It is not safe, warns the Family Firm Institute, for family owners to assume that the ownership and direction of a successful family business will remain stable. As the business grows, so do the risk of disputes between shareholders.
Without policies, anyone who owns shares in your family business could sell those shares to other people, including non-family members, at any time. Shareholders may also vote to change the members of your company’s board of directors. Similarly, as your shareholders’ pool grows larger, most of your shareholders will end up with a smaller percentage of your company’s shares that would yield lower dividends (if the company is paying dividends). This situation could create frustration among these minority shareholders and lead to costly conflicts with your salary-receiving family members.
Avoid many of those disputes by defining clear shareholding policies at the earliest stages of your family business existence.
Deloitte highlights in its article ‘Shareholder Agreement in Family Companies’ that, an effective shareholding policy or shareholder agreement should include:
- Who are the shareholders and how are the shares held
- Quorum for the shareholder meeting
- Board of directors
- Voting rights
- Transfer of shares
- Sale of shares
- Dividend policy
- Dispute resolution mechanism
Find below some tips about some of the specific clauses you should include in your shareholder agreement. Always consult with a lawyer experienced in family business to draft your policy or agreement. He/she will ensure your agreement is tailored to your business specific circumstances, shareholders and regulations.
Board of director
Since your board is responsible for the oversight of your company’s business and appoints your CEO and other executive employees, a voting agreement helps to ensure that your company’s strategic direction remains on track. Your shareholder agreement should accordingly include specific provisions relating to:
- The composition of the board of directors,
- The number of individuals permissible on the board of directors,
- Provisions for non-executive directors and a directors’ election mechanism, including an entitlement for certain family members or shareholders with a specific shareholding interest, to make certain appointments to the board of directors.
Clarifying the voting rights necessary to vote for strategic decisions is critical:
- Clarify what decisions require a majority vote (51%) e.g. your decision to increase the authorized share capital of the company, versus what other decisions require other majority vote e.g. 75% for alterations to your company’s memorandum and articles of association or a change to your company’s name.
- Decide if decisions such as ways to finance the business or shifting the strategic goal of your business could be left up to the regular voting rights of your board of directors or should be ruled by specific provisions.
- Include a clause for a majority vote (e.g. 75% or 90%) for specific strategic decisions such as your strategic acquisitions or borrowing facilities; your decisions to repay your directors’ loans or shareholders’ loans; your decisions to allow borrowings in excess of a specified amount; your decisions to transfer, sell or otherwise dispose of any part of the business; your decisions to pay any dividend or make any distribution to the members of the company.
Transfer of shares
Permit or restrict the transfer of shares in your agreement:
- Provision to maintain control: certain transactions may not be undertaken without the consent of a specified shareholder. This allows the shareholder to maintain control and protect his/her investment.
- Provision in case of death/ divorce: ensure that the shares are transferred to the shareholder’s spouse, to a family member other than the spouse or provide that the company buy back the shares
- Provision to prevent outsiders from becoming shareholders: oblige shareholders not to sell their shares to third parties without first offering them for sale at the same price and terms as the third-party offer to the existing shareholders or to the company at a specified price.
- Provision for transfers for estate planning purposes, to children or trusts, or to an entity controlled by the transferring shareholder, or to an existing shareholder.
Sale of shares
In the event one of your shareholders wishes to exit the business, prevent potential conflicts by including:
- Provision for valuation: protects shareholders who wishes to exit by ensuring they receive a fair value for their shares.
- Provision for discount: oblige the shareholder to sell their shares to your existing shareholders at a discount
- Provision for cash flow considerations: define mechanisms that allow your family members to sell their shares at a fair value if they prefer cash instead. At the same time, protect your remaining shareholders to ensure that any payment to the exiting shareholder does not negatively impact on the cash flow of your business in a case where your company buys back the shares. Include accordingly a clause to allow for the buyback over time of the shares by your company through a Shares Redemption Fund. The fund is usually financed by contributing a small percentage of your profits to it every year over.
- Provision for tag along/ drag along rights: If your majority shareholder is selling his shares in your company, your minority shareholder is entitled to “tag along” and sell his/her shares to the same purchaser on the same terms. Similarly, if your shareholder wishes to sell his/her shares, a drag along clause will allow them to compel the other shareholders to sell their shares, on the same terms.
Agree on a dividend policy for shareholders for harmonious relations among shareholders, including those who are not salaried in your business. At the same time, protect the liquidity of your company by including provisions that dividends are only payable if profits or cash reserves are at a certain level.
Dispute resolution mechanism
Conflict can be costly and damage durably your business sustainability. Make sure you include an arbitration clause where all parties agree to be bound by the decision of the arbitrator.
For more information,
- consult IFC Family Business Governance Handbook
- Deloitte ‘Shareholder agreements for family business’
- Family Firm Institute, ‘Shareholder agreements: planning for certainty in business direction and succession’
Explore more resources about IFC Family Business Governance
- How strong is your governance? Try out the Sample Listed Family Business Governance Self-Assessment Tool
- Why it is important to start planning the governance of your family business
- What governance is adapted to your family business growth
- Is succession planning taboo in your family business
- Roles and conflict resolution in your family business
- Communication and conflict resolution in your family business
- Family managers versus outside managers in your family business
- How to set up an effective board in your family business