DTM Legal’s Fredrica Jarrett outlines the importance of Shareholders’ Agreements, and the risks of not having them.
Whether you are a shareholder of an owner managed business with fellow shareholder directors, a shareholder in a business where you are not involved in day to day operations, or you are thinking about starting a joint venture business; it is important that everyone involved in the ownership and management of the company is clear as to their rights and responsibilities (and those of their fellow owners and managers).
The risks of not having a Shareholders’ Agreement
- Disagreement can often arise amongst shareholders, leading to a position where the shareholders cannot agree on the best way forward, and there is no majority to pass a resolution
- Minority shareholders can often end up having little control or say in the running of the company
- The board could potentially have too much control, without any shareholder involvement on certain matters which shareholders feel they should have been consulted about
- Articles of Association of a company are a public document, and as such may not be appropriate to address sensitive or internal company issues
- Things may not work out as planned and difficulties can arise without a clearly defined exit strategy
How a Shareholders’ Agreement can overcome the risks
A Shareholders’ Agreement can detail how to deal with disputes and the outline the procedures to follow in the event of a “deadlock” situation.
“Texas shootout” or “Russian Roulette” clauses requiring a shareholder to state a price per share at which he will either buy or sell can be included, and it can also provide much more protection for minority shareholders than those provided in the Companies Act 2006.
Shareholders with smaller shareholdings can ensure their involvement by listing matters which will require their consent or enable certain shareholders the right to appoint a director – this also enables shareholders with smaller holdings to ensure the protection of their investment.
A Shareholders’ Agreement can be used to control the division of power between the directors and shareholders and the extent of shareholders’ influence over the management of the company. This can include details of matters which require either the consent of either all or a specified majority of the shareholders.
It is a private contract between the parties and can address issues which for reasons of confidentiality shareholders may not want detailed in the Articles of Association.
As the company is often also a party to the Shareholders’ Agreement it can be used as a mechanism to bind the company to particular obligations, and it can also outline the circumstances in which the agreement will terminate and the procedure for the transfer of shares.
What else can a Shareholders’ Agreement contain?
- How the company is to be managed and how the board is to be appointed
- The financing of the company and how future finance will be raised
- The procedure which applies in the event of a shareholder wishing to dispose of his shares (and the circumstances in which a shareholder may be forced to dispose of his shares) including how shares are to be valued, the right of first refusal for the company and other existing shareholders and any necessary prohibitions (for instance stopping the sale to competitors)
- The issue of further shares and whether current shareholders get the first option to subscribe so as to maintain their existing percentage holding
- Dividend policy of the company. What percentage of post tax profits should be paid to shareholders each year and a provision detailing when the company is not obliged to pay any dividends
- Any restrictive covenants placed on the shareholders whilst they are a shareholder and/or once they have sold their shares
TOP TIP – Restrictive covenants in Shareholder Agreements can carry more weight than those in employment contracts! An outgoing shareholder will usually receive payment which can be directly related to the value of the company.
Why should you have a Shareholders’ Agreement?
A Shareholders’ Agreement can cover as many or as few matters as the parties feel necessary. It creates a balance between the need to protect shareholders whilst enabling the board to run the company without undue interference.
Far too often people set up companies with friends or relatives without consideration of protecting their interests in the company until it is too late.
Having a Shareholders’ Agreement and getting it right from the beginning can save a lot of time and costs further down the line if things do go wrong!