Why Do I Need a Shareholders Agreement?
Solicitors are often asked by business owners ‘Why do I need a shareholders agreement?’ or ‘Do I really need a partnership agreement?’
The problem we see time and again is the fall out, and expense, which occurs when parties do not properly document the relationship between the owners. If proper agreements are not in place then the process of unravelling the relationship between business owners can be an expensive and lengthy process, particularly if a dispute has arisen. This is particularly the case where the business owners are friends, family or even spouses.
Most parties go into a business relationship with the best of intentions and a mutual goal. Difficulties often arise however as individuals circumstances change over time. For instance, one business owner may want to exit a business much sooner than another business owner or there may be a change in a business owners personal circumstances for instance to do with health or marriage. These are factors which are not always foreseen when going into a business relationship but have the potential to cause conflict between owners which can be difficult to resolve.
What is the difference between a shareholders agreement and a partnership agreement?
A shareholders agreement applies where the business is a limited company. A partnership agreement only applies to an incorporated entity. However the underlying provisions and protection from these documents are similar.
In this article, I will focus on Shareholders Agreement but remember that similar issues and considerations will apply to Partnership Agreements.
What kind of issues will a shareholders agreement cover?
Broadly speaking, shareholders agreements can cover almost anything to do with the relationships between owners in the business. I will however deal with common matters to consider.
It is imperative that Shareholders have properly drafted restrictive covenants to protect the business in the event that one of the shareholders leaves a business.
Barring some minor implied and statutory duties, there is no automatic protection for a business if a shareholder leaves a business to join a competitor and then seeks to take key clients to the new business. This can be catastrophic for a business. I have certainly seen circumstances previously where shareholders have left business to either join a competitor or set up another business and have taken all or almost all of a client base with them because they were not subject to restrictive covenants.
Generally restrictive covenants in a shareholders agreement are much more enforceable than in an employment contract. Common restrictions may present a shareholder soliciting or dealing with customers of the business for a certain period of time. In some cases it is justifiable to have a clause preventing an exiting shareholder from competing with the business or working in a competitor within a certain geographic radius. If drafted properly, these clauses are enforceable.
This is another area which is often overlooked but is incredibly important to a business. As a general rule, Directors and Shareholders can take what steps they deem to be appropriate for the benefit of the business.
Difficulties can arise where different shareholders have different views as to what steps should be taken for the benefit of the business.
A shareholders agreement will place restrictions on shareholders as to what steps they can take without obtaining the consent of the other shareholder(s). This may include, for example, restrictions on how much a shareholder can spend, or commit a business to spend or hiring employees or employees above a certain salary. It may be that all shareholders must also consent to other material changes such as a change in the name or nature of the business, a change of accountants or auditors. You may want to restrict other shareholders from binding the company into certain credit agreements or from giving security, or personal security for credit.
Without formal agreement on these matters, Directors and Shareholders can be left with very wide powers which may result in them entering into agreements or liabilities which other shareholders do not agree with.
Good Leaver / Bad Leaver Provisions
The last thing you want as a business owner is to have to remove a shareholder from a business due to issues of misconduct, fraud or other matters to then find that you remain obliged to pay the outgoing a shareholder a fair market value to recover the shares, if you can recover the shares at all.
Good and Bad Leaver provisions dictate the circumstances in which an outgoing shareholder is entitled to receive the full market value for the shares. It may also dictate circumstances in which shareholders must sell their shares to a company and where they may only receive nominal value for the shares. Again it is essential that these clauses are drafted carefully so as to reflect the competing needs of the shareholders.
Sale of Shares
Shareholder agreements will set out how a shareholder can sell their shares and who has to be given the option to buy the shares. Without formal provisions in place it could be open to shareholders to sell shares to parties unconnected with a business, even a competitor. Whilst this may be unlikely, it is important to have provisions in place dealing with who can buy shares in the business and circumstances in which shareholders may be obliged to sell their shares.
Shareholders may also want to consider ‘Drag and Tag’ provisions to prevent the division of shareholders. These provisions broadly mean that if shares are sold to an external individual that all shares must be sold, subject to certain conditions.
To summarise, the above are just a few examples of key business issues which owners must have adequately documented.
The proper drafting of a shareholders agreement will prevent disputes, rogue shareholders and ultimately save a business cost and time. Each shareholders agreement is individual to that business as each business is different.
It is essential that business owners take formal legal advice on this. Think of it like an insurance policy, whilst no one wants to pay for insurance, you wouldn’t want to trade without car insurance, business insurance, professional indemnity insurance and alike. In many ways a shareholders agreement is no different.
Partner and Head of Corporate, Richard Coultard, has been involved in many cases where formal agreements have not been entered into and such disputes can be extremely expensive to resolve.
Richard regularly advises businesses on shareholders agreements, and is more than happy to speak to any business owners who would like some informal guidance.« Go backContact us »