Chapter 5: Company's governance
IN THIS LESSON
If you are working on a transaction that requires shares to be transferred to the buyer from the seller, consider any restrictions from doing so.
Overview
Normally there will be restrictions on a shareholder from transferring or selling their shares held in a private company. The specific restrictions are often found in the Company’s constitution or the Shareholders Deed (or shareholders agreement). If there are restrictions in both of these then consider which document overrides the other if there is an inconsistency between them.
Normally the transfer restrictions won’t apply if a shareholder is transferring or selling their shares to certain ‘affiliates’ or ‘related parties’. You should consider any relevant definitions in the contracts to see whether the party the shares are being sold to falls within these definitions.
Pre-emptive rights
A common type of restriction on transferring or selling shares is called a “pre-emptive right”. A pre-emptive right gives the existing shareholders the opportunity to purchase the shares to be sold or transferred before they are offered to third parties.
There are different ‘types’ of pre-emptive rights, including a right of first refusal and a right of first offer.
A clause outlining a pre-emptive right generally involves the following process:
Notice to other shareholders: The shareholder wanting to sell its shares is generally required to give notice to the other shareholders that it is intending to sell its shares and the number of shares to be sold.
Offer period and notice: The shareholders wanting to buy the shares generally have a limited period of time to make an offer to buy all or some of the shares by giving notice. If an offer isn’t made within this time, then the shareholder loses its right to make an offer to buy the shares.
Offer terms: If an offer is made, the shareholder will set out the terms and conditions of its offer, including the number of shares and the price. This offer will remain open for a limited period of time and the selling shareholder will notify whether or not it accepts the offer.
Selling to a third party: If the selling shareholder doesn’t accept the offer then it can sell the shares to a third party within a certain period. The seller may need to comply with other conditions e.g. a ‘tag along’ right (see below). The sale to a third party will generally need to be on more favourable terms to the seller than the terms offered by another shareholder in the process described above (assuming a shareholder made an offer to buy the shares).
Other considerations
Tag Along Rights
If this right exists, then a third party is required to also purchase the other shareholder’s shares, generally on the same terms as they are buying the selling shareholder’s shares. It gives the shareholder the ability to ‘tag along’ and sell their shares on the same terms. This right would normally apply to ‘minority’ shareholders and allows them to tag along.
There is generally a process that needs to be followed by the selling shareholder to implement the tag along rights of other shareholders.
Normally there is a minimum amount of shares that the selling shareholder proposes to sell (e.g. 50% of the shares) for the tag process to apply.
Drag Along Rights
This grants the majority shareholders the right to force the minority shareholders to accept a sale of the company, even if the minority shareholders do not want to.
Lockup Periods
In the case of an Initial Public Offering (IPO), the issuer will often include a lockup period that limits the transfer of shares for a set period of time. This helps to ensure that the company is not flooded with shares and maintains a stable stock price.
Anti-dilution or a Right of First Refusal
This is a contractual agreement between shareholders and the company that gives the shareholders the right to purchase additional shares in a company before they are offered to other potential buyers.
