10 Key Reasons Why Every Company Should Have a Shareholders’ Agreement in Place
10 Key Reasons Why Every Company Should Have a Shareholders’ Agreement in Place
What is a shareholders’ agreement?
A shareholders agreement is a contract entered into between all of the shareholders of a company and, normally, the company itself, to govern the relationship between the parties and to include the personal rights and obligations of shareholders. Together with the Articles of Association of the company and the Companies Act 2006, this will form the rules and requirements by which the company, directors and shareholders are required to act in relation to each other and the company itself.
Even though there is no legal requirement to have a formal shareholders agreement, here are 10 reasons why every shareholder of a private company should consider having such an agreement in place.
Despite everyone’s best intentions, often during the day to day operation of the company the shareholders and/or the directors may run into a dispute. Disputes can be very time consuming and expensive and can take everyone’s attention away from focusing on the success of the company. When disputes do arise, there is often little in the general law that is of assistance and sometimes the only solution may be to dissolve the company, even if the company itself is successful.
A shareholders agreement can be a very useful tool in avoiding and managing such disputes and can include provisions setting out a mechanism for the parties to resolve disputes without needing draconian measures such as dissolving the company. Sometimes to resolve a dispute, one or more shareholders may agree to sell their shares to the other shareholders. A shareholders agreement will often include valuation provisions to ensure a clear valuation mechanism for those shares and avoid a further dispute regarding the price to be paid.
Sometimes during the life of a company the shareholders and/or their representative directors may not see eye to eye on certain matters, and agreement on certain issues with a required majority cannot be reached. In such a case the business might be adversely affected, for example it may lose a lucrative business opportunity due to inaction.
A shareholders agreement can mitigate this risk by having provisions which set out what should happen where there is a deadlock between the parties, including mechanics for the parties to buy each other out.
3. Investor protection
It is common for smaller companies to have a group of shareholders who are considered to be investors, in the sense that they have injected money into the company for working capital or other requirements in exchange for an equity stake in the business.
Investors are taking a risk on their investment as they may not recover the monies which they invested into the company and so they often require the shareholders to agree certain provisions designed to protect their position. For example, they might require performance targets for the company to meet within a given time and if those targets are not met, the investor has the ability to require certain actions to be taken, or has the opportunity to take control of the company. These provisions are often found in a shareholders agreement.
4. Unknown parties
The starting position at law is that shares are, unless agreed otherwise, freely transferable and so there is a risk that a shareholder may decide to sell or transfer their shares to a completely unknown person or even a competitor. That new shareholder may introduce uncertainty as to the future of the business or act in a way to frustrate the success of the company.
To protect against this there are often provisions in the articles of association of the company and/or a shareholders agreement to ensure that if a shareholder proposes such a transfer then the other shareholders are offered the leaving shareholder’s shares first at an agreed price.
If the other shareholders do not take up that offer then the shareholders’ agreement should also contain a requirement for the recipient of those shares to enter a “Deed of Adherence” whereby the recipient agrees to be bound by the terms of the shareholders’ agreement. This gives the other parties to the shareholders’ agreement comfort in knowing that any new party has to act in accordance with the provisions of the existing shareholders’ agreement.
The shareholders are likely to have access to valuable confidential information about the company by reason of their involvement in the business. Whilst the general law provides that a person who has received information in confidence cannot take unfair advantage of it, most shareholders are not prepared to rely on this alone. A shareholders agreement containing confidentiality provisions is the best way for a company to ensure that the shareholders will keep information about the agreement and about the company confidential during the life of the agreement and following its termination.
A shareholder may wish to establish another business that potentially competes with the existing company, but that won’t often sit well where the parties have gone into a venture together and have shared information, knowledge, clients etc. A shareholders agreement may impose a series of restrictions on each shareholder to the effect that he will not, at any time when he is a shareholder, and for a specified period of time after he ceases to be a shareholder, carry on any other business that competes with the business of the company or entice away customers, employees or key suppliers of the company. These restrictions can be stricter than may exist in any employment contract and can be very valuable in protecting the interests of the company and avoiding conflict. They are also helpful to ensure that each shareholder puts all his efforts into the company and is not distracted by other ventures.
7. Minority shareholder protection
A shareholders agreement may provide protection for minority shareholders by reserving certain decisions for the unanimous consent of all the shareholders, for example decisions to vary the articles of association or permit the registration of any person as a new member. This will effectively give the minority shareholders veto rights and ensure they cannot be adversely prejudiced by the majority shareholder(s).
The shareholders agreement may also contain “tag along” provisions, which say that if the majority wishes to sell their shares to a third party buyer, that buyer would be forced to offer to buy the minority shareholders’ shares on the same (or better) terms. This will enable the minority to leave the company if they do not want to continue under new management and control.
8. Majority shareholder protection
For investors, exit from the company at a price whereby they realise value for their investment is of particular importance. A “drag along” provision operates where the majority shareholders in particular wish to sell their shares to a third party but the third party is only willing to purchase 100% of the shares in the company. In those circumstances, the selling shareholders can “drag along” or force the minority shareholders to also sell their shares to that third party on the same terms. This ensures that the majority is not left without an exit route.
9. Management of the company
Usually the parties to a shareholders agreement will have the right to appoint either themselves as a director or to nominate someone else to act as a director on their behalf. Often the shareholders come together to form a company because of the various skills and strengths which each of them bring to the table. As a matter of general principle, the directors conduct the business of the company on a day to day basis and so if one director has a background in marketing it may make little sense for that director to be the director who is responsible for the finances, for example. In these situations there may often be a lot of stepping on each other’s toes and general inefficiency which may also lead to disputes. A shareholders agreement may therefore provide that the nominated or representative directors of the various parties will each be responsible for certain matters agreed at the outset, which usually means getting the most out of their respective skill sets.
10. Managing expectation
One of the practical benefits of a shareholders agreement is that during the process of agreeing what provisions the shareholders agreement should contain and deal with, the parties are required to think through various different issues and discuss with the other shareholders of the company the various scenarios, for example what should happen if a shareholder wishes to leave, what happens if a shareholder dies, how should the company raise any required additional finance and what are the exit strategies for the business. This allows the shareholders to discuss and agree various different policies at the outset when relations between the shareholders are positive and there is a greater likelihood that a pragmatic solution will be reached, therefore increasing likelihood that the shareholders of the company will work amicably together for the future success of the company.