The importance of a shareholders’ agreement – especially for employee shareholders

Dave was the sole shareholder and director of a small software company with two employees, married couple Julie and Sam. Julie and Sam were both hard-working, loyal employees, and after attending a small business seminar Dave decided to reward their loyalty by offering them shares in his company. Julie and Sam were keen to take up his offer, and the company issued them each a 20% shareholding.

As time went on, the business picked up some major clients on the strength of some innovative software solutions and began to grow rapidly. A larger company became interested and approached Dave with an offer to purchase the company that was too good to refuse.

Dave was keen to accept the offer, retire comfortably and move to a smallholding in the Wairarapa. However, he found himself in a difficult position. Sam had moved on some time ago to another company, but had remained a shareholder as Dave had never thought to discuss purchasing his shares.

Julie, meanwhile, knew that the larger company intended to disestablish her position. In order to protect Julie’s position, Sam and Julie both refused to sell their shares to the larger company, and the parties found themselves at a stalemate. Dave was going to have to put his retirement plans on hold for the time being. Further, because Sam was now refusing to sell back his share, Dave realised that he would have to remain as a shareholder even though he was no longer an employee.

Employee ownership is something that is being actively encouraged overseas, and is already seen in some major New Zealand companies as a way of rewarding employees and enhancing employee loyalty. However, it is important that company directors think very carefully about drawing up a shareholders’ agreement before offering employees any such arrangement.

In Dave’s situation, he could have included in his shareholder agreement that any employee would cease to be a shareholder if he or she was no longer an employee. He could also have included a ‘drag-along’ clause, which would have enabled him to force the minority shareholders to also sell their shares to a third party purchaser.

There are other important matters that can be covered in your shareholders’ agreement, which can be found in our: Shareholders’ Agreement Checklist 

If you would like to discuss a shareholders’ agreement for your company, contact us on (04) 4736850.