The Importance of having a shareholder agreement

By Woop / 25th June 2023
The importance of a shareholders agreement

If you have, or if you are thinking of starting a company with more than one shareholder. It is very important you consider having a shareholders agreement put in place early doors.

Even though it is not a legal requirement, working without this agreement could leave you and your fellow shareholders in a precarious position for many reasons.

We explain below, why you should invest your time and money in coming to an agreement with all shareholders as soon as possible.

Shareholders don’t often fall out but it can happen!

When a new business relationship is in its infancy, you probably wouldn't foresee a scenario where you would find it difficult to make decisions together. Unfortunately, we know this sometimes happens and can often lead to a fallout.

Most business owners and shareholders will tell you they have at some point disagreed with each other. This for us is not necessarily a bad thing, we even believe this is healthy as long as the disagreements are considered for the benefit of the company. There is nothing wrong with showing a bit of passion in the boardroom! 

Whilst your relationship remains healthy and all shareholders are able to make key decisions amicably between themselves A Shareholders Agreement will probably not be referred to but having one tucked away does provide peace of mind, should you ever need to refer to it. 

A shareholders agreement can often be considered as the “default position” in times when clarity is needed.

Regulation and management

The running of the company is generally left to your board of directors and their management teams however, it is quite often that certain key decisions are not left to the discretion of the directors and instead require shareholder approval. 

It's worth remembering that many directors are not always shareholders.

Protection to all shareholders

A robust agreement can provide protection for minority shareholders, as well as majority shareholders.

Minority shareholders are often reserved from making certain decisions such as committing the company to a higher level of costs or investment. This is a good example of how the agreement protects both the minority and majority shareholders. Decisions such as these can often only be made with the unanimous consent of all the shareholders. 

Tag along provisions are also very prevalent and having these clauses in your agreement enables a minority shareholder to “tag on” to a majority shareholder in the event of a share sale situation. 

Again, both parties are protected here because if the majority shareholders attempt to sell their shares, the minority will automatically “tag on”  avoiding the need to seek a buyer for their shares.

Having “drag along” provisions within your agreement provides the majority shareholders with the peace of mind that in the event an offer is made it can be accepted by the majority shareholders. This clause can force the holders of the remaining shares (minority) to accept the offer on the same terms, which means there is a lesser risk of the deal falling through.

Transferring shares

You will often see “the right of first refusal” in many shareholders' agreements. This type of clause can provide a mechanism where, should one shareholder wish to sell their shares, effectively this clause gives the other shareholders or the company the first option to purchase those shares. It's their “right of first refusal”

This clause is very important as it protects the remaining shareholders by staying in control of who can actually acquire shares in the company. Rather than allowing external investors and individuals who are not known to the company or its shareholders. 

One really important factor about having Shareholders’ Agreements is that it helps with key decisions, in the event a shareholder dies. The agreement should dictate and even complement the terms of life insurance policies, which were taken out for this purpose.

Shareholdings and employment

Shares are often held by directors or key employees of the company, which is fine until one shareholder wishes to resign and leave the business. Situations like this can cause many challenges if you don’t have a robust agreement in place.

Having a robust shareholders agreement that clearly states their employment is linked to their shareholding, provides protection to the other shareholders in the event a person who wishes to leave, must offer their shares up for sale to the existing/remaining shareholders.

Not having this clause clearly within your agreement means there is no requirement for the exiting shareholder to sell their shares, if they cease to be employed in the business.  Therefore, they would continue to benefit from the hard work of those who remain within the business.

Restrictions and compete clauses

If a shareholder exits the business there could be a risk they may set up or work for a company that competes with your business. Therefore, you may wish to apply restrictions within your shareholders' agreement to protect you against such circumstances. 

These types of restrictions are usually much more robust than you would normally associate with employment contracts.  Therefore, we highly recommend you take this into account when having your shareholders' agreement written.

There is nothing worse than working tirelessly hard, sharing all your creative ideas and building your business to then face an exiting shareholder, who is going to be in competition benefitting from all your hard work.

Dispute and resolution

Should you enter into a dispute, there can be specific provisions laid down in the Shareholders’ Agreement to deal with this.

It's worth considering a clause that clearly outlines at what stage there would be a referral to mediation, or who any arbitrator may be, such as the company’s representative law firm. 

Dividend policy

Your Shareholder’s agreement should also include your “dividend policy”. This outlines the different dividends that may be payable to each shareholder, particularly if you have different classes of shares.

Business stability

Having a Shareholders’ Agreement helps demonstrate stability for your business in many ways, such as;

  1. It provides peace of mind for all shareholders, that there is a clear legally binding procedure to follow in the event of any ambiguity or dispute.
  2. A clear understanding of what shareholders can and can’t do, that involves fellow shareholders.
  3. Show professionalism and stability in the event of a potential buyer, particularly for lenders and other organisations that may be looking to invest or purchase your company.
  4. Shows a willingness to respect one another.

Finally, once you have had your Shareholders Agreement written and it's filed away, don’t forget about it! 

It is good practice to review this on a regular basis, particularly if any key decisions are made at shareholders and directors meetings, that could alter the way the company is currently operating.

Remember, if shareholders come and go you will need to update and re-execute your agreement.

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