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SHAREHOLDERS AGREEMENT SOLICITORS

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The Importance of a Shareholders' Agreement

The Importance of a Shareholders Agreement

As a business owner, did you consider how the company shareholding should be structured other than just the number of shares that each shareholder holds? You don’t know what you don’t know, so unsurprisingly, most business owners fail to consider this.

In most SME’s, shareholders will also be a director and/or employee. An important point to understand is that shareholders do not have any legal duties or obligations to the company.

So, what happens if there is a disagreement between shareholders?

What if they are close friends or family members? Fallouts can impact the company without the right legal structure being in place. You could potentially end up having nothing to show for your money, time and effort which you have invested in your company.  Even worse, you could end up with a costly legal dispute which may also lead to an irreversible breakdown of relationships. 

In the absence of a Shareholders Agreement, a company’s standard constitution and the Companies Act 2006 provide limited protection for shareholders. For example:

  • There are no provisions to prevent a director from being removed by 51 per cent of the shareholders, even if that director has the largest majority shareholding;
  • Important decisions are made by a majority, so even a single director who might be a majority shareholder, could be out-voted.
  • The articles of association can be amended by a 75 per cent majority of the shareholders, so a majority of shareholders could remove the protection of the minority shareholders.

When setting up a company, or looking at restructuring, a shareholders agreement can address issues such as those above. 

WHAT IS A SHAREHOLDERS AGREEMENT?

A shareholders agreement is a written agreement between all the shareholders of a company. It regulates the relationship between the shareholders, the company and the directors. It should provide clarity and will set out the framework on how the company is governed and operated. It will also deal with how disputes are resolved. 

The main aim of a shareholders agreement is to protect assets. A well drafted shareholders agreement will help mitigate against costly and potentially damaging shareholder disputes, should they arise in the future. 

Here are 8 common scenarios that a Shareholders Agreement can regulate

1. Decision Making on Important Strategic Matters

How will decisions be made in the company? What consents are needed by shareholders on important issues such as borrowing money from the bank, litigation, entering into significant contracts etc.

Will decisions be unanimous or by majority or will certain positions have enhanced voting rights? Will the chairperson be given a casting vote where there is no majority?

The relationship between shareholders who are also directors will usually be governed by the Articles of Association and a shareholders agreement.

If they are also employees, then that relationship with the company should also be clearly set out in a service contract.

2. Dispute Resolution (Deadlock)

A shareholders agreement will often contain a “deadlock clause” over internal disputes, for example, the strategic direction of a company. This typically occurs where there is a 50/50 shareholding. It may also be that a majority of shareholders wish to sell their shares, but a minority shareholder refuses.

A deadlock clause would set out the mechanism by which these disputes are resolved, for example by reference to an independent arbitrator or a buyout mechanism which would help set the price of the shares.

3. Transfer of Shares

This is likely to come up if a shareholder wishes to sell their shares to a third party who may not be the right fit for the business.

  • The directors will want to ensure that they have a say about who will become the new shareholder if someone wants to sell. This can be done using pre-emption rights.
  • It might be that the shareholder agreement stipulates that the shares must first be offered back to the company to buy, failing which they could be offered to existing shareholders pro-rata, failing which they could then be sold to a third party with the consent of the board.
  • Compulsory transfer of shares on certain events such as bankruptcy, death, serious illness or incapacity or on ceasing to be a director or employee. In events such as this you may want the shares to be offered back to the company as a matter of course.
  • On the issue of death, often cross option agreements are used, backed up by a life insurance policy for each shareholder, which would cover the sale of the shares back to the company on behalf of the personal representatives.
4. Share Valuation

There will often be a mechanism for valuing shares, which could also include a penalty provision for a “bad leaver” where for example fraud, dishonesty or gross misconduct is found, such that the valuation of the shares are downgraded. 

    5. Share Class Rights

    Regulates the Share Class Rights. There are 3 basic rights: 

    • Ability to vote 
    • To receive dividends 
    • Receive a return of capital 

    These rights can be varied to suit the circumstances. It could be that you look at allotting different classes of shares. For example, one class could have full voting rights and another can have rights to dividends but no voting rights at a general meeting. 

      6. Issuing New Shares

      Often a company will need to issue more shares. A shareholders agreement can use pre-emption right so that existing shareholders get first refusal on the issue of new shares, thereby protecting their share holdings. The agreement could also stipulate that new shares cannot be issued without the consent of a certain percentage of shareholders. 

        7. Policy Framework

        Policy framework can also be set out in a Shareholders Agreement, for example: 

        • The consents needed to determine payment of dividends and how they will be paid 
        • Repayment of directors loans and any interest to be paid 
        • The ability to raise finance at a later stage, albeit through banks or private equity 
        • Personal Guarantees – If taken out in support of company obligations, other shareholders could be made to contribute to the liability of that shareholder if the PG is called in 
        • A business plan could also be set out, which all directors agree to. 
        8. Restrictive Covenants

        Sometimes a shareholder may wish to set up a competing business. If the shareholder is also a director and employee, this could be addressed in a service agreement by reference to a restrictive covenant. Importantly, they can also be addressed in a shareholders agreement. The benefit here is that restrictive covenants in a shareholder agreement can be wider and longer than in any employment contract and easier to enforce.  

        When should you consider a Shareholders Agreement? 

        • If your business has two or more shareholders;
        • Worth considering when you are starting a new business with other people;
        • If you are buying a company with others;
        • If you are buying shares in an existing company (whether new shares or from an existing shareholder)
        • If you are retaining shares, after you sell or transfer shares to other people within your company.
        • At any time, as ultimately, it is always best to agree on terms whilst parties remain on good terms.

        How Much Does a Shareholders Agreement Cost? 

        If you get professional advice, then the cost that you will pay will depend on a number of factors such as:- 

        • The complexity of the agreement 
        • Location of the advisor (London rates tend to be higher) 
        • The number of drafts that might be required 
        • The extent of discussions or negotiations with other professional advisors and other parties 
        • The urgency of the matter 

        We charge from £750 + VAT to draft a shareholder agreement. 

        How long does it take to draft a Shareholders Agreement? 

        Again, this comes down to a number of factors including:- 

        • Complexity 
        • Number of parties involved 
        • Clarity of instructions 

        On average I takes around 2-3 weeks to draft the agreement, which includes taking instructions, first draft, review and amendments. 

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          Read all about Anu Hart, Managing Director of Kumari Hart Solicitors

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