Why Every South African Business Needs a Shareholders Agreement

When a company is formed, its founders usually share a vision, trust one another and want to move quickly. That is precisely the moment to agree what happens when circumstances change: a shareholder wants to leave, another dies or becomes incapacitated, new investors arrive, or the founders can no longer agree on the direction of the business.

01The MOI and the Shareholders Agreement

Under the Companies Act 71 of 2008, a company's Memorandum of Incorporation (MOI) is its founding constitution. It is filed with the Companies and Intellectual Property Commission and is therefore accessible to third parties. A shareholders agreement is a private contract between the shareholders, which allows commercially sensitive arrangements to stay confidential.

The two documents must work together. Section 15(7) provides that a shareholders agreement must be consistent with the Act and the MOI, and any provision that is inconsistent is void to the extent of the inconsistency.

The lesson is simple: draft the MOI and the shareholders agreement together, and amend the MOI at the same time as the agreement wherever the two need to align. A promise to amend the MOI later may not be enforced.

02The Clauses That Prevent the Most Costly Disputes

Share transfers and new share issues

The MOI of a private company must restrict the transferability of its shares. A shareholders agreement typically sets out how that works in practice: a right of first refusal for existing shareholders, how the price is determined, and which transfers are permitted without consent. On new share issues, section 39 gives shareholders of a private company a right to subscribe in proportion to their holdings unless the MOI provides otherwise.

Drag along and tag along rights

A drag along right allows a majority that has agreed to sell the company to require the minority to sell on the same terms, so that one holdout cannot block a sale. A tag along right protects the minority by allowing it to join a sale by the majority on the same terms.

Deadlock resolution

In a company with two equal shareholders, deadlock is a real risk. Without an agreed mechanism, the outcome may be litigation, and in serious cases a court may order a solvent company to be wound up where its directors are deadlocked. A shareholders agreement can provide for escalation, mediation, expert determination or a buy out mechanism instead.

Leaving the business

Good leaver and bad leaver provisions determine what happens to the shares of a shareholder who resigns, is dismissed or breaches the agreement, and at what price. A buy and sell arrangement, often funded by life or disability cover, allows the remaining shareholders to acquire the shares of a shareholder who dies or becomes disabled without the business carrying the cost.

Reserved matters, funding and dividends

The agreement can list decisions that require approval by a specified majority of shareholders, such as issuing shares, taking on significant debt or selling key assets. It should also address whether shareholders must fund the company, on what terms, and the policy on distributions, which remain subject to the solvency and liquidity test in section 4 of the Act.

Restraints and dispute resolution

Reasonable restraints of trade and confidentiality undertakings protect the business if a shareholder leaves. A clear dispute resolution clause, usually providing for confidential arbitration, keeps disagreements out of public court records.

03When to Put One in Place

The best time is when the company is formed. The next best time is now, and in particular before bringing in a new shareholder or investor, before a significant capital raise, or when the founders' roles in the business begin to diverge. An existing agreement should be reviewed whenever the shareholding changes and checked for consistency with the current MOI.