Introduction to Shareholder Agreements - PowerPoint - PowerPoint

							Introduction to
Shareholder
Agreements

Geoff Taber
and           WatStart Presentation
Chad Bayne    July 3, 2008
Introduction to Shareholder Agreements



   A contract among the shareholders of a corporation to set out the
    principles, rules and procedures that will govern:
      the affairs of the corporation; and
      the relationship between the shareholders
   No such thing as a “standard form” shareholder agreement –
    each agreement deals with specific facts




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Basic Goals of a Shareholder Agreement



   Establish ground rules for the business
   Identify common interests/strengths of participants
   Identify unique interests/strengths of participants
   Provide appropriate incentives or penalties
   Focus on potential problems; provide appropriate solutions
   Create a flexible and enduring agreement




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Key Considerations



 Nature of Industry
 Nature of Participants
     Owner/Operators?
     Founders?
     Employees?
     Financial Investors?
   Other Key Considerations:
     Voting agreement
     Closely-held company
     Unanimous shareholders agreement




4
Core Concepts of a Shareholder
Agreement


 Governance
 Liquidity; Restrictions on Share Transfers
 What to do if Someone Leaves?
 Dispute Resolution




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Governance - Overview



 What would happen if there were no agreement?
 Need to balance shareholder control with letting management
  run the business
 Common themes:
     Board Representation
     Shareholder Oversight
     Future Capital Requirements
     Commercial Behavior




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Governance – Board Representation



   Size and composition of board of directors
      Who gets to nominate board members?
      Adapt to changes in equity holdings
           “de minimis” level
        Adapt to context (major shareholder position)
           Conflicts of Interest
           Observer status
        Committees
 Quorum for meetings
 Board expenses (travel, fees, etc.)
 D&O Insurance?
 Should a shareholder be deemed to have agreed, as a
  shareholder, by acts of its Board nominee?

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Governance – Shareholder Oversight



 Information Rights
 Effective oversight/veto re certain matters
       Examples include:
          issuing equity
          borrowing money or encumbering assets
          selling assets
          amending constating documents (articles and by-laws)
          entering into agreements with non-arm’s length parties (shareholders,
           employees, etc.)
     Approval process (board, shareholders, class of shareholders)
     Quorum
     Sunset clause



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Governance – Future Capital
Requirements


   Are existing shareholders the first alternative for new money?
   Shareholder loans vs. Equity
   “Pay to Play”
   Should Board be required to pursue third party debt?
   Should shareholders be required to guarantee loans?
   Should shareholders have pre-emptive rights; should certain
    issuances be carved out?
   Should future equity issuances be subject to special approval?
   How should “surplus earnings” be used? Should there be a
    dividend policy?




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Governance - Commercial Behavior



 Do these fit in your Shareholder Agreement? If not, where else?
 Non-competition and non-solicitation covenants
      Confidentiality
      Ownership of IP
      “Reverse vesting” for founder shares
    Lock-up of shares




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Liquidity and Restrictions on Transfer -
Overview


    Two sides of the same coin:
       “Control” the shareholder group with transfer restrictions
         Provide a way to monetize the investment
 Consider the exit horizons of the shareholders (which will differ)
 Standstill
         No third party dealings, no share transfers and no termination
          triggers during an agreed “honeymoon” period




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Liquidity and Restrictions on Share
Transfer


    General prohibition on the transfer of shares
       Permitted transfers – related parties (spouse,
        children), likely company, RRSP, trust, affiliates, etc.
       Pledge of shares in limited circumstances?

