What is a Shareholders’ Agreement and does my business need one?

Contract for Shareholders Agreement

What is a shareholders’ agreement?

A shareholders’ agreement is, as you might expect, an agreement between the shareholders of a company. Its purpose is to protect the shareholders’ interest in the company, to establish a fair relationship between the shareholders and govern how the company is run. It will contain specific, important and practical rules relating to the company and the relationship between the shareholders. It will complement the company’s articles as well as giving additional protection to shareholders. This can be beneficial both to minority and majority shareholders.

Does my business need one?

If you own shares in a small or medium-sized business, the answer is almost certainly yes.

Setting up a new business, or carrying out a restructure of an existing one, is a hugely exciting undertaking and there’s always lots to think about. When first starting out it’s hard to imagine what might go wrong, especially if you are going into business with friends or family. So, although it’s not a legal requirement to have a shareholders’ agreement, putting one in place right from the start gives you the opportunity to set out in writing how you want your company to be run.

Crucially, the agreement can provide defined processes to follow, depending on how the business develops. For example, if it’s a great success and you have the opportunity to sell the whole business; or if things don’t go according to plan the shareholders’ agreement can set out a pre-agreed exit strategy.

What should I include in my shareholders’ agreement?

Unlike the articles of association and special resolutions, a shareholders’ agreement does not need to be filed at Companies House. So, in addition to having a defined process for dispute resolution and demonstrating the good governance and stability of your business, a shareholders’ agreement allows the company to retain an element of privacy regarding its internal workings and the relationship between the shareholders.

There are certain key elements that you should consider when putting together a shareholders’ agreement. It’s a good opportunity to sit down with all the shareholders and think about how you want your company to be run. Of course, it’s impossible to plan for every eventuality so it’s important to have a checklist. Some of the key topics you might wish to include are explained below.

  • Shareholder power

    Generally, the day-to-day running of a company is left to the board of directors. However, the shareholders may believe that there are certain decisions that should not be left to the discretion of the directors and instead require shareholder approval, particularly if there are directors who are not shareholders. For example, you may require a director to get the approval of shareholders before obtaining further investment.

  • Appointing directors

    The fall-back position for appointing a director is a 51% majority of the shareholders. However, it’s not always in the best interest of the business that the remaining 49% of the shareholders do not have a say in who runs their company. So, a shareholders’ agreement may state that a majority of 75% is required, thus allowing a much higher proportion of shareholders’ interests to be taken into account.

  • Dividends policy

    One of the main concerns of a shareholder will be how they will receive a profit from the company they have invested in. A shareholders’ agreement should therefore set out how shareholders will be paid their share of the profit. This is of vital importance if your shareholders hold varying classes of shares, which have different dividend rights attached to them. Setting out this process in writing in your agreement will prevent any disputes arising when dividends are paid.

  • Protection for majority and minority shareholders

    It’s not unusual for a company to have majority and minority shareholders. Where this is the case, the shareholders’ agreement should set out how both sets of shareholders’ interests will be protected in certain circumstances when unanimity between all shareholders is needed:

    • Protection for minority shareholders

      The Companies Act and the company’s articles do provide some basic protection for minority shareholders. However, a shareholders’ agreement can provide additional protection by stating that certain decisions, such as the ability for the company to issue further shares, can only be made with the unanimous consent of all the shareholders. The agreement may also contain ‘tag along’ provisions; these enable a minority shareholder to ‘tag on’ to a majority shareholder in a share sale situation where the majority attempt to sell only their shares rather than seeking to find a buyer for all the shareholders.

    • Protection for majority shareholders

      On the flip side, provisions can be included to protect majority shareholders, for example to prevent minorities from blocking key decisions and resulting in the company being stagnant. Additionally, ‘drag along’ provisions will usually operate where an offer is received to buy all of the shares in a company and the majority shareholders wish to accept that offer. These rights allow the majority to force the holders of the remaining shares to accept the offer on the same terms so that they do not scupper the deal.

  • Provisions for ‘good’ and ‘bad’ leavers

    One of the main issues to consider when putting a shareholders’ agreement in place is what should happen if one shareholder wants to leave the company. You may not want the shareholder who leaves to be able to sell his shares to anyone. This could leave you and the remaining shareholder(s) running a company with an unknown shareholder. Therefore, it’s important to set out a defined process for the sale of leavers’ shares. Usually, this is a provision in the agreement which requires the shares to be offered to the remaining shareholders first. It’s also a good idea to include ‘good’ leaver and ‘bad’ leaver provisions. These will dictate at what price a leaver’s shares will be sold to the remaining shareholders. For example, a ‘good’ leaver may be a retiring shareholder, and so may sell their shares back for market value, whereas a ‘bad’ leaver, who is being terminated, could be forced to sell their shares either at market value, or for the price they paid for them.

  • Non-compete clauses

    Non-compete clauses allow shareholders to formally exclude any shareholders from creating companies which directly compete with the company while they are a shareholder. Such a provision will often continue in force for a certain time after the individual ceases to be a shareholder of the company.

Are there any disadvantages?

There’s no doubt that for the vast majority of businesses, a shareholders’ agreement has many advantages. However, it’s worth considering the few disadvantages to this type of contract before you proceed:

  • Less flexibility
    Having a contract in place for how shareholder relationships and the company are governed can be seen as preventing the company from being run in a flexible way.
  • Increased minority shareholder protection
    This can be seen as a disadvantage to the majority shareholders who own the highest proportion of shares in the company, as it allows the minority further protection than in the articles. However, including ‘drag along’ provisions in the agreement (as described above) will ensure that a minority shareholder cannot block the sale of the business.
  • Harder to amend a shareholders’ agreement
    Generally, in order for a shareholders’ agreement to be amended, it requires all of the shareholders to agree. Whereas, amending the articles usually only requires 75% to agree.

There is no doubt that a shareholders’ agreement is an important and useful tool for a company to have in its armoury: to set out its stall and also to protect individual shareholders. Once in place, the agreement should be reviewed periodically to check that it still operates in the way the company and the shareholders wish, and also to enable updates as your business develops and shareholders come and go.

Please note that this article is for information purposes only and does not constitute legal advice. If you would like further information or to talk to one of our business advisers about drawing up a shareholders’ agreement, please contact us.

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