When setting up a limited company, business owners tend to focus on the immediate tasks needed to get the company up and running. These include incorporating the company with Companies House, registering for taxes and getting your first sale through the door. One fundamental document that often gets overlooked is getting a shareholders agreement in place.
The main purpose of shareholders agreements is to safeguard the interests of all shareholders. This legally binding document clarifies ownership of shares, decision-making procedures, dividend distribution, share transfer processes, director appointments, dispute resolutions and confidentiality provisions.
It may seem appropriate to start a company on a business partner’s handshake, but what happens if a business partner dies or becomes incapacitated? Without a shareholders agreement in place, the beneficiary of the estate is perfectly entitled to sell their shares to a third-party buyer.
What are shareholder agreements?
A shareholders agreement is a legally binding contract that sets out the rights and responsibilities of the company shareholders.
It is a private contract entered into by the existing shareholders of the company. The shareholder’s agreement is in addition to the constitutional documents required by company law, such as the articles of association.
A shareholders agreement aims to protect the company shareholders and the company’s business interests.
A well-written shareholders’ agreement will include the following provisions:
- Ownership and Shareholdings– The agreement should stipulate the number of shares held by all the shareholders and the voting rights attached to different classes of shares. Having these provisions clearly documented helps reduce potential misunderstandings and disputes between shareholders, which can be time-consuming and takes the focus off the running of the company.
- Decision-Making Process– The decision-making process is an essential aspect covered in the shareholder’s agreement. This agreement should clearly define the rights of the shareholders in making key decisions about certain matters like director appointments, dividend voting, and deadlock situations. By incorporating these processes within the shareholder’s agreement, fair treatment of all shareholders is ensured, particularly for minority shareholders where certain decisions require unanimous consent.
- Share Transfers– A shareholders agreement should contain provisions against the transfer of shares, including the right of first refusal to remaining shareholders or restricting the sale of shares to a third-party buyer. A shareholders agreement will include the process should a shareholder wish to sell their shares if directors resign. Good and bad leaver provisions and permitted transfers can be written into the agreement. Without this clause in place, an existing shareholder could transfer shares to anyone without other shareholders’ consent.
- Confidentiality and non-competing business– These provisions protect sensitive business information and prevent shareholders from engaging with other businesses deemed a competitor to the company’s business during and after their time with the company. These restrictions can provide more protection than an employment contract. Therefore, protecting the company’s intellectual property and competitive advantage.
- Dispute resolution– Disputes between shareholders can be time-consuming and disruptive to a business. Having a dispute process planned can prevent disruption to the ongoing business.
- Exit strategies– A shareholders agreement can determine an exit strategy for shareholders wishing to sell their shares. These provisions can include buy-back arrangements, enabling the company to repurchase the shares, as well as tag-along and drag-along agreements, which force minority shareholders to participate in the sale of the business on the same terms. Additionally, methods for establishing the market value of their shares can be outlined. These clauses safeguard all shareholders when an existing shareholder wishes to sell their shares, providing a clear pathway for outgoing shareholders to exit the business while protecting existing shareholders from unknown third-party shareholders.
- Succession planning– If a shareholder dies or wants to sell to family members, a shareholders agreement will outline the process for transferring ownership. This sets out any restrictions or rights on the inheritance of shares.
A shareholders agreement is a custom document, bespoke to each company, with specific clauses to suit each company’s needs. It provides clarity, protects all the shareholder’s interests and prevents disputes caused by misunderstandings between shareholders.
Do you need to have a shareholders agreement?
Where there is more than one shareholder within a business, we recommend taking legal advice and getting a shareholder agreement written to meet your business needs.
No one starts their own business with the intention of getting into disputes with other shareholders. In most cases, uncontrollable events, such as death or the divorce of one of the parties, cause disputes.
A lot of hard work and effort goes into building up a successful business, and whilst shareholder agreements may seem like draconian measures, they offer protection for the shareholders and the business.
As the agreement has to have shareholder approval, it can also act as an exercise to ensure all shareholders have a mutual understanding.
What happens if you don’t have a shareholders agreement?
Without a shareholders agreement in place, the only legal document with regards to shareholders’ rights is the company articles of association.
This does cause limitations such as:
- Misunderstanding between shareholders on key matters relating to the business. This includes how to make decisions and the rights of shareholders, including dividend and voting rights.
- Limited shareholder protection, particularly for minority shareholders.
- Elongated disputes. Resolving disputes can be detrimental to the company’s business without an agreement. Legal proceedings can be costly and drag out far longer than following a clearly defined process in a shareholders agreement.
- No exit strategy or succession planning. This could lead to the company having a new shareholder if an existing shareholder has sold their shares without consulting the remaining shareholders. If a majority shareholder sells their shares, this could lead to the business being controlled by an unknown third party.
Examples of disputes we have come across for companies that have not had a shareholders agreement in place include:
- Refusal of a spouse to sell shares in a divorce
- Spouse inheriting shares on the death of a business partner
- Shareholders setting up a new business in competition with the company
Minority shareholders vs majority shareholders
Minority shareholders own less than 50% of a company’s shares. As a result, unless they have a shareholders agreement contrary to company law, they have limited input into the company’s decision-making.
As votes cast under company law are based on shareholding percentage, it is the majority shareholders that have the most influence over business decisions.
A majority shareholder can appoint directors, change the company constitution and make major business decisions without any input from a minority shareholder unless there is a shareholder agreement in place to the contrary.
Talk to Spotlight Accounting
Preparing a shareholders agreement requires legal advice, not accounting advice, and we would always recommend using a reputable solicitor to draw the shareholders agreement up.
No one starts out in business to get into disagreements with other directors and shareholders. Whilst shareholders agreements are not a legal requirement to starting a business, we would strongly recommend where there is more than one shareholder to get one in place, as it clearly defines shareholders’ rights and gives an added level of protection.