A shareholders agreement is a private contract between a company’s shareholders. It sets out how the company runs, the rights and obligations of its shareholders and how shares are managed. Although shareholders’ agreements are not legally mandatory, they are strongly advisable for any business that wants to run smoothly. A well-drafted shareholders’ agreement tailored to your specific needs protects both you as a business and your shareholders from disputes and gives the company a strong internal structure that matches your objectives.
A shareholder’s agreement is essential for any company which has two or more shareholders, whether it’s a family company, two or more friends going into business together, or a business with external investment.
Below, we will list out the main benefits and protections a shareholders’ agreement can provide, and the issues that can transpire from not having one.
Stronger protections for shareholders outside the articles of association:
Articles of association are legally required for any business operating in England and Wales. They regulate the internal aspects of the company, such as voting rights and how directors are appointed. A shareholders’ agreement sits alongside the articles and provides further protections that are not covered in the articles.
The articles of association are publicly available on Companies House, which means anyone can view them. On the other hand, shareholders’ agreements remain private as an internal agreement between the shareholders who have signed it. This means your company’s confidential information, such as dividend policies, are kept away from the public eye.
Shareholders' agreements also protect the interests of both majority and minority shareholders in light of the sale of shares:
Tag along rights – aim to protect minority shareholders. If majority shareholders want to sell their shares, tag-along rights allow the minority to join the sale at the same price and terms as the majority shareholders. This protects minority shareholders from being pushed aside in a sale.
Drag along rights - allow the majority shareholders to force minority shareholders to sell their shares, so that a buyer can buy all that shares in the company. Having these rights in place can prevent a minority from blocking from a sale, which overall promotes a smooth business transaction.
Pre-emption rights – require a shareholder who wants to sell their shares to offer them to other shareholders before offering to sell to outsiders. This is a way of keeping shares within the company with established shareholders rather than someone else.
Leaver provisions – this sets out what happens to a shareholders’ shares if they leave the company, for example through retirement, resignation or death. These provisions make sure that when a shareholder does leave, they sell their shares back to the company and can set a price for their shares depending on how they left.
‘Good leavers’ are those who leave the company through no fault of their own, such as through retirement. They would receive a fair market value for their shares and may even get to keep some of them.
‘Bad leavers’ are those who have acted in bad faith towards the company, for example, breaching the shareholders’ agreement. They would be compelled to sell their shares at a lower value than a good leaver.
This provision overall helps the company protect its ownership and share structure.
Decision-making and resolving deadlocks:
Shareholders agreements set out how key decisions are made, also known as ‘reserved matters’. These reserved matters can’t be made without shareholder approval and include, altering company’s articles, allotting new shares, approving new directors and changing the company’s name. This allows the voices of majority and minority shareholders to be heard.
Additionally, shareholders agreements help to avoid future conflicts by setting out pre-agreed terms and agreements to resolve a deadlock (where votes are tied). These can include giving the chairperson a casting vote at board level, or passing the issue to a mediator, which allows an independent third party to help resolve the conflicts without bias. Without such mechanisms in place, the business could be incapable of making any further decisions and could be at risk winding up.
Internal structures tailored to your business:
Having a shareholders’ agreements in place offers your business a more refined and tailored agreement that fits the aims and aspirations your business and shareholders have. They can deal with the following:
- Dividends – how the profits of the business get split amongst shareholders and what profits get put back into the company.
- Restrictive covenants – stop shareholders from poaching any clients and employees of the business, both while they are a shareholder and for a period after.
- Appointment rights – what rights the shareholders have regarding appointing and removing directors.
- Transfer rights – how and to whom shareholder can transfer their shares, and any restrictions on this.
- Confidentiality provisions – these can prevent shareholders from disclosing the company’s private information, such as its intellectual property.
Binding new shareholders:
Shareholders’ agreements need the approval of all those who have signed it when a new shareholder is joining the company. When this approval has been made the new shareholder must sign a deed of adherence under which binds the new shareholder to all the terms and conditions of the existing shareholders’ agreement. This creates a consistent structure for the business by ensuring that all shareholders, new and old are held to the same rules, which protect the businesses structures and keep ownership secure.
What might happen if you do not have a shareholder agreement:
If you choose not to have a shareholders agreement, your company will only be governed by its articles of association and the Companies Act 2006, which can leave the business and its members unprotected in many areas. This can include:
- Shareholder disputes arising due to the lack of pre-agreed terms,
which could lead to very costly disputes that will take time away from the progress of the business. Inevitably any exit without a shareholder’s agreement will be more costly and take more time to resolve.
- When shareholders leave no matter the reason, they could keep hold of their shares and take from the business despite no longer being a part of it.
- Without a shareholders’ agreement a shareholder may be able to sell shares to anyone. This could mean the wrong people get involved in your business leading to a possible breakdown in relationships and / or a loss of control.
- Deadlock can happen where there is a 50:50 split and no one holds an overall majority. If there is no agreement, the business could be unable to make any decisions. This could potentially lead to litigation or even the company winding up.
Having a shareholders’ agreement in place can prevent these major risks from affecting your business. Our expert commercial and corporate legal specialists can draft and negotiate shareholders’ agreements for start-ups, SME’s and large businesses. Contact us today on 0161 696 6170 if you want to set up a shareholder’s agreement.
Blog author: Santana Schmool
Comments