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15 September, 2021 | Peter Smith
Reference to the FMCA is useful because the issues of shares in a company to people who have been employees is regarded as being part of an employee share scheme. The FMCA requires all employees entering into employee share schemes to sign off an acknowledgement or warning that:
The Companies Act is the act of parliament that sets up a government department called the Companies Office. The Companies Office and the Financial Markets Authority regulate the running of companies. The Companies Act also prescribes the rules for companies and in particular the rights of shareholders.
The rights of shareholders may be modified or altered by virtue of the Shareholder Agreement for the Company and/or its Constitution.
The basic rights of shareholders however are:
It is important that prospective shareholders in a company understand the difference between shareholders and directors. While shareholders in a company are the owners of a company, their role is a passive role, as apart from the right to approve major transactions, shareholders do not have a role in the management and strategic planning of a company.
Management and strategic direction is under the control of the directors. It is the directors that prepare the strategic plan, the business plan, financial budgets and forecasts, manage relationships with employees and make sure that the company completes is statutory obligations in terms of tax returns, GST returns, health and safety, etc.
While shareholders can vote for the directors of the company, they do not automatically have a seat at the board of directors of the company. In many instances minority shareholders have no right to be directors or to vote for the appointment of directors.
Because the Companies Act specifies that the rights of shareholders may be amended or modified by virtue of the Constitution and the Shareholders Agreement of the Company, it follows that there may be in a company, various classes of shares all with different rights.
There may be, for instance, voting shares where the shareholders holding those shares have the right to vote at shareholder meetings and the right to appoint and remove a director. There may also be non-voting shares where the holders of those shares do not have the right to vote at shareholder meetings of the company or the right to appoint a director. It is usual however that all shareholders have an equal right (proportionate to their shareholding) to the pool of money available for payment by way of dividends – although there may be more than one separate pool of money from which dividends to the various classes of shareholders are paid.
The Constitution is a generic document that covers off things such as:
A Shareholders Agreement is a prescriptive document that is unique to each company. There is some cross over with the company’s Constitution from the point of view that the Constitution often has a clause confirming that the Shareholders Agreement of the Company is the pre-eminent document and takes precedence over the Constitution. A Shareholders Agreement often repeats for the sake of clarity the details of the shareholders in a company and the pre-emptive provisions should a shareholder wish to leave the company.
Shareholders Agreements generally cover off the following matters:
The Shareholders Agreement should set out the roles and responsibilities of the working directors and working shareholders.
The profits from which dividends are paid, are calculated after the remuneration paid to working directors and working shareholders. This remuneration and the expenses able to be claimed together with the “perks” for working directors and working shareholders must be transparent and details of how the remuneration, expenses and perks are calculated should be set out in the Shareholders Agreement.
The Shareholders Agreement should set out the dividend policy for the company. A standard dividend policy for instance is that dividends representing 75% of after tax profit are to be paid as dividends.
There is always a list of things that cannot be done in a closely held company without the consent of all shareholders, or at least a substantial majority of shareholders. These include:
These are just four examples of the do’s and don’ts that are set out in a Shareholders Agreement.
Shareholder Agreements will often set out the rules relating to how to exit a company in terms of the period of notice to be given and how shares are to be valued. There may be a minimum period during which shares must be held before they can be offered for sale.
Traditionally, employees who become shareholders are often financed into the shareholding by the company. It may be for instance that there is a minimum period during which they must hold their shares before those shares have any value so that if the employee leaves the company ahead of time, then they forfeit their shares without payment.
There will always be confidentiality clauses in a shareholder agreement under which shareholders pledge to keep the information and business details of the company confidential.
If it is important that shareholders not be able to take away the intellectual property and trade secrets of a company and set up in opposition, then there is often a restraint of trade clause preventing shareholders doing just that for a period of time after ceasing to be shareholders.
The above covers the main points that are set out in shareholder agreements.
Entry by employees as, shareholders of a Company, is often done in two or more steps, by way of an example, a two-step path to shareholding is as follows:
Step One
A certain number of shares would be issued to each of the employees which shares would have no voting rights. The value of the shares would be lent to the shareholders by the company and repaid out of dividends.
Step Two
Once the loan by the company to an employee/shareholder for the purchase of shares had been repaid and the shareholder was fully conversant with and committed to the business of the company, then the directors would invite the shareholder to take a further block of shares in the company with together with the shareholders existing shares would be converted to full voting shares. Whether that shareholder was invited to be a director of the company would depend on the skills and management competencies displayed by that shareholder.
We anticipate that this article assists with a better understanding of company law insofar as it affects employees proposing to become shareholders of a company, and the matters covered by constitutions and shareholder agreements.
If you’re looking to buy shares in a closely held (private) company, are starting a new company or need assistance with a shareholder’s agreement or any business law related advice, contact expert Commercial Lawyer, Bret Gower by phone on +64 9 837 6893 or email bret.gower@smithpartners.co.nz