In the first part of our series on “Introduction to shareholder’s agreement”, we present to you the clause on Board of Directors.
A start-up and/or SME’s board of directors is likely to be constituted of its founder(s) and investors. Yet an enterprise, be it a start-up or SME, needs to determine the board composition. This means determining the number of members in the board, names of members to be appointed, mechanism of appointment, and rules for non-executive directors.
The board of directors is responsible for the management of the business and the corporation. Therefore, the shareholder agreement should facilitate a board representation that is in the best interests of the stakeholders of the venture or enterprise.
Appointment by election
Towards this, the agreement should provide for an election mechanism as a standardized method to add more directors as the venture grows. The agreement should lay out the rights for investors such as family and friends with specific shareholding interests so they can make appointments to the board.
Usually, board appointments and removals require a majority of shareholders (i.e. 51%) to allow effective control of the company. However, this means that a minority shareholder (i.e. 49%) will not have the right to representation on the board. Looking out for their interests, a shareholder agreement allows a minority shareholder the right to appoint a director as long as they hold a minimum percentage of shares (e.g. 25%).
Meeting and decisions
The agreement should provide the shareholders to agree on one or more independent directors – someone not affiliated with any shareholder – to break any deadlock in strategic decision-making and voting.
The shareholder agreement may also prescribe the minimum frequency of Board Meeting during a fiscal year. It provides for a board member to call an ad-hoc meeting after giving a notification in advance of predefined days. For the first few years of incorporation, the agreement could provide for a meeting as frequently as monthly. To save the members any inconvenience, the agreement could be flexible with the mode of attendance and allow telephone or audio-video internet conferencing.
Rights and powers
The shareholder agreement vests the board of directors with some rights and power. These include
- Determining the terms and price of issuing the “Issued Shares” to the shareholders
- Passing resolutions such as Special Directors’ Resolution, Unanimous Directors’ Resolution, at a properly constituted board meeting and either unanimous or majority consent by the signatures of all the directors of the Company
- The election, appointment, and determination of officers, the auditors, and advisors, defining their duties, functions, and remuneration
The agreement can empower the board to conduct its proceeding with a quorum of just two directors.
The board of directors’ are entrusted with approving management’s recommendations about the future direction of the corporation. This is a huge responsibility given its ramification on the success and longevity of the corporation. The shareholder agreement sets the precedent for the organisation of the board of directors to question the management about the strategic choices. This way it assigns the board the responsibility and accountability for its company’s strategy.