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Proprietors Agreement

 

This is the title of any agreement used by IGS to document the relationship between the Proprietors of:

  • a Company (a "Shareholders Agreement");

  • a Partnership (a "Partnership Agreement"); or

  • a Unit Trust (a "Unit Holders Agreement").

 

Purpose of Agreement

The purpose of a Business Proprietors Agreement is to:

  • regulate the management of all companies, trusts and other entities involved in the Business;

  • specify Special Majority requirements with respect to important management issues;

  • minimise dispute with respect to management issues;

  • specify dispute management procedures; and

  • regulate the terms upon which Proprietors may exit the Business or sell their Equity (including options to purchase and valuation issues).

 

Multiple Business Entities

It is common for many Businesses to use a combination of different Business Entities.

For example, in the case of a professional practice, there might be a Partnership, a Unit Trust and a Company Trustee.

The standard IGS Proprietors Agreement documents the relationship with respect to all of the entities, not just a single entity.

The Business Proprietors’ Agreement deals with equity in any companies and related entities (e.g., trusts), so that the standard fee applies to agreements for more complicated structures than a simple company structure.

The standard IGS Agreement also devotes more attention to terms of exit than most standard agreements and it dovetails in with the Business Insurance Trust Agreement.

 

Questionnaire

IGS uses a standard Questionnaire to obtain instructions with respect to the requirements of the Business.

IGS will supply a Fixed Legal Fee Quotation upon receipt of the completed Questionnaire.

Please contact IGS to obtain a copy of the Questionnaire.

 

Interaction with Business Succession Agreements

The purpose of a Business Succession Agreement is to deal solely with the last of the issues dealt with by a Proprietors Agreement.

If you have a Business Succession Agreement, it does not mean that you have a fully-fledged Proprietors Agreement.

By the same token, if you have a Proprietors Agreement, it does not mean that you have an adequate legal strategy to deal with your Succession Plan and your Insurance Arrangements.

In most cases, you do not.

Click here to read about why.

 

ISSUES REQUIRING SPECIAL CONSIDERATION:

Tag and Drag Along Rights

The standard IGS Proprietors Agreement contains Pre-emptive Rights that require a Proprietor who wishes to sell their Equity to offer to sell it to the other Proprietors, before they can try to sell it to a Third Party.

The Pre-Emptive Rights are drafted as a Call Option that enables the Purchasers to force the Vendor to sell their Equity on the terms specified in the Agreement.

The standard Agreement also contains "Tag and Drag Along Rights" that might be triggered when a Proprietor wishes to sell their Equity to a Third Party (subject to the other Proprietors' Pre-emptive Rights).

These rights apply if a pre-defined percentage or number of Equity Holders (the Vendors) wish to sell their Equity to a Third Party.

“Tag Along Right”

A Tag Along Right gives the other Equity Holders the right to “tag along” or participate in the sale to the Third Party on the same terms and conditions as the other Vendors.

This prevents them ending up in business with the Third Party against their will.

Example

Assume that a company has four equal shareholders.

Three of the shareholders (totalling 75% of the company) (A,B and C) receive an offer from a Third Party to purchase their shares.

The fourth shareholder (D) declines to exercise its Call Option, which would have enabled it to purchase the 75% of the company that it doesn't already own.

The reason might be that D doesn't wish to borrow the funds necessary to pay the Purchase Price.

Instead, D believes that if the other three shareholders are selling their shares, it would like to as well.

This would give the Third Party ownership of 100% of the company.

The Tag Along Right prevents A, B and C from selling their shares to the Third Party, unless the Third Party purchases D's shares on the same terms.

“Drag Along Right”

A Drag Along Right gives the Vendors the right to “drag along” the other Equity Holders in their sale to the Third Party.

This right forces the other Equity Holders to participate in the sale of 100% of the Equity in the Business to the Third Party, potentially against their will.

The sale would occur on the same terms and conditions as the other Vendors.

Example

Assume that a company has four equal shareholders.

All four of the shareholders receive an offer from a Third Party to purchase their shares.

In this case, the Third Party wants to acquire 100% of the company.

Three of the shareholders (totalling 75% of the company) (A,B and C) wish to accept the offer from a Third Party.

The fourth shareholder (D) doesn't wish to sell its shares to the Third Party.

As a result, it has the power to frustrate a sale to the Third Party.

Again, D declines to exercise its Call Option, which would have enabled it to purchase the 75% of the company that it doesn't already own.

The Drag Along Right gives A, B and C the right to force D to sell its shares to the Third Party on the same terms.

This would give the Third Party ownership of 100% of the company.

Threshold Equity Holding

The Agreement needs the parties to specify an agreed Threshold Equity Holding, which will trigger the Tag and Drag Along Rights.

For example, it would not be normal for an Equity Holder with only 25% of the Equity to force Equity Holders with 75% of the Equity to sell their Equity against their will.

