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What should a shareholders’ agreement contain?

When entrepreneurs decide to set up a business and form a company, it’s easy to be optimistic about the future. After all, remaining upbeat is a critical component of success. However, amid all the excitement, it’s easy to neglect one critical aspect of company formation, and that’s how to regulate the day-to-day relationship between the founders as they operate the business, and what to do in the case of a disagreement. Putting in place a shareholders’ agreement at the beginning, however simple, is a relatively easy way to ensure that you are both aligned when it comes to decision-making, how disagreements are handled, and how your valuable investment can be safeguarded.

What is a shareholders’ agreement?

A shareholders’ agreement is a contract between the shareholders of a company that works together with the company’s Articles of Association and the general law to determine the rights and duties of shareholders.

When a company is first set up, shares will be issued (these shares represent a share in the value of the company as represented by its assets). For a limited company that’s issued ordinary shares, each share comes with the right to a single vote on company affairs.

However, it’s important to note the difference between the powers of shareholders and directors when it comes to running the business. Being a shareholder doesn’t automatically give someone the right to make decisions about the day-to-day running of a business, for example what goods and services the company will provide, whether the company buys property or borrows money – these decisions are taken by the board of directors.

So, directors operate the business, the shareholders own the business, and the Articles and general law give the shareholders certain rights to control the company and the way the directors operate, for example, who can be a director and how they are appointed. Often, with small companies, the directors and shareholders are the same people.

Despite the fact that the directors run the business, shareholders who own more than 50% of the shares can, in effect, control most decisions a company makes because of their oversight of the directors and the company. And shareholders who own 75% of the company’s shares have absolute control.

Because some shareholders may not be happy with this arrangement, particularly if they have a minority of the shares, they may nevertheless want some say in the way the company is run. And 50/50 shareholders may want to decide in advance what to do if they can’t agree on an important matter relating to the company’s business.

The way to regulate this relationship between the shareholders, and by implication, the relationship with directors and the company (that is a legal person in its own right), is via a shareholders’ agreement. A shareholders’ agreement is, in effect, all about control.

What is the purpose of a shareholders’ agreement?

A shareholders’ agreement is a contract in which the parties agree to use their votes in a certain way to regulate the way a company is run and give a degree of control to shareholders who might otherwise be put at a disadvantage.

Here are some examples of the purpose to which a shareholders’ agreement could be put:

  • Shareholders who are not directors of the company may want a say in decision making. They may have made a large investment in the company and want to protect that investment as much as possible by having a say
  • Very small companies, for example those with only two shareholders who are also directors, may want to ensure that decisions of the company are only taken by unanimous vote and decide in advance what happens if that’s not the case. Without a shareholders’ agreement, if the shareholders/directors disagree and hold 50/50 shares, the company is ‘deadlocked’ and can’t make a decision
  • Minority shareholders who, ordinarily, would not have much (or any) say in the way the company is run may nevertheless want the right to veto certain decisions of the board (for example, major changes of business direction, company mergers or acquisition or sale of company property)
  • The agreement will also control the way (and the price at which) shares can be issued, sold or transferred
  • It will also ensure that company business is kept confidential and restrict leavers’ ability to set up competing businesses

So, the purpose of a shareholders’ agreement is to distribute control more fairly between a company’s owners, each of whom may have made different contributions to the company.

It can:

  • Modify the decision-making ability of directors and shareholders
  • Protect the rights of minority shareholders who otherwise might have little power over the running of the business
  • Avoid disputes between shareholders escalating because there is already an agreement in place that regulates what to do in the case of a disagreement
  • Put in place a process to follow when a shareholder wants to sell their shares or dies

Is a shareholders’ agreement necessary?

A shareholders’ agreement isn’t essential, but unless you own 100% of the shares of a company it is highly desirable to put one in place when the company is formed.

What is included in a shareholders’ agreement?

A shareholders’ agreement can contain any provision the parties to it feel necessary.  Typically, however, they contain clauses dealing with the following issues:

Decision-making and the board of directors

Because, ordinarily, shareholders have little say in the running of a company unless they are directors, there is the potential for differences of opinion between themselves and the board. If shareholders wish to be more involved in the company, a shareholders’ agreement can, for example, give them the right to veto certain decisions, participate in discussions relating to major issues such as business strategy, acquisitions and disposals, financing etc. It can also enable them to receive regular updates on business matters such as the right to receive copies of the business plan. The shareholders’ agreement may also dictate how and when directors’ and shareholders’ meetings take place, quorum and voting arrangements.

Another area where shareholders commonly want some control is over the appointment and dismissal of directors, and directors’ pay and benefits, particularly since this can affect the amount of profit that can be distributed to members as dividends. The agreement may also deal with how and when dividends will be paid.

Shares

A shareholders’ agreement will usually contain provisions that deal with the transfer of shares if a shareholder dies, becomes bankrupt or retires from the business, including a pricing mechanism so that a fair sale price can be agreed. In addition, there will be restrictions on who a shareholder can transfer their shares to – generally, small companies don’t want third parties becoming involved in the business by way of a share transfer. If a shareholder wishes to sell, this may only be with director approval, or the other shareholders may be given the right of first refusal over the shares being sold. It will usually also cover what happens if new shares are issued.

There may also be provisions called ‘drag’ or ‘tag’ along clauses that may force a shareholder to sell their shares if the majority agree to sell the business, or conversely that enable a shareholder to sell along with the majority at the price agreed.

Capital

Shareholders have no obligation to provide financing to the company beyond the price they pay for their shares. However, especially if a company is a start-up, a shareholders’ agreement can sometimes provide that the shareholders be invited to participate in the financing of the company, for example as working capital.

Disputes

Particularly if a company is owned 50/50, a shareholders’ agreement may contain provisions dealing with how disputes are resolved, and if they are unable to be settled amicably, how, for example, a shareholder may exit the company.

Confidentiality and restrictive covenants

A shareholders’ agreement will usually contain provisions requiring directors and shareholders to keep confidential all matters relating to company business. In addition, it may contain provisions preventing shareholders starting competing businesses or dealing with customers of the company.

Does a shareholders’ agreement override articles?

No, a shareholders’ agreement will not override the Articles – if there is a conflict, then the articles will prevail. However, it is possible to provide in the shareholders’ agreement that should a conflict arise, then the shareholders and directors will act together to change the Articles so that they agree with the provisions of the shareholders’ agreement.

The best way to avoid a conflict is to seek legal advice from an experienced corporate solicitor when drafting your shareholders’ agreement so that the Articles can be changed at the same time as the shareholders’ agreement is signed, if this is necessary.

How do you draft a shareholders’ agreement?

The best way to draft a shareholders’ agreement is to ask a lawyer to draft this for you, as they will ask specific questions designed to help you work through different options, depending on your particular circumstances.


What next?

For more answers to commonly asked questions and advice on shareholders’ agreements, deadlock and company disputes, consult our corporate solicitors. Get in touch on 0800 689 1700, email us at enquiries@hjsolicitors.co.uk, or fill out the short form below with your enquiry.

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