What is a shareholders’ agreement?
A shareholders’ agreement is a legally binding contract between the shareholders of a company. It can be made between all members, or a specific selection of them. In particular circumstances, it can also include parties that are not shareholders.
The agreement sets out their rights, privileges, protections, and obligations. This helps to safeguard investments, as well as make sure the relationship among shareholders is secure and that the business runs smoothly.
When is a shareholders’ agreement used?
This type of contract is completely optional, and can be introduced at any stage of the business life cycle. They’re generally recommended whenever there is more than one shareholder in a business – this way, it protects minority shareholders’ rights.
When should a shareholders’ agreement be put in place?
It’s a good idea to implement a simple shareholders’ agreement if you want to:
- Clearly establish the rights of each shareholder
- Manage the mandatory transfer of shares
- Make sure that shareholders can’t prevent the sale of the business
- Strengthen the power and protection of minority shareholders
- Have an effective dispute resolution process
- Govern the management of the company
- Link shareholding to employment
- Have privacy around how the business operates (as there is no need to file it with Companies House)
Why have shareholders’ agreements?
The key reason to have a shareholders’ rights agreement is so you can make sure that there’s complete clarity and certainty around what can and cannot be done by each party. This guarantees that decisions will be made with a full consensus and necessary discussion.
An agreement makes it perfectly clear what rights shareholders have, how equity and shares are issued, and how disputes are settled. On top of this, the process of negotiating the contract itself allows each shareholder to better understand the aims and direction of other stakeholders, as well as the business as a whole.
What different types of shareholder agreements are there?
The main one is a general shareholders’ agreement. This is considered to be a commercial contract between the shareholders, and it is subject to the company’s articles of association and by-laws. They aren’t required to have specific clauses, and so all of the regulations within it are customised to the parties involved.
What happens when a shareholders’ agreement is breached?
In the unfortunate situation that there has been a breach of contract, there are various remedies available. The agreement, after all, is legally binding. The following remedies are the most common:
- The innocent party has the option to either end or affirm the agreement.
- Damages can potentially be regained by the innocent party if they’ve experienced a loss due to the breach. However, it’s important to note that these can be difficult to quantify.
- A court order may be potentially granted in order to make the party who has broken the agreement perform as stated in the agreement.
- An injunction can be pursued by the innocent party to prevent a threatened breach from taking place.
Protecting the rights of a shareholder
How does a shareholders’ agreement help a minority shareholder?
The contract can potentially work in favour of the minority shareholder. As it can overwrite both the Companies Act and the articles of association, a minority shareholder can end up with more rights to all or any of the dividends, as well as voting or capital.
Plus, there is often a ‘tag-along right’ in these contracts. This entitles the minority shareholder to prohibit the sale of a 50.1% interest – unless a like offer has first been made for the 49.9% interest.
If there is no legal obligation, why should we have a shareholders’ agreement?
While there’s no legal requirement to have this type of contract in place, many opt to. A shareholder agreement can reduce the chance of any disagreements between shareholders, and protect their interests and rights if there are any issues.
Why is legal advice important in the shareholder agreement?
Do I really need a shareholders’ agreement?
It’s preferable to have one in place, as it can save considerable time and money in the long term. A small business shareholder agreement where everyone knows their legal rights will help to avoid any potential disputes.
What problems can arise if you don’t have a shareholders’ agreement?
Besides disputes, a number of issues can develop if this contract is not in place. These include the following problems:
- Minority shareholders could prevent the company’s sale.
- Employees or directors who own shares could leave the business and still own their shares, reducing the profits for the shareholders that remain.
- Departing shareholders could take all the knowledge, customers, and trade gained with them – putting them in a good position to set up a viable competing business.
- If there are only two people or companies and they have equal voting shares, a deadlock could potentially happen if they can’t come to an agreement. Without the shareholder contract in place, neither party would have control of the business.
Important clauses in a shareholder agreement
The main clauses in a standard shareholders’ agreement include:
- Circumstances in which unanimity for important decisions is necessary
- Shareholding limitations, including when the transfer of share would be forbidden, the procedure for transfer, and how to work out the fair value
- Any disagreement that should involve alternative dispute resolution rather than court proceedings
- Enter and exit strategy for shareholders – like buy-out rights (or against) specific members
- How to settle deadlock situations – this includes a dedicated decision-making process to make sure that these can be dealt with effectively
What makes shareholder agreements complete?
The following should be on your shareholders’ agreement checklist when it’s drafted:
- Duration of the agreement
- Company structure – this includes how the share capital is split, and classes of shares for each shareholder
- Types of shares
- Shareholders’ rights to the type and percentage of shares they own
- How dividends are divided
- Shareholders’ voting rights
- Actions which need the approval of shareholders first