Why do you need a shareholders' agreement?

As you start a business venture with friends or family, it is tempting to assume that you will always be able to resolve any issues that arise…

As you start a new business venture with friends or family, it is tempting to assume that you and your colleagues will always be able to resolve amicably any issues that arise. The unfortunate reality is that people fall out. Without appropriate legal documents to address these issues, such a fall-out could have significant detrimental consequences, not just for the stakeholders in dispute, but for the business itself. 

How can you protect yourselves?

If you’ve decided to run the business through a company, you should put in place an appropriate legal framework of properly tailored articles of association and a complementary shareholders’ agreement. Many of the disputes which typically arise between shareholders can be avoided or resolved quickly if there are documents in place which deal with the issue. 

What is a shareholders’ agreement and who needs one?

It is a private arrangement between the shareholders of a company (and, often, the company itself), which regulates the parties’ relationships with each other. Unlike the articles of association, a shareholders’ agreement does not ordinarily need to be filed at Companies House. Shareholders’ agreements are useful for any company with more than one shareholder, but particularly where different shareholders are to be treated differently, where there are complicated shareholder arrangements, or where the company is owner-managed or family-run. 

What does it do?

It can save money, time and distress. It will typically specify procedures, protections and controls around issues such as decision-making, ownership and dispute resolution. Some of the issues that it would typically cover include:  

Reserved matters

Whilst strategically critical decisions can be decided by a simple majority of the directors, shareholders’ agreements commonly contain a list of important matters that require the consent of a particular shareholder(s) before they can be undertaken by the company. For a shareholder who has invested heavily, this is an important safeguard.

Restrictive covenants

How would you feel if a key shareholder manager was able to resign and set up in competition nearby after only a few months? A shareholders’ agreement may include covenants by the shareholders preventing them from, for example, competing with the company’s business, or poaching customers or staff both while they hold shares and for a period of time after they cease to hold shares.

Dispute resolution

What happens if there is a dispute between shareholders? What if the company is managed by an even number of individuals and has become deadlocked? Such circumstances can cripple a business. A shareholders’ agreement can provide a mechanism for resolving any dispute between the parties, ensuring that any resolution is kept confidential and, consequently, avoiding the expense of full litigation.

Defaulting/departing shareholders

What happens if a shareholder manager is no longer pulling his/her weight in the business? Should (s)he continue to receive dividends? Would you be happy to pay them? What happens if a shareholder dies and his/her shares pass to his/her estate? Do you want to be in business with the deceased’s spouse? A formal agreement may require the compulsory transfer (often to the other shareholders) of an individual’s shares should (s)he cease to be an employee (for any reason) or should (s)he breach the terms of the agreement. The price for the transfer can sometimes be covered by the proceeds of an insurance policy, which pays out on the death of the shareholder.

Composition of the board

A shareholders’ agreement may entitle investors to appoint directors, to ensure that their views are taken into account when the board takes business decisions.

Drag & tag along

Shareholders’ agreements may contain provisions to prevent (i) a minority shareholder ending up in business with someone they don’t know; or (ii) a majority shareholders who wishes to sell being thwarted by the minority. “Tag-along” rights protect minority shareholders by obliging a selling shareholder to procure that anyone acquiring control of the company makes an offer to all shareholders on the same terms. “Drag-along” rights enable certain shareholders to “drag” others into a sale process with them and thus guarantee to the buyer the acquisition of the entire company.

In the early enthusiasm of running a new business, few wish to consider what will happen if the relationship breaks down. Our experience tells us that disputes take longer, and cost more, to resolve if there is no written agreement in place. We can advise you how to limit that risk and protect your interests appropriately.

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