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Shareholders’ Agreement: Why You Need One.

Date Added 09.04.24

When setting up a business, whether it is with friends, family or colleagues, it is very easy to fall into the mindset that nothing will go wrong at any point now or in the future. You might even assume that due to the relationship you have, you will not need a formal document in place to record your working arrangements. You might think that the idea of suggesting such a document may well give the impression that you don’t trust your new business partners. However, even the closest of business relationships can break down, leaving you with a potentially costly legal dispute.

This is where documents such as shareholders’ agreements come in, as they give individual shareholders additional protection and the confidence to embark on business ventures safe in the knowledge that all parties are protected.

In this article, we look at shareholder agreements in detail and discuss what you need to know to protect yourself and your business.

What is a shareholders’ agreement?

A shareholders’ agreement is essentially an arrangement made, usually, between all of a business’s shareholders (i.e. the shareholders in a Company, there are similar agreements for a Partnership – partnership agreement, and LLPs – member’s agreement).

The agreement outlines, amongst other things, the objective of the business, provides rules regarding the fundamental management decisions of the business, states shareholders’ obligations and rights, regulates how shares are transferred and provides information on how shareholder interests will be protected and their relationships regulated.

A shareholders’ agreement is a private document as it is not registered at Companies House and that is why this agreement is used rather than changes to the Articles of Association of the Company, which are registered at Companies House.

What protection do you have without it?

Without a shareholders’ agreement, a business’s only protection is the Articles of Association. The Articles are a legally binding document required, under the Companies Act 2006, by every public and private company in the UK. The Articles of Association are a set of rules that outline how a business will be run, how decisions are made for the business and which act as a contract between the shareholders, directors and the Business.

The Articles of Association are a business’ most important constitutional document and are put in place at the point of incorporation.

Minority shareholders also have statutory protection against any “unfair prejudice” that might be carried out by the majority shareholders (e.g. making decisions that reduce the value of the minority shareholders’ shares).

Why would you need a shareholders’ agreement?

Whilst a shareholders’ agreement is not required by law and is often seen by some as not necessary, the value it can provide is very important. Not having an agreement in place can create a lack of certainty in how to deal with different situations and scenarios and if matters escalate can often lead to disputes, which will be much more expensive than the cost of a shareholder agreement.

Tollers’ experienced Commercial Team has outlined below the benefits a Shareholders’ agreement can bring both to shareholders and a business and why it is in everyone’s best interest to have an agreement in place:

1. Ensuring proper governance of the company

The everyday management of a company is carried by the board of directors, with shareholders having little or no involvement in management decision-making. A shareholders’ agreement will specify how major decisions should be taken (e.g. capital expenditure over a specified amount). Those decisions might require the unanimous consent of the shareholders or a majority. This mechanism therefore allows the shareholders to exercise management decisions and to limit the authority of the board of directors. This ability to make fundamental management decisions becomes vital when the directors on the board are not shareholders in the company.

2. Protection for Majority shareholders

A shareholders’ agreement can be drafted to protect the interests of majority shareholders. A majority shareholder may not always take an active role in the daily running of the business or may not have a majority representation at board level. An example of protection for the majority shareholder is a “drag along” clause. The “drag along” clause enables a majority shareholder to force minority shareholder(s) to participate in the sale of the company. This is so the minority cannot stop the sale of the company.

3. Protection for Minority shareholders

Shareholders’ agreements can be drafted to protect minority shareholders and to ensure that they are not taken advantage of or that the majority shareholders do not force decisions that are not in the minority’s best interest. For example: a clause can state that certain decisions such as the appointment of other shareholders must be done with the unanimous decision of all shareholders. There can also be “tag along” clauses that ensure that the minority shareholders are not left behind in a sale.

4. Resolving Disputes

A clause can be included in the agreement for dispute resolution with the aim of helping resolve disputes between shareholders promptly and cost-effectively. Dispute avoidance is achieved by including a framework for how specific decisions are to be made.

5. Transfer of shares

If in the absence of restrictions in a shareholder agreement or the Articles of Association, shares may be transferable (there are some statutory protections). This could damage the business as an unwanted third party could purchase the shares and/or take control. This third party could be a stranger or a longstanding competitor. A common clause that can be included is that if a shareholder wants to sell their shares, the other shareholders have the right to purchase them before they are made available outside the company. If this does occur, the new shareholder is normally obliged to enter into a ‘deed of adherence’ whereby they become bound by the terms of the shareholders’ agreement. This safeguards the original shareholders and ensures that the new shareholders agree the terms already agreed between the existing shareholders.

6. Setting out the rights and obligations of shareholders

There are many factors to consider when setting out the rights and obligations of shareholders.

A shareholders’ agreement can set out what rights the shareholders possess and provide clarity on the obligations each shareholder has in the running of the company and its decision-making processes. Some of the rights the agreement can set out are:

  • The right to vote on company decisions;
  • The right to dividends;
  • The right to sell shares;
  • The right to information.

These help to provide clarity to shareholders, avoid misunderstandings relating to roles and ensure all shareholders are treated fairly and that their interests are protected.

How Tollers can help

When seeking any legal agreement or document, it is always advisable to seek expert legal advice. This is because commonly, risks lie with what has not been included rather than what has.

Constitutional documents such as the Articles of Association or a shareholders’ agreement are tailored to work in the best interest of the business, their management and share structure. There may be templates for agreements, however, these documents are not “one size fits all”.

Receiving expert legal advice to ensure the agreement is tailored to best suit your business, the situation and the shareholders is crucial and will avoid creating possible issues in the future.

Tollers Commercial Law Team is experienced in drafting and negotiating shareholder agreements and will ensure you receive the correct documentation for your business regardless of whether it is a simple shareholders agreement or a complex all-encompassing one.

To find out how Tollers can help you and your business with a bespoke shareholders agreement… Talk to Tollers on 01604 258558 our team is on hand to guide you through the process and ensure the best solution is put in place.

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