Shareholders’ Agreements
What are they and why do you need one?
When setting up a company (especially with friends and family), it’s easy to assume that nothing will go wrong. You might also think that proposing a Shareholders’ Agreement sets a negative tone between the shareholders.
The reality is, even the closest of business partners fall out, so it’s important to agree what will happen in those circumstances. Failure to do so could be costly, and create legal disputes between shareholders.
What is a shareholders’ agreement?
A Shareholders’ Agreement is a written contract between the shareholders of a company, setting out how the company will operate, and the rights and restrictions of the shareholders. Its purpose is to protect the shareholders in the event of a dispute, and establish a fair relationship between them.
Shareholders’ Agreements vary from company to company, but often provide protection when:
- Dividends are to be distributed
It should be clear from the outset how dividends will be distributed between the shareholders. A Shareholders’ Agreement will usually place contractual obligations (and restrictions) on how dividends are to be distributed – ensuring that all shareholders are treated fairly.
- New shares are to be issued
It is common practice for businesses to issue new shares – particularly when raising funds. However, issuing new shares like this will mean that all shareholders are diluted.
A Shareholders’ Agreement will set out a procedure for issuing new shares, and often provide existing shareholders with a ‘right of first refusal’ – preventing their shareholdings from dilution.
- Shares are issued to employees
It is common practice (particularly in the start-up industry) to offer shares to key employees as part of their remuneration, and to reward them for their hard work. It’s a great way of incentivising the core team.
However, this creates a number of risks:
- What will happen if the employee chooses to leave employment?
- What will happen if the employee commits an act of gross misconduct?
A Shareholders’ Agreement will deal with each of these scenarios, by providing the company with a right to buy back the employee’s shares. These are known as ‘leaver provisions’.
- A shareholder wants to sell his shares
Allowing shareholders to sell their shares can bring unwanted and problematic shareholders.
Shareholders’ Agreements usually include restrictions on selling shares, preventing those unwanted business partners.
- A shareholder dies
When a shareholder dies, any shares owned by that shareholder will fall part of his/her estate. This can provide unwanted third parties with control over the company.
A Shareholders’ Agreement can deal with this scenario, by providing the company (or another shareholder) with a right to buy those shares in certain circumstances – retaining control over the company.
- The business is preparing for an ‘Exit’
A buyer of the company may want to purchase the entire share capital of the company. However, this can be difficult if certain shareholders are unwilling to sell. This can often break a deal.
A Shareholders’ Agreement would normally include an obligation on minority shareholders, to sell their shares in these circumstances. This is known as a ‘drag along’ provision, and provides protection for majority shareholders.
- When shareholders fall out
When shareholders fall out, it is fairly common for one of those shareholders to walk away (and potentially sell their shares).
A Shareholders’ Agreement would usually contain restrictions on the sale of shares, and provide a mechanism for resolving disputes.
- When a shareholder decides to set up a competing business
Where shareholders are involved in the operations of a business, they will usually have access to trade secrets and confidential information (such as customer lists and business plans). Having access to this type of information can make it easy to set up a competing business.
Shareholders’ Agreements can include contractual restrictions, preventing shareholders from setting up competing businesses and/or soliciting employees.
Timing
We advise many businesses about Shareholders’ Agreements and a wide range of other corporate and commercial matters. The best time to enter into a Shareholders’ Agreement is always ‘now’.
If you’d like to protect you or your business, call us on 02476 231000 and speak to one of our experts.
