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Why it’s so important for you to have a shareholders’ agreement

Recently, we sat in a meeting with a key business client, their accountant and lawyer. Over the years we have worked closely in lots of different areas, and this time the topic for discussion was ‘putting a shareholders’ agreement in place’.

A shareholders’ agreement is a vitally important legal document which all limited companies should have in place. However, the reality is that very few do!

When establishing a company with family or friends it is easy to assume that nothing can go wrong in the future. As you trust one another you may think that there’s no need to put a formal shareholders’ agreement in place. Or, perhaps you think that asking for such an agreement will make it sound as if you don’t trust your business partners?

In many cases, nothing goes wrong and businesses function well. However, even friends and family members can fall out. If this happens, you could end up with nothing or in a protracted and acrimonious legal dispute with former colleagues.

As a business owner, having a shareholders’ agreement is key. We’ll explore why.

What is a shareholders’ agreement?

A shareholders’ agreement is an agreement between the shareholders of a company. It can be between all or, in some cases, just some of the shareholders; for example, those who hold a particular class of share.

The aim of the agreement is to protect the shareholders’ investment in the company, to establish a fair relationship between the shareholders and to govern how the company is run.

The agreement:

  • Describes how the business will be run
  • Sets out shareholders’ rights and obligations
  • Defines how important business decisions will be made
  • Regulates how shares in the company are sold
  • Provides an element of protection for both majority and minority shareholders.

When should a shareholders’ agreement be put in place?

Generally speaking, it is a good idea to put a shareholders’ agreement in place when you form your company and issue the first shares. Doing it at this stage ensures that everyone understands their own rights and responsibilities as a shareholder.

However, investors may want to postpone the implementation of a shareholders’ agreement until the company is up and running. However, in our experience, while clients have every intention of returning to it at a later date when there is more time, something else always takes priority!

What should a shareholders’ agreement include?

The contents of a shareholders’ agreement will depend on the number of shareholders and their respective shareholdings. However, the key elements to include are:

  • How shares are issued and transferred
  • What happens to shares on the death of a shareholder
  • How a shareholder can sell shares
  • Provisions to prevent unwanted third parties acquiring shares
  • Any ‘tag-along’ or ‘drag-along’ provisions (see below)
  • How dividends are paid
  • Protection for minority shareholders, including the requirement for certain decisions to be agreed by all shareholders
  • How the company is run, including appointing and removing directors, financing the company, how often board meetings should be held etc.
  • Dispute resolution procedures.

What issues can a shareholder agreement help you to tackle?

  1. Protection

In many cases, the ownership of the business is not split equally between each party. Many businesses have minority and majority shareholdings.

A shareholders’ agreement can be drafted in a way that protects minority shareholders from being outvoted and having significant changes made to the company against their will.

Many shareholders agreements contain ‘tag along’ and ‘drag along’ rights, which can protect both minority and majority shareholders’ interests in various circumstances:

  • ‘Tag along’ – enables certain shareholders (often minority shareholders) to force other shareholders who wish to sell their shares to procure an offer for the shares.
  • ‘Drag along’ – enables the majority shareholders to force the minority shareholders to sell their shares to a third-party who makes an offer to acquire all shares in the company.
  1. Dividends and payments

When you own your business, you have lots of options in how your company profit is distributed. This will often also depend on the type of shareholding someone has.

It’s important to decide on this process early so that shareholders know where they stand and to help you avoid potential future conflicts.

  1. Confidentiality

Your shareholders are likely to have access to confidential information about the company because of their involvement in the business.

Whilst the law provides that a person who has received information in confidence cannot take unfair advantage of it, most shareholders are not prepared to rely on this alone.

A shareholders’ agreement containing confidentiality provisions is therefore the best way for your company to ensure that shareholders keep information about the agreement and the company confidential during the life of the agreement and following its termination.

  1. If you fall out

However close you are with friends or family when you set up your business, you may fall out with shareholders in time. And, disputes between shareholders can be time-consuming and expensive and may impact on the running of the business.

Even if this is hard to foresee at the outset, it can pay to plan ahead by drafting a shareholders’ agreement that sets out how any disputes will be dealt with.

Such an agreement can include provisions that set out a mechanism for the parties to resolve disputes without having to resort to dissolving the company. A shareholders’ agreement will therefore often include valuation provisions to ensure a clear valuation mechanism for those shares and avoid a further dispute regarding the price to be paid.

Get in touch

If you need further advice regarding the issues raised here, please, get in touch. Email hello@sovereign-ifa.co.uk or call us on 01454 416653.

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