28th September 2018 ❘

Shareholders’ agreements: why every new business should consider one

What is a shareholders’ agreement?

A shareholders’ agreement is a contract entered into between the shareholders of a company, and often the company itself.

When starting up a company with more than one shareholder, it makes good business-sense to take the time to draft a shareholders’ agreement with your fellow shareholders. A shareholders’ agreement provides a legal framework which can prove invaluable in securing stability, consistency and the future success of your business.

Are shareholders’ agreements a legal requirement?

Shareholders’ agreements are not a legal requirement.

As shareholder agreements are not a legal requirement, they are often overlooked by businesses starting out, as resources are often limited and money is committed elsewhere.

However, investing your time in coming to a practical and carefully considered shareholders’ agreement at the outset of your business relationship could save you much time and expense further down the line.

A shareholders’ agreement can exist alongside your company’s articles of association, but would go much further in setting out the powers of directors, establishing how your company is run, offering wider rights to shareholders and protecting their interests in ways that your articles of association may not.

Why should my business have a shareholders’ agreement?

There are various compelling reasons to have a formal shareholders’ agreement in place when setting up a company, the key benefits to bear in mind are as follows:

1. Stability

A shareholders’ agreement can offer clarity and certainty in terms of company procedures. They also demonstrate forethought and, crucially, a willingness to invest in the future of your business. A shareholders’ agreement will offer additional stability to your business and demonstrate to potential funders that yours is a business worth investing in.

2. Dispute resolution

When starting up a new business, fall outs and disagreements between your chosen business partners are likely to be the furthest thing from your mind. However, the reality is that disagreements do occur between business partners, even those on the best of terms.

If there is no formal procedure in place in order to deal with these disputes, resolving them can be time consuming, expensive and can only sour relations further.

Having a shareholders’ agreement in place from the outset can pre-empt these potential conflicts by setting out a specific dispute resolution procedure. For example, involving a third-party mediator to negotiate between the parties. This then allows you to focus on the running of your business rather than spending significant time and resources resolving shareholder fall outs.

3. Control

Not only can a shareholders’ agreement help regulate relations between shareholders, a carefully drafted agreement could also regulate the manner in which your business is run. Generally speaking, the day to day running of a business is the responsibility of the directors of a company and business decisions are made by way of a simple majority vote at board level.

A shareholders’ agreement, however, can limit directors’ powers and allow the shareholders to have a greater say in the company’s affairs. For example, key decisions can be reserved for approval of the shareholders, such as borrowing in excess of certain limits, issuing new shares or appointing new directors.

5. Protection for shareholders

A shareholders’ agreement can also offer additional protection for both majority and minority shareholders which go above and beyond a standard set of articles of association. Two methods of this include “tag along” and “drag along” provisions.

“Tag along” provisions

For example, where a majority shareholder decides to sell their shares, “Tag Along” provisions in a shareholder’s agreement would entitle minority shareholders (those owning less than 50% of shares) the opportunity to participate in the sale at the same time and for the same price.

“Drag along” clauses

Conversely, a shareholders’ agreement can offer similar protection for majority shareholders by incorporating a “Drag Along” clause. Where a majority shareholder receives an offer to buy 100% of the shares in a company, minority shareholders can be ‘dragged along’ and forced to accept the offer and sell their shares at time and price decided by the majority shareholder.

A drag-along clause in a shareholders’ agreement would provide important protection for the majority (usually those holding over 75% of the shares) when it comes to selling the company, as the decision to sell cannot be frustrated by a minority shareholder.

Drag-along and tag-along provisions can be contained in either a bespoke set of articles of association or a shareholders’ agreement.

6. Restrictions

When a shareholder leaves the company, you may want to restrict their future business activities for a specified period of time to protect your company from competition.

Restrictive covenants in shareholders’ agreements

A shareholders’ agreement could provide for this by incorporating restrictive covenants which prevent former shareholders from, for example:

  • establishing a rival company;
  • working for a competitor;
  • enticing away your existing customers;
  • poaching any of your employees.

Confidentiality clauses in shareholders’ agreements

To the same end, incorporating confidentiality clauses in a shareholders’ agreement can prevent the passing on of confidential company information to competitors, reducing any threat to your business posed by rival companies.

Shareholders’ agreements: setting strong foundations

Although it may not be high on your list of priorities when starting out on your new business venture, the process of sitting down and drafting a detailed shareholders’ agreement can clarify each shareholder’s expectations and help establish a fair and equitable relationship between fellow shareholders.

A shareholders’ agreement can reduce the potential for conflict, provide a degree of security for shareholders and ultimately help cement a practical and stable foundation upon which to build a successful business.

If you would like further information on shareholders’ agreements or require advice on drafting a shareholders’ agreement for your business, please do not hesitate to contact Burnetts’ Corporate Law team here.