Summary of Article
What is a Shareholders Agreement?
A Shareholders Agreement is a contract between the owners, the shareholders, of a business. That could be an agreement between you and your spouse, you and your best mate of 20 years, or you and investors.
There is no legal requirement for a limited company to have a Shareholders Agreement, but I strongly recommend every limited company to have one, even if it is just you and your spouse (and perhaps more so!)
A Shareholders Agreement governs and regulates the relationship between shareholders. Relations are great when relationships are great, but what if they turn sour? As you’ll see below, a Shareholders Agreement can be very useful.
It is better to put in place a Shareholders Agreement at the outset of starting a company, but it is often the furthest thing from your mind. However, here’s 8 reasons why you definitely should not get a Shareholders Agreement.
1. Shareholders Never Fall Out
“We’ve been friends since School”
“She’s my wife and my best friend”
“I trust him. He’s a good guy”
I’ve heard them all. You’re different, you and your fellow shareholders will never fall out, never have a disagreement, so it’s fine you don’t need a shareholders agreement.
I’ve dealt with loads of shareholder actions at Court and almost all of them are preceded by a falling out of the two or more shareholders. And boy do they fall out. It is never just a tiff; they end up all bitter and twisted, personal and like the worst divorce ever. At least in a divorce, there’s usually a new “better” relationship on the agenda!
A Shareholder’s Agreement allows you to set down what happens if there is a dispute and agreements cannot be reached on decision-making processes, including referral to mediation or a third party decision-maker such as an accountant/auditor.
2. You have no intention of having different dividend policies
In many family companies, accountants have advised company owners to add non-working spouses as shareholders in order to extract profit through dividends. While on the face of it, this is less attractive than it has been in the past for tax reasons, it is still a common option.
If you don’t want to have the flexibility to give dividends to certain share classes (sometimes known as ABC Shares, or Alphabet shares – A Shares, B Shares etc) then you do not need a Shareholders Agreement.
If you do, then get a Shareholders Agreement in place as this will help document and record matters properly.
3. You’d be happy with a stranger buying your co-shareholder’s shares
Without a shareholders agreement, a shareholder of a company can technically sell his or her shares to a third party. Imagine a situation where you are then having to deal with someone you don’t know, or worse still that they don’t work and just extract profit out of the business. What are you going to do then?
With a Shareholders Agreement, you can control the sale of shares through what is known as Pre-Emption Rights. These allow you to require a selling shareholder to offer their shares to the other shareholders first before any sale can take place. A so-called “right of first refusal” is important to ensure that the business is not taken over by external and potentially unknown third parties.
4. You have no intention of growing and selling the business.
Many good businesses have a plan to grow and develop a business and have an exit plan to sell the business at some point. It’s a good strategy.
A Shareholders Agreement will allow you to include provisions known as Drag Along rights, which allow majority shareholders to force the sale of minority shareholders shares in circumstances where an offer to purchase the whole shares of the company is made.
If you are looking to sell, the last thing you’d want to jeopardise the sale is a minority shareholder being awkward in the hope of getting a bigger payment or just wanting to hold on to their shares. Drag Along rights ensure those shares are also sold.
5. You don’t have any minority shareholders
A minority shareholder is someone who typically has less than 25% shareholding, as this means they cannot block certain decisions being made.
However, many companies still want to provide minority shareholders with protection over some of the decision making to give them comfort. One example could be the issuing of new shares (and thus diluting current shares which would be very detrimental to a minority shareholder) and so a Shareholders Agreement might require unanimous consent of all shareholders voting to allow such actions.
Shareholders Agreements can also include Tag Along provisions. Tag Along provisions are similar to the drag-along provisions referred to above, but allow the minority shareholder to tag on to a majority shareholder selling his shares – i.e requiring a buyer to buy the minor shares as well as the major shareholding.
6. You do not offer shares to employees.
Often directors or other senior employees are given shares in the business to motivate them financially and link the business growth to their own pay packet.
However, giving shares to an employee is dangerous if not done properly. If they were to leave, resign, be fired etc then no doubt the company would want them to transfer the shares back and not to be able to sell them and profit from them. Whether they are sold back at “par” (e.g. at £1 per share) or there is a valuation mechanism attached, it is important to know the position.
The best way to achieve this certainty is to have them enter into a shareholders agreement and include a mechanism that if they leave employment that they must offer up for sale their shares. The agreement can then determine at what price that should be. Sometimes it can be different for a “good leaver” compared to a “bad leaver”.
7. You don’t care if someone leaves and sets up in competition against you.
If you’re super confident that a shareholder leaving your business and setting up in competition, taking away all your clients/customers and using a similar brand name to your business is not an issue, then you don’t need a shareholders agreement.
However, this is a real risk and I’ve seen it happen a lot with some significant damage caused.
A Shareholders Agreement can include restrictions, also known as restrictive covenants, to limit:
- setting up competing businesses
- dealing with customers/clients
- soliciting customers/clients
- affecting suppliers
- poaching staff
8. You will never need to borrow money
Having a Shareholders Agreement demonstrates to third parties such as a Bank that you are serious, you have given things some thought and built-in some resiliency to the business, that any future disputes could be dealt with swiftly and effectively. Banks like such stability.
Shareholders Agreements – Do I Need One?
In summary, the answer is yes – if you have a limited company with more than 1 shareholder, you should almost certainly consider having a shareholders agreement.
I offer a fixed-fee service for drafting Shareholders Agreement. We’ll discuss what the business needs are first before I prepare a bespoke shareholders agreement to suit your company.
I’m a commercial solicitor in Leicester and so I help Leicester Businesses (and further afield) in drafting Shareholder Agreements Leicester.
Contact Me Now
Call me on 0116 3667 900 for a no-obligation discussion
Shareholder Agreement Solicitor
Call: 0116 3667 900