, the shares will need to be transferred. Issues can arise if the selling shareholder, for whatever reason, refuses to sell or does not transfer the shares when required. The Shareholders Agreement can set out that, in such circumstances, the company be authorised to act as the attorney of the selling shareholder and undertake the transfer on the agreed terms.
Most small businesses do not have a large number of shareholders, which is why it is particularly important for the Shareholders Agreements of small businesses to contain a “first right of refusal” clause. It is a clause, which can protect your business by ensuring that controlling interests in the business won’t be given to third parties who may have no interest in running the business or values which do not fit with your business vision.
A Shareholders Agreement is an extremely important legal document. If you have any questions regarding a Shareholders Agreement, or if you would like to have one drafted, you should speak with one of our experienced contract lawyers.