10th January 2020
What is a shareholders’ agreement and does your business need one?
A shareholders’ agreement is a document that governs the relationship between shareholders of a company. It sets out the rights and obligations of the shareholders, sets out what a company can and can’t do and regulates the sale of shares in a company. The agreement is usually drafted so that it dovetails with the articles of association of the company.
It is easy to assume that nothing will go wrong in the future and hopefully nothing will. You might assume that as you have a good working relationship and trust your fellow shareholders, you don’t need a formal document that sets out your working arrangement.
If a situation arises in future where there is a disagreement, although the articles will help to some extent, a well thought through shareholders’ agreement will give individual shareholders more protection. For example, if one shareholder acts dishonestly then there is normally not a lot that you can do to make them transfer their shares unless there are specific provisions contained within the documentation.
If you are going into a new venture with someone, shareholders’ agreement gives you more confidence about your future relationships with them and helps you to avoid costly litigation in future.
Are articles of association not enough protection?
The simple answer here is ‘no’. There are three key reasons why this is the case:
- A shareholders’ agreement works in conjunction with a company’s articles of association but will give shareholders greater protection than can be provided by the articles alone. One reason for this is because companies are often set up quickly and cheaply just with standard articles that will not include much detail regarding protective provisions for shareholders or define the limits or extents of their responsibilities.
- As opposed to articles of association which is a public document made available at Companies House, the shareholders’ agreement will remain private and confidential between the shareholders and will not be open to view by others such as creditors or non-member employees.
- Once in place, a shareholders’ agreement can only be amended with the agreement of all of the shareholders whereas the company’s articles of association can be changed by a 75% majority meaning that a shareholders agreement provides better protection for minority shareholders.
Which businesses should have shareholders’ agreements?
Any shareholder in a company with more than one shareholder should consider the benefits of a shareholders agreement. You can have a shareholders agreement between all of the shareholders or those with certain kinds of shares. Some people will never need to rely on it but it gives the comfort that if it is needed in future, it will be there as a security blanket.
Whilst the shareholders’ agreement is recommended for every company, there are certain situations in which it might be more of a necessity. For example:
- Where an employee is issued shares or granted a share option as an incentive for their loyalty – in such a case you need to ensure that there is a carefully drafted shareholders agreement in place which provides for share transfer provisions to apply if they cease to become an employee.
Example: Restaurant businesses often give some shares in the business to the chef as they know how crucial that particular chef would be for the business and the effect it would have on the business if that chef was to leave. In that case, you would want some sort of provision to make the chef transfer his / her shares over if he did leave.
- ‘Dragons Den’ type scenario – A third party investing money into your business. In such a scenario, the investor will want some control over the company to protect their financial stake.
- A company that offers professional services (solicitors, financial advisers etc.) where a carefully drafted shareholders agreement will contain provisions so that if one of the shareholders is struck off or has their practising certificate terminated, then the other shareholders would be able to force a transfer of that person’s shares.
How does the shareholders’ agreement protect a minority shareholder?
Without a shareholders’ agreement, a minority shareholder (one owning less than 50% of the shares) will generally on their own have little control or say in the running of the company.
Being a minority shareholder and having a shareholders’ agreement that includes the requirement for all shareholders to approve certain decisions ensures that you have a say in the important decisions that impact the company. This allows the shareholders to decide on what is a crucial matter, as to whether key decisions under the Shareholder Agreement itself, should require a ‘majority’ or ‘unanimous’ vote. This could be decisions on:
- the issue of new shares;
- appointment or removal of directors;
- taking on new borrowings; or
- changing the main trade.
A minority shareholder may also want a provision included that if someone is willing to buy the shares of a majority shareholder, that shareholder can only sell the shares if the same offer is made to all shareholders including minority shareholders.
This is often referred to as a “tag-along” provision. This should then ensure that minority shareholders receive the same return on their investment as the other shareholders.
How does a shareholders agreement protect the majority shareholder?
If a majority shareholder wants to sell their shares but a minority shareholder is unwilling to agree then including a provision forcing that minority shareholder to sell their shares is important otherwise the minority shareholder could hold the majority shareholders to ransom. This is often referred to as a “drag along” provision. This will then allow the majority shareholder to realise their investment at a time and price that they feel is appropriate.
Another concern is where a minority shareholder could transfer their shares to anyone. This could cause problems for the other shareholders, especially if the sale is to someone the other shareholders do not want to be involved with the company.
Conversely, however, to force an unhappy shareholder to stay may cause more problems than having a new unknown shareholder who is interested in the company being successful. All the shareholders need to work together for the business to thrive. To overcome these problems, shareholders’ agreements will often include rules around share sales and transfers – who shares can be transferred to, on what terms and at what price.
What clauses can you expect to see in a shareholders’ agreement?
You can expect to see the following clauses in a carefully drafted shareholders agreement:
- Restrictions on share transfers so that you consent to who your fellow shareholders are.
- A requirement that shareholders consent is obtained for all key strategic decisions and expenditure made by the company
- restrictive covenants imposed on a shareholder to stop them from competing against the company after they have ceased to be a shareholder
- Regulations on the day to day running of the company – including appointing, removing and paying directors, frequency of board meetings, deciding on the company’s business, financing of the company.
- Rights and obligations of the shareholder
- Provide an element of protection for minority shareholders
- “Tag along” and “Drag along” provisions mentioned above.
- Dispute resolution procedures
There are several ‘off-the-shelf’ agreements available for free download on the Internet. Shareholders agreement do have many agreements in common, however, it is strongly advisable to have a well thought through agreement drafted to protect the specific situation at hand and the needs of the individual business. For example, a shareholders agreement between two 50/50 shareholders will have very different provisions to one that is seeking to protect shareholdings of shareholders with different proportions.
Every situation requires careful thought and professional advice to ensure that the documentation is suitable for the intended purpose.
Don’t hesitate to get in touch with Sweeney Miller’s commercial solicitors today.