The Importance of a Shareholders’ Agreement
Having a well-drafted shareholders’ agreement in place not only documents the understanding between shareholders in relation to particular matters, which can provide certainty, but can also provide shareholders with better protection in the unfortunate event of relationships deteriorating.
So what is a shareholders’ agreement?
A shareholders’ agreement is a contract between the shareholders of a company, and more often than not, the company itself, which sets out agreed matters between them such as how shares can be transferred, how dividends are payable, non-compete restrictions and exit plans, amongst other things. It gives the shareholders personal rights and imposes personal obligations on the shareholders.
The agreement can provide protection to minority shareholders and majority shareholders, regulate the transfer of shares, impose restrictions, govern decision-making, and much more.
It is also very easy for individuals to go into business together and to hit the ground running without thinking about what happens to the company if there is a major disagreement. Despite good intentions, there will be times during the life of a company where disagreements occur. A shareholders’ agreement can include a dispute resolution procedure which can be utilised if relationships have broken down, and which will give the parties a structured plan in stressful circumstances.
However, it is important to ensure that the company’s articles of association are consistent with the shareholders’ agreement to avoid uncertainty or conflict and ensure adequate remedies are available in the event of a breach of the provisions. Together, the articles of association and the shareholders’ agreement regulate and govern the running of the company, the relations between the company and its directors & shareholders. Below are a few common questions often asked when discussing the benefits of a shareholders’ agreement.
Below are a few common questions often asked when discussing the benefits of a shareholders’ agreement.
Why should the shareholders have an agreement?
Some of the main benefits of a shareholders’ agreement are:
- In the event of a dispute occurring, a well-written shareholders’ agreement can provide a dispute resolution procedure to be followed, with the intention of resolving disputes swiftly in order to protect the company’s business. A shareholders’ agreement may also prevent a dispute escalating as
the provisions may assist in clearing up any misunderstanding between the parties.
- Share transfer provisions, such as pre-emption rights (the right of first refusal), compulsory transfer provisions (deemed transfer of shares in certain situations) and permitted transfers (the ability to transfer shares to family members or intra-group).
- It can include specific policies in relation to the declaration of dividends, providing for certain levels of dividend to be declared, certain reserves to held or different policies that apply to different classes of shares.
- It can offer protection to minority shareholders, such as providing for matters that require the consent of minority shareholders or “tag along” rights in respect of any sale of shares by the majority shareholders allowing the minority to “tag” on to that sale.
- It can also offer protection to majority shareholders, such as the ability to oblige the minority shareholders to sell their shares if an offer is received for the entire share capital of the company and they wish to sell.
- It can detail agreed provisions relating to the management of the company at the director level, which helps to provide clarity and consistency regarding the day to day running of the company. For example, detailing matters that would require the consent of the shareholders or allowing specific shareholders to appoint directors.
- It can impose restrictive covenants on the shareholders, restricting their ability to be involved in any business that competes with the company’s business or provides services to the clients of the company or engages suppliers.
- It can provide for what will happen where consent to certain matters require the consent of two or more parties and such consent is not forthcoming. As a result, the inaction may adversely affect the company’s business. Deadlock provisions can be included in an agreement which provides the mechanics of how the deadlock will be resolved, usually by providing that the parties can buy each other’s shares.
- It can impose confidentiality restrictions on the parties to the agreement to protect valuable information that is key to the company’s business, both whilst the parties are involved in the company and after.
- The process of drawing up a shareholders’ agreement requires the shareholders to address many provisions and scenarios, such as what happens if a shareholder wishes to transfer or sell his shares or passes away, exit strategies, and how shares would be valued in different scenarios. On a practical level, this engages the shareholders to discuss, consider and agree with each other an acceptable position in relation to such matters which, in doing so, focuses minds and minimises the risk of disagreement in relation to such matters in the future if and when they arise.
- It can include provisions that relate to commercially or financially sensitive matters which are not appropriate to be included in the articles of association of the company (which is a publicly available document).
- The agreement can also demonstrate that the shareholders have planned ahead and have acknowledged that disputes may arise, but have attempted to address how such disputes would be handled to minimise disruption and detriment to the company and its business. Having such foresight can create a good impression if the company is seeking finance or investment from third parties.
What are the risks of not having a shareholders’ agreement?
Some of the main risks of not having a shareholders’ agreement are:
- If things don’t work out as planned, difficulties can arise without a clear exit strategy for shareholders.
- Shareholders who leave their employment with the company may be able to retain their shares, which is often commercially undesirable.
- Minority shareholders are forced to rely on statutory rights which, in practice, may be cumbersome and expensive to enforce.
- Minority shareholders may be able to block a sale.
- If there is a deadlock situation and no resolutions either at director or shareholder level, draconian measures such as winding up the company may be the shareholders’ only option, which can be extremely time-consuming and expensive.
- Shares are, at law, freely transferable unless the articles of association of a company, or any relevant agreement between shareholders, prevents this. So without appropriate share transfer restrictions, the shares are at risk of transfer to unknown parties.
- Reliance on common law confidentiality obligations which may be more difficult to enforce.
- Departing shareholder’s ability to set up a competing business, poach employees or suppliers.
- The directors may be able to take decisions of the company which the shareholders would want to be involved in, such as excess capital expenditure, acquisitions or sales of other businesses or assets, making or receiving loans or other financial commitments.
What are the benefits of seeking legal advice on a shareholders’ agreement?
It is always advisable to seek legal advice on the terms of any legal agreement.
It is often the case that the risks lie with what is not in the agreement rather than what is.
The terms of a shareholders’ agreement and the articles of association of a company are very much tailored to a company’s share and management structure, and the company’s future plans. The agreements are not “one size fits all” and receiving advice appropriate to your company circumstance is imperative to avoid creating more problems than the agreements solve.
We can negotiate and draft all terms of a shareholders’ agreement and articles of association on your behalf. We have vast knowledge and experience in drafting both simple and complex agreements and articles to suit your needs. Getting the right legal advice at the right time can help to keep your business running smoothly in order to achieve long-term success.