Does your business need a shareholders’ agreement?

We often find that business owners overlook the importance of entering into a shareholders’ agreement. A shareholders’ agreement forms the basis of a legal contract between the shareholders of a company, and acts to regulate the procedures, rights and obligations of those shareholders. A common assumption is that the company’s Articles of Association and the Companies Act 2006 deal with all of the issues that may arise. Whilst the contents of the Articles of Association and Shareholders’ Agreement are often quite similar, the main distinction between the two is that the Articles of Association are a public document, whereas the Shareholders’ Agreement is private in nature. Therefore, it is common for companies to deal with certain issues solely in the Shareholders’ Agreement due to the increased element of privacy.

The importance of having a shareholders’ agreement is not something that should be overlooked by any company with more than one shareholder. Some of the key reasons why entering a shareholders’ agreement may be beneficial for your company are detailed below:

  1. Restricting the Powers of Directors

Generally speaking, the day-to-day operations of your business are likely to be the responsibility of the directors. However, if required, your shareholders’ agreement could be drafted to provide that specific decisions are to be reserved for approval of the shareholders, so as to limit the powers of the directors. The shareholders’ agreement could even go as far to require that certain decisions can only be made with the unanimous consent of all shareholders. One example could be to require shareholder approval to borrow monies in excess of certain limits.

  1. Dispute Resolution Procedures

Whilst everyone is getting along, a shareholder dispute is likely to be the last thing on your mind. However, business can often be unpredictable, and disputes can occur at any time. It would therefore be pro-active to have an agreement in place setting out how such disputes will be dealt with, should they ever occur.

Dealing with shareholder disputes will often be time consuming, costly and detrimental to the operation of the business. In circumstances where a dispute does arise and there is no clear procedure to resolve said dispute, shareholders may well have no choice but to part ways and dissolve the company.

Having a well-drafted shareholders’ agreement in place will assist you in being able to potentially pre-empt any disputes from occurring and, where they do occur, manage them so as to prevent any negative impact on the operation of the company.

  1. Restrictive Covenants

In a situation where one shareholder decides to leave the company, there is a risk that the former shareholder may set up a similar company operating in competition with the interests of the company in question or alternatively, go to work for a competitor. The Companies Act 2006 and your Articles of Association usually do not foresee this situation.

A shareholders’ agreement could be drafted so as to restrict a former shareholder from acting in this manner. The agreement could impose a series of restrictions, known as restrictive covenants, that prevent a shareholder’s ability to carry out similar business activity for a specified period within a specified geographical location. These restrictions could be vital in protecting the interests of a business, and ultimately, the value of the company in the long term.

  1. Exit Strategy

Planning for the succession and/or sudden departure of a shareholder is probably not an issue that is at the forefront of your mind. However, it should remain an important consideration. In circumstances where a shareholder dies and passes their shares to their estate or where they decide to sell or transfer their shares to an external third party, you may experience difficulty running the company should the third party decide not to co-operate.

To prevent the above, it is common for companies to include provisions in their shareholders’ agreement known as ‘pre-emption rights’. These are rights which require the shareholder who is exiting the company to offer their shares for sale to either the remaining shareholders or the company, in the first instance, before selling to external third parties. This would give you, as a remaining shareholder of the company, the right of first refusal in relation to the departing shareholder’s shares.

  1. Majority & Minority Protection

If you are a majority shareholder, there may be a situation that arises whereby you would like to sell your interest to a third party. However, a minority shareholder may not want to sell their shares and could subsequently block the transaction. As a result, the third party may then withdraw from the transaction. This situation could be prevented by incorporating what are known as ‘drag along’ provisions in your shareholders’ agreement which would state that if you, as a majority shareholder, intended to sell your shares, you are able to force the minority shareholder to sell their shares to the third party for the same price.

Alternatively, if you are a minority shareholder, there may be a situation that arises whereby the majority shareholders are looking to sell their interest in the company to a third party. In these circumstances, minority shareholders could find themselves stuck in the company following a change in control of the majority shareholders. Minority shareholders can prevent this situation occurring by incorporating what are known as ‘tag along’ provisions into your shareholders’ agreement. These rights entitle minority shareholders to participate in the sale at the same time and at the same price for each share as the majority shareholders. The minority shareholder technically “tags along” with the majority shareholder’s sale.

Ultimately, the drafting of the shareholders’ agreement would need to be bespoke as the contents of the agreement would largely depend on the wishes and requirements of you and your fellow shareholders, whilst also being drafted with the commercial interests of the company in mind.

If you would like to discuss the benefits of a shareholders’ agreement or would like our Company Commercial department to draft a bespoke shareholders’ agreement for your company, please get in touch at businesslaw@woodfines.co.uk