    Right of First Refusal/First Offer
         Balance need for liquidity vs. acceptability of new
          shareholders
            ROFR – first obtain offer from third party, then offer
             shares to existing shareholders on same terms
            ROFO – first offer shares to existing shareholders, then
             to offer to third parties on same terms




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Liquidity and Restrictions on Transfer
(cont’d)


    “Tag-along” rights
        Liquidity for minority shareholders
           For all holders?
        Co-sale with Founders?
    “Drag along” rights
      Reciprocal of “tag-along” rights - liquidity for major shareholders
      What are appropriate triggers?
      “Acceptable Consideration”




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Liquidity and Restrictions to Transfer –
Forced Sales


    Events giving rise to forced sale (to corporation or to
     shareholders):
         Bankruptcy or insolvency of shareholder
         Material and continuing breach by a shareholder of agreement
          terms (including enforcement of arbitral result)
         Change of control of shareholder
         For individual shareholders - death or incapacity,
          separation/divorce
         For individual shareholders employed by the corporation -
          termination of employment, convicted of a criminal offence




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Liquidity and Restrictions on Transfer –
General Considerations


 Third party offers: preference is for all cash
 Establish definite time windows for all intra-shareholder steps
 Seller to appoint purchaser as his/her attorney-in-fact
 If seller breaches agreement:
       Transfer void?
       Shares subject to call?
       Penalty price?
    Who is buyer?
       Consequences to seller
       Consider issuer bid provisions, deemed dividends and corporate
        insolvency tests
    What is the price?
       FMV
       “penalty” price

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Liquidity and Restrictions on Transfers
(cont’d)


 What Else?
 What to do if Shareholder breaches the Agreement?
        result different if an employee
    Remedies:
      lose Board nomination right?
      lose voting rights?
      forced sale? (consider appropriate price)




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Liquidity and Restrictions on Transfers -
Valuation of Shares


 Third party transactions
 Agreements between shareholders or the corporation (such as
  forced sale)
      Periodic agreement
      Formula based
      Third party valuator




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Liquidity and Restrictions on Transfers –
Share Valuation Methods


    Periodic agreement
      But, most companies just don’t bother
      “baseball” method
    Formula – based approach
        Asset–based
        Earnings–based
        Industry–specific




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Liquidity and Restrictions on Transfers –
Share Valuation Methods (cont’d)


    Third party valuator
        Conflict of interest
        Who pays?
        Establish guidelines
           Control block premium
           Minority discount
           Insurance proceeds
           Personal services




19
Liquidity and Restrictions on Transfer –
Exit Strategies Overview


    Exit discussions - always difficult
         What is an appropriate exit mechanism?
         Appropriate exit events will differ based on focus of agreement
          (whether designed primarily for governance and/or liquidity) and
          nature of company
         All parties have different time horizons
         Forces the business to address the liquidity deadline
         Define trigger events




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Liquidity and Restrictions on Transfer –
Exit Strategies


 Scheduled exits – frequently tied to trigger events
 Redemption right (subject to solvency tests)
 “Put” right
 Alternative remedies:
       Board control
       Ability to put corporation up for sale
       Joint sale
    Initial Public Offering
         Registration Rights




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Liquidity and Restrictions on Transfers –
Exit Strategies (cont’d)


    Non-scheduled exits - frequently tied to deadlock situations
    Two shareholders
         Shotgun clause
            One shareholder sets a specified price at which it is willing to either sell
             its shares to the other shareholder, or purchase the other shareholder’s
             shares. The other shareholder then has the option of choosing which of
             these alternatives to accept.
            Does not work if there is a financial imbalance between shareholders
         Liquidation
            Either shareholder can initiate the dissolution of the corporation.
    More than two shareholders
         Auction
            Each shareholder makes a sealed bid for all the shares, highest bid wins.
            Does not work if there is a financial imbalance between shareholders
         Liquidation
            Any shareholder can initiate the dissolution of the corporation.



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Liquidity and Restrictions on Transfers –
Exit Strategies (cont’d)


    Term of agreement
        Sunset – i.e. a fixed term or termination on pre-agreed events
           Agreement of all or a specified percentage of shareholders
           One person becoming sole shareholder
           Liquidity event (such as IPO)




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Dispute Resolution



    Address dispute and deadlock situations
      Board level
      Shareholders level
      Tie in with Exit Strategies
 Escalations
 Mediation
 Arbitration
 Enforcement (particularly in international context)




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Further Information



 Geoff Taber – (416) 862-6614 or gtaber@osler.com
 Chad Bayne – (416) 862-4708 or cbayne@osler.com




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