Solicitors for a shareholders agreement

We understand why many start-up businesses think they can wait to get a shareholders’ agreement in place. As against this, there are so many reasons why, when setting up a limited company with several shareholders, that a shareholder agreement is vital to ensure the smooth running of the company.

With many small businesses there are often just one or two or a small number of shareholders when the company is set up. At this point, it is common and fully understandable for there to be great optimism about the business but also that you are in business with the right people, often friends or family. Unfortunately, things change and shareholder disputes are very common and very damaging, especially for growing businesses which are becoming successful.

Articles of association vs shareholders agreement

The main difference between articles of association and a shareholder agreement is that the articles exist when the company is incorporated. A company has a choice between adopting the model articles or implementing their own bespoke articles. A shareholder agreement is not a mandatory requirement fora company.

Articles apply to all shareholders and directors of a company. This applies when they receive shares or are appointed to an office (such as a director). A shareholders’ agreement may only be enforced if the shareholder has either signed and accepted the agreement originally (as a signatory) or if a new shareholder signs a deed of adherence, in which they agree to be bound by the terms of the shareholders’ agreement.

A benefit to a shareholders’ agreement is that it is a private contract. This means that a shareholders’ agreement does not need to be filed or sent to Companies House. It remains a confidential document between the shareholders. Conversely, articles of association and any amendments to them must be submitted to Companies House and are easily available on the public record.

The drawback to a shareholders’ agreement is that any material amendments will (usually) require unanimous consent. On the other hand, amending the articles only requires approval of at least 75% of the shareholders, meaning you do not necessarily need all shareholders to agree.

It is therefore important that a shareholders’ agreement is drafted carefully and is forward thinking to minimise the need for changes in the future.

Why you need a shareholders’ agreement

Often, on the incorporation of a company, the shareholders delay or neglect to put in place a shareholders’ agreement and instead rely on the existing articles of association. The reasons are understandable, with new shareholders excited or optimistic about the new venture failing to see the potential pitfalls, or otherwise placing discussions on a shareholders’ agreement on the ‘backburner’.

However, situations may arise where there are disputes between the shareholders, which can be damaging to a new business. A company’s articles of association can assist with dealing with some issues, although a lack of bespoke clauses particular to the company and other general clauses, make it difficult to rely on articles in most disputes. A well-crafted shareholders’ agreement can better deal with issues that arise.

For example, minority shareholders have limited rights and control in making decisions and running the company. The model articles of association do not provide any rights to these shareholders, other than what is already provided under the Companies Act 2006 (Companies Act). Exercising or protecting shareholder rights under the Companies Act may well involve litigation, which can be expensive and time consuming.

A shareholders’ agreement can provide protections for minority shareholders such as tag along clauses (which protects a minority shareholder in the event of a potential sale of the company), right to information about the company (the Companies Act only gives shareholders the right to receive limited information, such as board minutes), and increasing the threshold of shareholder consent for important decisions (this allows the minority shareholder to block or at least influence some decisions).

What clauses are common in a shareholders’ agreement?

• Setting out the rights of shareholders, including the rights of minority shareholders.
• Share transfer procedure – this sets out the position on transfer or sale of shares, including any pre-emption procedures, and the requirement for a deed of adherence to bind new shareholders.
• Drag along and tag along clauses – drag along clauses allow the majority shareholders to compel minority shareholders to sell their shares in the sale of the company, whereas tag along clauses allow minority shareholders to join the majority in the sale of their shares. These clauses provide benefits to both the majority and minority shareholders.
• Day to day control and participation – what obligations are expected of shareholders in the management of the company.
• Restricting individual shareholders and/or directors powers – a board of directors manages the day-to-day affairs of the company and is usually given powers to manage its affairs. Some important decisions may be reserved for the shareholders to consider and approve, as they see fit. This may include limits on borrowing or expenditure, adoption of business plans, employing people at a certain salary, etc.
• Death, illness, or bankruptcy of a shareholder – a shareholder agreement will commonly detail what should happen if a shareholder dies, becomes seriously ill or is made bankrupt.
• Pre-emption rights – rights of pre-emption refer to the ability of existing shareholders to benefit from a transfer of shares (from existing shareholder to a third party) or to the issue of shares. It operates to prevent dilution and to provide control over who a shareholder sells its shares to. Note that the Model Articles of Association with which many companies are incorporated do not include any restrictions on share transfers.
• Valuing shares – a shareholders’ agreement should contain a provision on how shares will be valued if a shareholder wishes to exit the company or is otherwise compelled to transfer their shares. An independent accountant (or the company’s accountant) usually determines the market value of the shares. The amount a departing shareholder receives is often linked to whether the departing shareholder is a good leaver or bad leaver (as those terms are defined in a shareholders’ agreement).
• Non-Competition Covenants – it is advisable to ensure that a shareholders’ agreement contains clauses protecting the confidential information and trade secrets of the business. It is common to include clauses which prohibit any departing shareholder from setting up a new business in competition with the company, or trying to poach customers, suppliers and employees.
• Process for dispute resolution – a clear dispute resolution process for resolving disputes is very important to minimise the risks of expensive, lengthy, and uncertain court disputes. This is also important to have in place in the event of a deadlock between an even number of shareholders.

How we can help

• Drafting shareholder agreements for businesses (either when incorporating a company or at a later stage).
• Amending or updating shareholder agreements.
• Ensuring that a shareholder agreement dovetails with and does not conflict with your company’s articles of association. 

Branch Austin McCormick has a team of commercial lawyers well to assist you in getting the right shareholders’ agreement for you. Please contact the corporate team.