What is a Shareholders Agreement?

A Shareholders Agreement is a contract made between all or some of the shareholders of a company, and usually the Company itself, in order to govern the relationship between the shareholders and to set out their rights and obligations.

Why should my company have a Shareholders Agreement?

When setting up a company with family or friends, you likely trust the people who are going to be your new business partners. You may therefore feel you don’t need a Shareholders Agreement, or that your partners may take offence at suggesting you put one in place. However, throughout the whole course of a business relationship, it is likely that disagreements will occur. It is easier, more amicable and cost effective to have a document to refer to that sets out the approach that will be taken in the event of a disagreement rather than to negotiate this once the fall out has already happened.

The Articles of Association of a company cover how the company will be ran, governed and owned to an extent however a Shareholders Agreement enables minority, majority and equal Shareholders to protect their rights in a way that is not covered by the articles.

Minority Shareholders Agreement

A minority shareholder is a shareholder with less than 50% of the issued share capital of the company. A minority shareholder has very few rights in the event they are unhappy with how a company is being run. As there is generally not a market for private shares, an unhappy minority shareholder does not even have the remedy of selling their shares.

A Shareholders Agreement allows minority shareholders to protect their rights in various ways. Some protections that can be included are:

  • Ensuring certain decisions require the consent of all the shareholders, not only the majority shareholder. An example of when this could be important is the decision to remove a director who is also a shareholder. Without a Shareholders Agreement to the contrary, the shareholders with more than a 50% majority can vote a shareholder director out of the company, leaving him with an interest in a company in which he has no management rights.
  • ‘Tag-along’ provisions that entitle minority shareholders to join in the sale when a majority shareholder sells their shares. Without this provision, minority shareholders may find themselves left behind if the majority shareholders exit the venture.
  • Pre-emption rights to require shareholders to give minority shareholders a reasonable opportunity to purchase their shares before selling them to a third party.

The Companies Act 2006 provides some statutory protection for minority shareholders; however the pre-emptive measure of drawing up a Shareholders Agreement is far more cost effective than reactively commencing legal action in order to assert your statutory minority rights. Importantly, a Shareholders Agreement provides a contractual remedy if its terms are broken by any shareholder.

Majority Shareholders Agreement

As discussed, in the absence of a Shareholders Agreement, shareholders will need to rely on the Articles of Association. The Articles of Association are a public document which must be filed at Companies House, whereas a Shareholders Agreement is a private document meaning there is no requirement to file it and it can be kept confidential.

In the same way that a Shareholders Agreement can be drafted to protect the minority interests of a company’s shareholders, it can also work to protect majority shareholders. An example is a ‘drag-along’ provision, which compels minority shareholders to sell their shares in the event the majority shareholders find a buyer.

Shareholders Agreements can be particularly vital for companies where there are only two shareholders both with 50% of the shares, as the Articles of Association are not particularly useful in the event of a deadlock. Shareholders can reduce risk by setting out what should happen in the event of a deadlock in an Shareholders Agreement.

Common issues that arise in family business that can be dealt with in a Shareholders Agreement

  • CONSENTS – Have you considered who will have the authority to make certain decisions? Often in family business, the shareholders want certain decisions to have to be made unanimously. Provisions can be inserted into the Shareholders Agreement to require all shareholders to have to consent to matters such as entering into substantial business contracts, commencing legal proceedings, varying the remuneration of directors and so on.
  • CLASSES OF SHARES – Will all the shareholders of your company have the right to receive dividends? Should all the shareholders have voting rights, or is one of the shareholders just acting as an investor and it is not intended that they have any control over the company? Creating multiple share classes and setting these out in a Shareholders Agreement allows companies to give shareholders different rights. These are particularly useful in family companies, where the needs and contributions of family members differ.
  • RESTRICTIVE COVENANTS – A restrictive covenant is a promise to not do something. You may want to include non-compete provisions into the agreement to prevent a shareholder leaving the company and carrying out business activities that could be detrimental to your company. Common restrictive covenants prevent a shareholder from setting up a rival company, working for a competitor, poaching existing clients or employees, or sharing confidential business information with competitors. Restrictive covenants are usually easier to enforce in a Shareholders Agreement than in an employment context as shareholders are considered to be on an equal footing, whereas there is a power imbalance between employer and employee.

What happens when a shareholder dies?

Estate planning is often not at the forefront of most people’s minds when they embark on a new business venture. However, the death of a shareholder can have a devastating impact on a company.

In the absence of a Shareholders Agreement or Cross Option Agreement to the contrary, the rules of intestacy will apply if a shareholder passes away. If the widow or personal representative of the deceased does not wish to sell the shares to the surviving shareholders, they will have an involvement in the company. This would be of particular concern if this new shareholder does not have experience or any interest in the company.

By far the easiest way to avoid disaster is to set out provisions in the Shareholders Agreement or a Cross Option Agreement dealing with what will happen in the event of the death or incapacity of a shareholder.

For further information on how a Shareholders Agreement could work for your business, please contact Richard Coulthard on 0113 284 5000 or alternatively email Richard.Coulthard@isonharrison.co.uk