EveryMonth (April 2011): Drafting Articles of Association – Holding the Aces

Drafting the Articles of Association is one of the most important legal issues when setting up a company, but there is a way you can make it easier for yourself. When you brief your legal adviser, you are likely to have the same key objectives in mind that most business owners do;

  • You want to protect your own position and safeguard the time, effort and money you have invested.
  • You need flexibility so you can incentivise key people with equity. But you need to have the authority to deal with underperformance or disloyalty if you have to.
  • You want a simple, flexible structure that you understand and that will not be an obstacle to future milestones.

The key to making sure the Articles achieve your objectives is to make sure you keep hold of the four ‘aces’:

Ace 1: Technical knowledge, customer & team relationships

Not a legal point at all, but crucial and easy to overlook. Maybe you sell a highly technical product that only you or a small team understand or perhaps your sales and marketing skills are critical. In some businesses, managing relationships with major clients may be key. Once you have worked out the fundamental dynamics of these business and relationship issues, you and your advisers will know how strong (or weak) your commercial position really is.

Ace 2: Voting control at Shareholders’ Meetings

Holding a majority (50.1% minimum) of the votes that can be cast at a shareholders meeting is key in order to be able to remove and appoint Directors. Since it is the Board of Directors who manage the affairs of the Company this is very important.

Ace 3: Voting control at Board Meetings

The Board of Directors manages the business of the Company and a key power is to terminate the employment contracts of staff including employed-shareholder-Directors – having a majority of Directors upon whose judgement and loyalty you can rely could be crucially important.

Ace 4: Chairman’s casting vote at Board Meetings

If the Board of Directors is deadlocked on any issue (that is the votes are split 50/50), the Chairman can exercise a casting or second vote.

Other key points to keep front of mind

Drag Along right

When you decide to sell your shares, you will need the ability to deliver 100% of the company to a buyer. If you say nothing in the Articles then the general company law position is that if you hold 90% of the company (and the shares are all one class) then a buyer of all of your shares can also compel the other shareholders to sell. However, this statutory procedure can be cumbersome, costly and difficult to implement.

What you need is a Drag Along Article – under this, if a specified percentage of the shares are sold to a third party, the remaining shareholders can be forced to sell their shares at the same price.

Buy-Back rights on employee-shareholders leaving

Your right to insist that leavers sell back their shares will be an important point. You need to set a “probationary period” which might be from one to three years or more from when the employee acquired their shares. During this period the shares can be bought back at the price paid. After that date the shares can only be bought back at their fair value.

Removing Directors

The Companies Act 2006 includes a special procedure for removing a Director. Following this procedure if you are not the only shareholder, or all shareholders are not in agreement, will take 28 days or more. A wait of this duration could threaten the survival of the Company and in such a situation an Article that allows the holders of 50.1% of the voting shares to remove any Director may be key.