Shareholders’ Agreements

7 May, 2010

When you are setting up a company and working hard to make it profitable it is easy to overlook the need for a Shareholders’ Agreement regulating your relationship with the other shareholders.  When everyone is optimistic about the future, it is hard to imagine that one day you may not all be in agreement or that one of you may want to withdraw and sell your shares.

 
What is a Shareholders’ Agreement? Why should your company have one?

A Shareholders’ Agreement regulates the relationship between the shareholders of a company and will normally, among other things, provide a framework within which the company is to be run and detail exit routes for shareholders.  The aim is to discuss, and put in place, procedures early in the relationship so that any disputes can be dealt with in a manner which avoids lengthy, stressful and costly litigation. 

 

The need for a Shareholders’ Agreement is even greater if there are an even number of shareholders each with equal rights because a “deadlock” could occur i.e. a position where the shareholders cannot agree on the best way forward and there is not a sufficient majority to pass a resolution.  The agreement should therefore provide procedures to follow in the event of a deadlock situation.

 

If a shareholder holds less than 50% of the voting shares of the company, they will be a minority shareholder.  Without protection from specific clauses in the company’s Articles of Association or a Shareholders’ Agreement, shareholders holding 75% or more of the shares will have almost complete control of the company and the board of directors.  The Companies Act 2006 provides limited protection to minority shareholders whose position has been prejudiced, but this involves recourse to the courts and can be both expensive and uncertain. 

 

What’s the difference between Articles of Association and a Shareholders’ Agreement?

 

 Articles of Association  Shareholders’ Agreement
 Have to be filed at Companies House and are on the public record  Private and confidential document that does not have to be publicly disclosed
 Governed by company law and binding on all members of the company  An agreement between the members of a private limited company who have signed up to it and is governed by contract law
 Can be changed by a resolution requiring approval from 75% of the shareholders  Can be altered and/or terminated by agreement rather than having to comply with the formalities of the Companies Act
 Personal rights and restrictive covenants are not valid if contained in the articles  Personal rights, unenforceable in the articles, are binding on all parties to the agreement

 

What is usually found in a Shareholders’ Agreement?

The following provisions are typically found in a Shareholders’ Agreement. However, this is not an exhaustive list of issues which could be included within a Shareholders’ Agreement and other points can be covered if relevant to the company in question.

• Restrictions on the transfer of shares;
• Mechanism for calculating the value of the shares if they are sold;
• Provisions regulating the resolution of disputes;
• Management issues e.g. who can appoint and remove directors, what is the maximum and minimum number of directors, how decisions will be made;
• Minority Protection Provisions – a list of items which cannot be changed (e.g. company name, type of business or limit on borrowing) without the written consent of all or a specific percentage of the shareholders.  These prevent the minority from being excluded from the management and decision making process of the company, ensure that they receive sufficient information about the company and prevent any interference with their rights; and
• Restrictive covenants and confidentiality provisions for existing and exiting shareholders.

 

Is there anything else you should think about?

• To provide the surviving shareholders (or the company) with the funds to buy a deceased shareholders’ shares it may be worth considering taking out insurance policies on the lives of each shareholder.
• When the shareholders are also the directors of the company it is easy to confuse shareholder issues with management issues which are dealt with by the board of directors.  In addition to a Shareholders’ Agreement, directors’ service contracts should also be put in place.
• If a new shareholder is joining the company, they will need sign a document by which they agree to become a party to the Shareholders’ Agreement.

 

Why should you have a Shareholders’ Agreement?

Most people have come across a company in which there is in-fighting and have seen how much damage can be done to the value and goodwill of the company by such a dispute and the associated costs in both time and professional fees.  Thinking about, discussing and agreeing a course of action in relation to these issues before troubles develop is likely to save you time and money and safeguard the interests of the company as a whole and your interests as a shareholder.  The question is “Can you afford not to?”

 

Reviewed in 2015