A properly drafted shareholders' agreement protects the
interests of both the controlling shareholders and the minority
shareholders. A shareholders' agreement may contain any number
of specific clauses, rights and obligations. Here, we explore five
of the most common clauses in a shareholders' agreement.
a) Shot Gun Clause
A shot gun clause allows a shareholder to offer to sell his/her
shares to another shareholder at a price and on the terms dictated
in the offer. The shareholder receiving the offer may either accept
the offer and acquire the shares of the offering shareholder at the
price and on the terms stipulated in the offer or reject the offer
which requires the shareholder receiving the offer to sell his/her
shares to the offering shareholder at the price and on the terms
stipulated in the offer. This clause is also referred to as a
reciprocal buy-sell clause. It provides liquidity and control over
who can acquire an equity interest in the company, while providing
an exit strategy for shareholders when specific triggering events
do not apply.
b) Hard Right of First Refusal
In order to protect the rights of shareholders looking to divest
of their interest, as well as those of the remaining shareholders,
shareholders' agreements often contain right of first refusal
clauses. A hard right of first refusal requires a shareholder
looking to divest of their interest to solicit offers from third
parties; they must then present the offer to the remaining
shareholders. The remaining shareholders are then given the
opportunity to purchase the shares at the same price and under the
same terms as the offer presented. Should the remaining
shareholders decide not to make an offer, the selling shareholder
may sell the shares at the price and under the terms stipulated in
the offer. This right typically favours the shareholders holding
the refusal right as a third party acquirer will rarely spend the
time considering a potential acquisition when faced with a
superseding right of first refusal.
c) Soft Right of First Refusal
A soft right of first refusal requires a shareholder looking to
divest of their interest to present a price and term of sale to the
remaining shareholders. If the shareholders holding the right of
first refusal do not elect to acquire the shares at the stipulated
price and under the terms specified within an agreed time period,
the selling shareholder is free to sell his interest to a third
party at a price and under terms no more favourable than those
offered to the remaining shareholders. The soft right of first
refusal typically favours shareholders looking to divest of their
interest. In the event the offer is not accepted by the remaining
shareholders they are free to solicit third party offers without
concern of the rights of refusal of the remaining shareholders.
d) Drag Along Provision
Many purchasers of a privately held company will only finalize
the transaction if it allows them to acquire 100% ownership. In
cases such as these the majority shareholders would not want to see
a deal stalled by one or more minority shareholders who are not
interested in selling their shares. A drag along provision
stipulates that if a third party offer for all of the outstanding
shares of the company is acceptable to the majority shareholders,
all of the shareholders are required to sell their shares at the
price and on the terms dictated in the offer. This provision is
also known as a mandatory sale clause and provides liquidity to the
e) Tag Along Provision
A tag along provision offers the non-selling shareholders the
opportunity to force the purchaser to acquire not just the majority
shareholders' shares but all of the shares. The minority
shareholders' interest would be purchased at the same price and
on the same terms as the majority shareholders. This type of clause
protects the minority by allowing them to sell if the majority is
being sold to an incompatible third party. This provision is also
known as a coattail provision.
In conclusion, in preparing a shareholders' agreement,
business owners ought to be aware of the mechanisms available to
them to protect their ownership interest and the liquidity of their
investment. When drafting shareholders' agreements,
shareholders should consider the potential benefits the five
foregoing clauses may provide.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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