Why do you need a shareholders’ agreement?

Posted: Wednesday, 21 March 2012 @ 10:00
Why do you need a shareholders’ agreement?

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Many limited companies are started each year by friends, relatives or former colleagues who have a great business idea and a desire to create a successful business. Few, however, appreciate the potential problems they are storing up for themselves by not having a formal agreement in place to set out the ground rules for their ownership of the business, determine the powers of each shareholder or provide a method for resolving disputes between the owners.

The solution is a legally drafted shareholder agreement.

A shareholders' agreement allows the members of a company to agree a range of matters relating to their involvement in the company, so that they will know what will happen in certain circumstances, rather than there either being nothing to govern those circumstances or having a default position implied which might not be that which they would choose. It is therefore a means of ensuring that the company and its affairs are run as you wish.

Some of the main issues which might be addressed in a shareholders’ agreement include:

Financing of the company 

  • what each party is contributing initially and whether as share capital or loan 
  • how any future finance will be raised – will it be by each party contributing in proportion to     their shareholding, some other ratio, outside source etc., or how decisions relating to future requirements will be taken.

management of the company 

  • specify what will be the main business of the company
  • how the directors will be appointed – which may supplement what is contained in the articles e.g. shareholders to be able to appoint themselves or a nominee
  • appointment of bank, accountant/auditor


dividend policy – will all profits be retained for growing the company or distributed? If not, how are profits to be applied and in what proportions or amounts?


share transfers – in most private companies the members will want to retain control over the shares, so that rather than members being able to transfer them to whoever they want, there will be a mechanism for anyone wanting to transfer their shares to be required to give the other members the first right to buy them accompanied by a formula to value them if the price cannot be agreed. Certain events will trigger those rights e.g. a shareholder being in breach of the agreement, death or ceasing to be actively involved in the business if that is a requirement.


Dealing with deadlock – if the members cannot agree, there are various options which can be written into the shareholders’ agreement to deal with the situation e.g. : 

  • veto – nothing happens without agreement, although that could allow a minority to prevent the majority taking action, so should only be allowed in appropriate cases.
  • various options are available to allow or require shares to be transferred using bizarrely named formulae such as Russian roulette, Texas or Mexican shootouts etc
  • arbitration, mediation, independent expert, nominated third party – possibilities although not usually the most satisfactory
  • winding up – the most drastic option if the parties really cannot agree which might in fact focus efforts on trying to find a solution.


Who needs a shareholders’ agreement?

The members of any company with more than one shareholder benefit from having a shareholders' agreement to govern issues between them not only as members of the company – which can be included in the articles – but personal matters.

Shareholders' agreements could be categorised as covering three main situations:  

  • A quasi-partnership – which is the classic owner managed business scenario where two or more friends/relatives/colleagues set up business together via a limited company, but will often refer to themselves as business partners.
  • A joint venture between two or more existing businesses which may in turn be individuals or limited companies where the parties come together to undertake a new business in the form of a limited company.
  • An investment from an outside source e.g. venture capital or other private equity investment. The investor is likely to require extensive controls, even if not taking a majority stake, and will often have its own form of shareholders’ agreement and articles with sophisticated share structures, different classes of shares etc.

What could happen if you don’t have a shareholders’ agreement? 

Without a shareholders’ agreement there is much more potential for disagreement between the shareholders, particularly if things start to go wrong. Even though the parties will start off thinking they have common goals and ideas as to how to reach them, those views can diverge over time – one may wish to invest any profits and grow the business; others may want to reap the rewards personally by taking out those profits.

If personal circumstances change or, for example, there is an age difference, one may wish to sell his/her shares, whilst the others want to carry on. The leaver may want to keep their shares or may want to sell them for the highest possible price and may not be concerned who buys them. Those staying on might not want the leaver as a ‘sleeping partner’. They would usually want to be able to acquire the leaver’s shares at a fair price, but without prior agreement they would have no right to do so. Without an agreement, they could otherwise be faced with a new owner of those shares with whom they have no previous relationship or knowledge. That new owner may or may not have any skill in the particular business. In a private company the value may be difficult to assess. The shareholders’ agreement can set a procedure and formula, as well as giving the remaining shareholders a right of first refusal on any sale which they would not otherwise have and can include circumstances where a transfer may be required.

When to get a shareholders’ agreement

Now!

It is always easier to get an agreement in place whilst everyone is in agreement. That might sound obvious, but how often do you hear that people have gone into business together saying they don’t need to spend the time and money on drawing up an agreement because they all agree about how the business will be run etc., but then down the line their views diverge or circumstances change and there is a disagreement? That can be much more expensive and time consuming to resolve and whilst their eye is off the ball, the business they have worked so hard to build up will suffer. This puts at risk everything they have invested.

If you’re in business with a partner, family member or friend, or if you are about to embark on a joint venture or take on external investment, talk to us about a shareholders’ agreement - call 0845 003 5639.

Article written by Sue Mann, Commercial Solicitor, November 2011

Blog by Gary Cousins
Gary has been providing legal advice to shareholders, directors and business owners for over 25 years. Specialising in dispute resolution Gary is based in Birmingham with clients throughout the UK and overseas. View profile
Call Gary on +44 (0)121 778 3212 or by email
This blog is not intended to constitute legal advice, nor is it intended to be a complete and authoritative statement of the law, and what we say might be out of date by the time you read it. You should always seek legal advice to confirm whether or how any information in this article applies to your particular situation. We offer a free telephone consultation to discuss your particular circumstances.

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