As my father once told me, ‘strong fences make good neighbours’. Even if you lived in the house next door to your brother or sister, you would probably want a fence between you to mark the boundary. And in a company context, a shareholder agreement performs much of the same function.
What is a Shareholders’ Agreement?
A clear written understanding of what is expected from each director/shareholder setting out individual roles and responsibilities together with a formula on how to distribute profile, together with an ADR resolution framework, will help to resolve these problems – in other words, a ‘shareholders agreement’.
It is a contract signed by shareholders usually upon their purchase of those shares to regulate their rights and obligations in the Company.
Why is a Shareholders’ Agreement Vital?
Many shareholder disputes arise from one party believing that they are putting more time and effort into the business or another thinking that the other shareholders are acting unfairly. As the shareholders’ agreement clearly defines every shareholder’s responsibility, it can resolve disputes by highlighting who is at fault and the required actions.
What Should You Include in a Shareholders’ Agreement
You should include the following terms and topics in your shareholder agreement:
1. Regulating Investment
Quite often, one person puts in more money than another. Failure to agree on expectations regarding investment can be fatal to a company’s long-term future.
2. Voting Rights
Shareholders’ agreements should define all shareholder rights. Voting rights can dramatically affect company policy and decisions. For example, do shareholders have the power to veto director decisions?
3. Obligations
Shareholders are in a privileged position, meaning they have obligations towards the company to wield their powers in particular ways. Your agreement can define their focus and ensure they act in the company’s interest.
4. Interests
Shareholders’ agreements can clarify everyone’s vision for the company and build a consensus. Without it, the board will lack direction and decision.
5. Restrictive Covenants
Shareholders have sensitive company information that can threaten the business if they leave their position. Implementing non-compete, non-disclosure and other restrictive covenants in your shareholders’ agreement prevents them from using their insight against you.
6. Shares
You must regulate share transfers and payments with the shareholders’ agreement to protect the interest of existing shareholders and bring in new shareholders.
7. Pre-Emption Rights
A shareholder agreement can give shareholders the right to buy issued or transferred shares before they are offered to third parties.
8. Terminations and Exit
If your company winds down or your shareholders want to exit the company, you need a defined process to avoid complex litigation.
9. Deadlock Provisions
If a majority doesn’t exist – e.g. a company run by two people on a 50-50 basis – then a deadlock provision like Texas Shootout or Russian Roulette in a shareholder agreement can prevent catastrophe.
What are the Risks of Not Having a Shareholders’ Agreement?
As with any relationship, a share purchase without a shareholders’ agreement leaves both the company and the shareholders open to huge issues.
Disagreements
Litigation is expensive for any party, though it can be easily prevented with clear terms and procedures in a shareholder agreement. Conflicts are almost inevitable when running a business; the process can settle them quickly and affordably.
Lack of Protection for Minority Shareholders
When making crucial decisions about the company, minority shareholders are often overlooked if the shareholders’ agreement does not establish voting rights.
Reduced Power of Majority Shareholders
Big decisions, such as a company sale, are often complex in the absence of a shareholders’ agreement. The company can miss lucrative deals if they face opposition and the shareholders’ agreement does not establish powers to force it through.
Problems Surrounding Shareholder Exits
Your agreement should have ‘good’ and ‘bad’ leavers provisions to control share buy-backs. Without one, the company cannot force out shareholders if required.
Will a Shareholders’ Agreement Overrule the Articles of Association?
The Articles of Association will override a shareholders’ agreement. However, shareholders and directors can adapt the Articles of Association to agree with the Shareholders’ Agreements. You should seek legal assistance to edit the Articles when signing a Shareholders’ Agreement.
How to Draft a Shareholders’ Agreement
You must carefully draft a shareholder agreement to cover every aspect of your company. Follow these steps:
1. Instruct Commercial Solicitors
You should always instruct an experienced Commercial Solicitor to draft your shareholder agreement to ensure it is legally binding and achieves your objectives.
2. Decide on Covered Issues
The first essential step is deciding which issues to include in your agreement. The nine mentioned above are essential starting points.
3. Establish the Shareholders’ Interests
The decision to invest is serious, and shareholders have many motivations. They may want to continue employment as a director due to the benefits and pay, receive more dividends, influence company actions and maintain business relations with the company’s clients and suppliers.
4. Value the Shares
You need to value your company to issue shares. You can value the business in many ways, none of which will provide a definite valuation. Every shareholder you take on will value things differently and emphasise various company assets. Always consult an accountant.
5. Identify the Decision Makers
Battles between shareholders and directors can run companies into the ground, and boundaries must be established.
If a shareholder acts as a director, they can have conflicting interests with the other shareholders. Your agreement should define the decisions that a director-shareholder can and cannot make.
6. Establish Voting Rights
Finally, you must decide how your shareholders will vote and the powers of each shareholder. You may include veto clauses.
Instruct Our Solicitors
If you are experiencing a disagreement with any of your shareholders and would like a second opinion, please contact our shareholder dispute solicitors, and we can offer our guidance.
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