Normally, the Threshold Equity Holding would be at least 50%, so that a majority is forcing a minority to sell their Equity.

Two Equal Proprietors

Care has to be taken if there are only two equal Equity Holders.

Should one Equity Holder with 50% be entitled to force the other Equity Holder to sell to a Third Party?

If the parties didn't want the Tag and Drag Along Rights to apply now, they could specify a percentage higher than 50% (e.g., 66%, two-thirds or 75%).

Three Equal Proprietors

The situation is more straightforward if there are three equal Equity Holders.

If they specified a Threshold Equity Holding of 66%, it would mean that, if two out of three Equity Holders wanted to sell their Equity to a Third Party, then:

  • they could drag the other Equity Holder along in the sale to the Third Party (against the will of the third Equity Holder); and

  • the other Equity Holder could tag along in the sale of 100% to the Third Party.

Other Proportions

Where there are more Equity Holders or they have different holdings of Equity, it's important to examine each of the various combinations that could or should give rise to the desired threshold.

 

Special Resolutions and Majorities

The standard IGS Proprietors Agreement gives the Proprietors the ability to set a number of alternative levels of majority for decisions about different important issues.

Two Proprietors

Where there are two equal Proprietors, then effectively every decision must be unanimous.

One Proprietor could not carry the vote against the other Proprietor.

If their Equity is unequal, then the issue is whether the majority Proprietor can prevail over the minority Proprietor in all circumstances where there is a difference or disagreement.

What decisions are important enough to require unanimous agreement?

Three or More Proprietors

It is particularly important where there are three or more equal Proprietors to determine what issues:

  • must be resolved unanimously; or

  • may be resolved by a majority of more than 50% but less than 100% (e.g., two Proprietors versus the third Proprietor).

It’s also important that the Proprietors consider the relative importance of different commercial issues.

Again, some decisions might require unanimous agreement. Others might require a lesser percentage.

 

Restraint of Trade

The Common Law allows a restraint of trade where a departing Proprietor is paid a Purchase Price for the Equity in the Business Entity that includes an amount attributable to the goodwill value of the Business.

However, the restraint must still be reasonable in scope (both territory and duration).

It will always be necessary to determine what restraint is reasonable in the circumstances.

Territorial Restraint

The territorial scope of the restraint will partly take into account where the Business Entity acquires its Clients from.

Time Restraint

This issue can involve slighty different considerations to the restraint that might apply to an employee.

The departing Proprietor will often have received a payment for their share of the goodwill of the business.

A restraint of trade is appropriate to protect the Proprietors of the business from the risk that, having paid a price for the goodwill, the departing Proprietor does not undermine that capital investment by setting up in competition with the original business and eroding its goodwill.

The time restraint can take into account any multiplier used in determining the goodwill of the business.

For example, if the goodwill is based on a multiplier of three times profit, then a restraint of thre years might be appropriate.

If a multiplier of one was used, then it would be difficult to justify a restraint of three years.

 

Profit Distribution Policy

The standard IGS Proprietors Agreement allows you to specify what differential Salaries, Bonuses and other Remuneration will be payable to the Proprietors and deducted from the Profit of the Business before its Net Profit is determined.

The Net Profit will normally be distributed in proportion to the amount of Equity.

If there are different classes of Equity, it might be appropriate to specify the priorities between the different clases.

Silent Partners

A detailed Profit Distribution Policy might be appropriate where there is a Silent Partner.

A Silent Partner is still entitled to share in the Net Profit of the Business, notwithstanding that they might not:

  • Work in the Business; or

  • Receive a salary.

On the other hand, the other Proprietors do work and are entitled to be paid before the Net Profit is determined.

Any salary and other remuneration payable to them effectively reduces the Net Profit of the Business (which is distributed proportionately).

High remuneration might reduce the level of Net Profit that is available for distribution to the Proprietors.

Thus, it is desirable that there be agreement on how salaries, bonuses, incentives and other remuneration are calculated.

 

Minimum Performance Criteria

The standard IGS Proprietors Agreement allows you to specify the minimum performance criteria of Proprietors (or Related Parties) who are employees or provide services to the business, the breach of which might:

  • constitute a breach of the Proprietors Agreement; and

  • trigger an Option to Purchase (or Call Option).

The standard Agreement does not purport to be an Employment or Service Agreement.

Thus, it is not intended to set out employment terms like sick leave, annual leave and long service leave.

However, some breaches of an Employment or Service Agreement might be serious enough to trigger an Option to Purchase.

Silent Partners

Where  there is a Silent Partner, it’s important that any criteria recognise that the performance criteria might not apply to the Silent Partner.

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

The standard IGS Proprietors Agreement documents the relationship with respect to all of the entities, not just a single entity.

See more Adviser Tips

 

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Current Marketing Schedule

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