Home Business Company Law Why Does Your Business Need a Shareholders' Agreement?

Why Does Your Business Need a Shareholders’ Agreement?

An effective shareholders agreement can protect against disputes between your company’s shareholders and directors.

A shareholders’ agreement is a private contract between some or all of the shareholders in a company, governing how the shareholders interact with the company, as well as with each other.

Any company that has shareholders should have a properly drafted shareholders’ agreement that details the rules for how the company is owned and operated.
Regardless of the size of the company or the number of shareholders, it is sensible to draw up an agreement at the company formation stage so that the roles and rights of the shareholders have in the company are clear, as well as the ownership of shares and what should happen in the case of a dispute.

Shareholders’ agreements are particularly useful in smaller companies, where the shareholders may also be company directors. The agreement should provide protection for the rights of minority, majority and equal shareholders, particularly where these are not detailed in the company’s Articles of Association.
Unlike Articles of Association, a shareholders’ agreement is not a legal requirement. However, they offer many benefits in respect of risk management and commercial certainty.

And as a private document, you may be able to use your shareholder agreement to deal with points you wish to keep private and out of the Articles of Association, which are publically available via Companies House.

What should a shareholders’ agreement include?

As there are no legal requirements for what to include in a shareholders’ agreement, they are very flexible and can be tailored to suit your business. There are several points that a good agreement should cover, though, as this will help to guide you through any disputes and ensure the smooth-running of the company.

Some of the key things that you should consider including in your shareholders’ agreement are:

  • Dispute prevention. It is sensible to have, in writing, procedures that would help to prevent disagreements from occurring between shareholders and directors. Some of the things it may cover are; what happens should a shareholder wish to transfer their shares (and to prevent any unfair personal gain), or what happens if a shareholder were to die in service.
  • How to resolve disputes. If a dispute does arise, there should be clear guidance set out in the shareholders’ agreement on how the dispute should be settled.
  • Shareholder voting rights. What can shareholders vote on and how much are their votes worth? Common things that shareholders can vote on include changes to the company’s structure, appointments of directors, or anything that could change the value of their share ownership. You can also choose whether to issue one vote to each shareholder to keep votes fair or allow one vote per share held which would give those holding a greater number of shares more voting power.
  • Decision making. Where does the decision-making power lie; with the shareholders, with the directors or both? It is wise to include which decisions can be made by who, such as limiting directors’ abilities to change the nature of the company or its assets without shareholder agreement.
  • Rights to remove or appoint directors. There are two ways in English law to appoint or remove directors of a private company. This is either through appointment by the board of directors or through an ordinary resolution of the shareholders. Your shareholders’ agreement should detail which way directors can be appointed or removed.
  • Protecting minority shareholder rights. In cases where important decisions about the company are being made, it may be a requirement that a unanimous vote is reached. This enables minority shareholders to have a say in the company without being overruled by majority shareholders.
    Dividend policy. It is sensible to include the dividend policy in your agreement as well as any dividend waivers as this can have an impact on the value of the shares and the tax the company pays.
  • What to do in the instance that a shareholder dies. Unfortunately, this scenario can arise, and it is prudent to have in place guidance on what should happen to the shares of a shareholder who dies in service. Usually, the estates of the deceased are transferred to their family, but this may not be suitable for shares in your company as it could leave you with someone unknown having a say in how your company is run. It is usual that in cases such as this, that the deceased’s shares are either bought back by the company or are offered to the other shareholders to buy.
  • Non-compete clauses. Non-compete clauses protect your company from your shareholders working with or for the competition whilst in your service or for a predefined time after they leave your company.
  • Share dilution. When companies are looking to raise capital (often, to either acquire something new or to pay a debt), they can issue new shares to prospective buyers. This has the effect of diluting the existing shares’ worth. Shareholders’ agreements should include clauses that help to prevent this from happening and that in cases where additional capital is required, funds should be found by alternative means.
  • Share value and shareholder interests. It is advisable to put in place measures to protect share value and shareholder interests. It can be the case that there are conflicts of interest between those running the company (directors and management) and the shareholders. Therefore it is important for shareholders to vote in a board of directors who will help to protect shareholder interests in the day-to-day running of the company, as well as driving forward the value of the company and thus the shares.

This list is not exhaustive and professional advice should be sought when drafting your own shareholders’ agreement so that clauses relevant to your business are included.

How does a shareholders’ agreement help a minority shareholder?

By holding the majority shares in a company, you usually have a controlling interest. This means that you can make decisions without a unanimous vote. However, most shareholders’ agreements have some sort of clause to protect the interests of the minority shareholders which for the most part works well at ensuring fairness. However, this can be a hindrance when a decision needs to be taken but a minority is preventing this from happening.

A common example of this is if the majority wish to sell their shares to an outside party (usually another company interested in acquiring the business), but they are prevented from doing so by the minority. For this decision to be taken without a unanimous vote, a ‘drag along’ clause is included in the shareholders’ agreement that means that minority shareholders have to sell their shares should the majority wish to. They are entitled to receive the same rate as the majority shareholders in this case.

Drafting a shareholder agreement for your company’s needs

Seek legal advice on your specific circumstances to take the most effective approach to shareholder agreements and Articles of Association.

As with any legal agreement it is recommended that you seek legal advice when drafting your documents. Not only does this ensure that every major eventuality is covered and mitigated for, but it also ensures fairness for the company and shareholders.

Lawble
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