It’s easy to imagine that nothing can go wrong when starting or running a business with friends or family members. In this situation, mutual trust is generally assumed - but that may not be enough in the event of future disagreements. Without a shareholders’ agreement in place to establish the terms of the business relationship, a potential dispute can turn into a legal issue that both parties would prefer to avoid.
In this article, we will look at what a shareholders’ agreement is, what it can cover - and whether your business should have one.
What is a shareholders’ agreement?
A shareholders’ agreement is - as the name would suggest - an agreement drawn up between a company’s shareholders. The agreement sets out clear rules about how the company should be run, and the specific nature of the shareholders’ business relationship. Typically, it will establish:
- Shareholders’ rights and obligations
- How important decisions should be made
- How company shares are sold or transferred
- Protection for minority shareholders (eg. those that own less than 50% of the shares)
Without this agreement, minority shareholders may otherwise have little or no influence over the company as key decisions are usually determined by the majority. A shareholders’ agreement can be designed to ensure that the approval of all shareholders must be sought for certain decisions (such as capital expenditure over a certain amount) regardless of the percentage amount owned by each.
Of course, there are many benefits for majority shareholders as well. An agreement can dictate whether and to whom minority shareholders can transfer their shares - ensuring that such a transaction would be in the interests of all shareholders.
For equal 50-50 shareholders, a shareholders’ agreement is always a very sensible investment as it can also set out provisions for dispute resolution. Without this agreed method of handling future disputes, the shareholders can reach an impasse over a disagreement, causing the business to grind to a halt.
Putting a shareholders’ agreement in place
A shareholders’ agreement is best established as early as possible when forming the company and issuing the first shares. If it's put off for long, there's a greater chance the lack of clarity could lead to conflicts or disputes between shareholders. If you've already been running the business for a long period of time, it can also be challenging to establish terms that satisfy all the necessary parties and work to benefit everyone's interests.
At the outset of a new business, the shareholders’ goals and expectations should hopefully be in alignment, and putting mutually beneficial terms down in writing can be a positive, reaffirming experience.
The process of creating an agreement can even work to strengthen the relationship between the shareholders, as it may encourage them to discuss possibilities they hadn’t previously considered. This can lead to a much greater understanding of each other’s values and priorities, and pave the way for a strong future running the company together.
What does a shareholders’ agreement cover?
The exact contents of an agreement will differ according to the unique needs of each business and its shareholders, but some typical provisions include:
1. Setting the rules for issuing and transferring shares
It may be prudent to include provisions preventing minority shareholders from transferring their shares to a competitor or other undesirable third party. It may also include the ability for the remaining shareholders to acquire the shares of an exiting shareholder on them ceasing to be an employee/ director of the company.
2. How the business is to be run
This might include appointing and removing directors, scheduling board meetings, banking and financial arrangements, strategic business decisions, and more.
3. How dividends are paid
This should also cover what proportion of profits are to be paid out as dividends each year.
4. Dispute resolution in the event of a disagreement
This might include referring disputes to a third-party mediator or arbitrator, or it might set out the terms by which one party could buy out the other.
5. Provisions for the benefit of minority shareholders
This includes factors such as ensuring that certain types of important decisions have to be agreed by everyone regardless of their proportional ownership.
6. Clarifying what happens in the event of a shareholder’s death
This is another important aspect of a shareholders' agreement which should not be overlooked.
7. 'Tag along’ or ‘drag along’ stipulations.
A tag along provision means that an offer to buy a majority holder’s shares must also be offered to all other holders, thus protecting the investment of minority holders. By contrast, a drag along provision states that if a majority holder wants to sell their shares (an external buyer is only likely to want to acquire 100% of the shares), all other holders have to agree and sell theirs for the same price and on the same terms.
Shareholders’ agreements for different situations
While the above outline is fairly typical, there's no prescribed format for a shareholder’s agreement. Every business and its shareholders is unique, and the agreement can contain as many or as few provisions as is necessary.
It isn't always necessary for a shareholders’ agreement to be signed by all of the business’s shareholders. Depending on its contents, it may only be relevant for certain shareholders and not affect the others.
Each shareholder will enter into the agreement voluntarily - they cannot be forced to sign. The exception to this is new shareholders who invest at a later stage and are required to sign a deed of adherence to an existing shareholders’ agreement.
A deed of adherence provision is a common element of shareholders’ agreements, and it ensures that any new shareholders have to agree to the same terms as all of the others. This will usually need to be signed before any transfer of shares takes place.
Shareholders’ agreements and articles of association
Shareholders’ agreements can have some overlap with a business’s articles of association, and these two documents should dovetail together. However, a key difference is that the articles of association are a public document, and the business’ shareholders may wish to keep some of their arrangement as a private matter. In this situation, a well-drafted and confidential shareholders’ agreement is a sensible investment. An experienced solicitor will be able to work with you to help you decide which provisions ought to go in which document, and to ensure that there are no inconsistencies between them.
In conclusion, a shareholders’ agreement is a vital legal document for many businesses and can protect the interests of both majority and minority shareholders. It allows the shareholders to each come to a mutually beneficial understanding at the outset and protect their investments - no matter what.
About the Author
Chris Brightling is Head of Corporate & Commercial Law at Girlings Solicitors - a law firm in Kent offering Corporate & Commercial, Debt Recovery, and other business law services. With nearly 140 years of experience providing business, personal and not-for-profit legal support, Girlings is one of the largest and oldest law firms in Ashford, Canterbury and Herne Bay.