The Importance of Entering into a Shareholders’ Agreement
As a business owner, why is it important for you to have a shareholders’ agreement? While it is not a legal requirement, without one you run the risk of operating on shaky foundations.
This article provides an overview of the certainty a shareholders’ agreement can bring to running your company.
In a nutshell a shareholders’ agreement is a contract which governs the relationship between all the shareholders and the company. When used alongside the company’s articles of association (the part of the company constitution that sets out directors’ powers, the type of business to be undertaken and the powers shareholders have over directors) the agreement sets out clear parameters, building solid framework from which to operate. This extra contract can:
- make corporate management easier
- provide protection for the parties involved
- provide a clear framework and process if things go wrong in the future.
There is no set template for a shareholders’ agreement and the parties involved decide what to include.
8 reasons why is it so important to have a shareholders’ agreement
- The agreement can enforce unanimous voting giving minority shareholders the power to veto decisions and restrict further shares being issued preventing unfair dilution.
- ‘Tag-along’ provisions can be included so in a majority shareholder buy-out, the buyers can be forced to buy the minority shares on similar or better terms.
- For majority shareholders, ’drag-along‘ provisions can force minority shareholders to sell their shares, which is useful when the buyer is only willing to purchase 100% of the company and minority shareholders are unwilling to sell. Drag-along provisions ensure that majority shareholders are not left without an exit.
2. Protecting investors
- Provisions can be included in a shareholders’ agreement covering what actions an investor can take if the company doesn’t perform as well as expected.
Overcoming stalemate situations
- Instructions on how to deal with a deadlock scenario can be included in an agreement providing a simple and effective way to overcome what could be a costly hurdle. Whilst the focus is on difference of opinions, the company may miss opportunities. Addressing these scenarios can be beneficial.
- When creating a new and exciting company a dispute might not be on your mind. Fall outs occur in the closest of relationships and it is savvy to think ahead. A shareholder agreement can include dealing with shareholder disputes by setting out options for mediation, arbitration, and alternative dispute resolution.
Dealing with a shareholder exit
- You can include the right of first refusal so the existing shareholders will be offered the shares first.
- The requirement for a deed of adherence (a short document in which a new shareholder agrees to be bound by the same terms as the existing shareholders) can prevent a maverick shareholder joining the company as they have to agree to the provisions in the shareholders’ agreement.
- For the leaving shareholder, the agreement can outline how they are treated. A good leaver who has retired or been made redundant may have preferential treatment and receive the fair market value of their shares. On the other hand, a bad leaver may decide to leave prematurely or breach the shareholders’ agreement and therefore may only receive a nominal (or par) value, or the price they originally paid for the shares.
- The agreement is confidential so it does not need to be made public.
- Shareholders can include confidentiality clauses in the agreement affording them even more protection.
- Restrictive covenants can be included in the agreement which prevent shareholders setting up rival businesses.
Establishing the right to dividends
- The shareholders’ agreement can set out what dividends the shareholder receives dependent upon the shares they own.
Protecting your business with a shareholders’ agreement
A shareholders’ agreement can provide certainty and protection in various situations but this is only when it is consistent with the articles of association. It is important to review the agreement regularly to ensure it works as expected and it is up to date with any shareholder changes. Best practice is to review the agreement in the event of:
- the death of a shareholder
- a share transfer or sale
- a new shareholder entering the company
- a change to the company business model.
An up to date and comprehensive settlement agreement is a valuable tool crafted to safeguard and build confidence in your company. So, although an agreement is not legally required, to reduce the risk to your business it is certainly a contract you should consider entering in to.
When considering a shareholders’ agreement, it is best to seek professional advice to ensure it is airtight, all shareholders are legally bound by it and it doesn’t conflict with any other agreements in place.