A well-drafted shareholder agreement is essential for protecting the interests of shareholders in a company. It outlines the rules for how they interact with one another and how the business is run. Here are the top 10 provisions every shareholder agreement should include:
1 – Right of Pre-emption on Transfer of Shares
Pre-emption rights give existing shareholders the first opportunity to buy shares, before they are offered to an outside party. This protects shareholders from unwanted third-party involvement and helps maintain control within the company.
Under the Companies Act 2006 (Companies Act), pre-emption rights automatically apply to the issue of new shares (unless modified by articles of association or shareholder agreement). However, these statutory rights do not extend to the transfer of existing shares. Including pre-emption rights in your shareholder agreement ensures that any shareholder intending to transfer shares must first offer them to existing shareholders – typically in proportion to their current holdings.
This in turn helps avoid a situation where a third party gains control of the company, or influences decision making against the interests of existing shareholders.
2 – Drag and Tag Along Clauses
These clauses provide protection for both majority and minority shareholders during a sale of shares.
- Drag-along: Allows majority shareholders to compel minority shareholders to sell their shares on the same terms during a sale. This ensures that the buyer can acquire 100% of the shares and reduces the risk of minority shareholders blocking a sale.
- Tag-along: Protects minority shareholders by allowing them to “tag along” with a sale. If the majority sells their shares, the minority can require that the buyer also purchases their shares on the same terms.
Both clauses prevent unwanted outcomes and ensure fairness during exit events. It is important that the threshold amount for triggering these clauses are clearly defined.
3 – Deed of Adherence
A deed of adherence binds new shareholders to the existing terms of the shareholder agreement. Without this provision, a new shareholder might not be bound by the agreement, leaving potential gaps in governance and shareholder obligations.
This deed is usually signed upon the transfer of shares to a new party. It ensures consistency across the shareholder base and protects the rights of all parties involved.
Including a template of the deed of adherence as a schedule in the shareholder agreement helps streamline this process.
4 – Good Leaver/Bad Leaver Provisions
Leaver clauses are designed to manage the exit of shareholders, particularly those who are also employees or key service providers.
- Good Leaver: A shareholder who exits the company under agreed conditions (e.g., retirement, redundancy, or other specified events) can sell their shares at fair market value.
- Bad Leaver: A shareholder who exits under less favourable circumstances (e.g., resignation, dismissal, or breach of agreement) may be forced to sell their shares at a lower or nominal value.
These provisions help protect the company from losing valuable shareholders under unfavourable terms and ensure a fair financial settlement.
It is important that shareholders clearly define and ensure that the exit events for good and bad leavers are fair.
5 – Restrictive Covenants
Restrictive covenants in a shareholder agreement can prevent former shareholders from engaging in activities that could harm the company post-exit. These typically include:
- Non-compete clauses: Prevent shareholders from starting or joining a competing business within a specified time and geographical area.
- Non-solicitation clauses: Prevent former shareholders from poaching employees or clients.
These clauses protect the company’s proprietary information and customer relationships.
It is important to note that restrictive covenants must be reasonable in scope and duration to avoid being unenforceable under UK law.
6 – Reserved Matters for Voting
Reserved matters are significant decisions that require shareholder approval before being actioned by the board of directors. These can include:
- The sale of major assets
- Issuance of new shares
- Limits on the amount of borrowings by a company
- The giving of guarantees by the company
- Changes to the company’s constitution (e.g., amendments to articles of association)
By clearly listing these matters in the shareholder agreement, you ensure that shareholders maintain control over key decisions that could significantly affect the direction of the company. Therefore, it is important that there is consideration of which decisions are crucial for shareholder involvement and ensure that they are detailed in the agreement to avoid ambiguity.
7 – Deadlock and Disputes Resolution
Deadlock provisions are particularly important in businesses with equal shareholding (e.g., 50:50 ownership). These clauses provide mechanisms to resolve situations where shareholders cannot agree on key decisions.
Common provisions include:
- Mediation and arbitration: Require shareholders to mediate or arbitrate disputes before pursuing litigation.
- Russian Roulette or Texas Shootout: Allow deadlocked shareholders to offer to buy each other’s shares at a specified price. If one party accepts, they must sell their shares at that price.
Including clear deadlock resolution mechanisms ensures the business can continue operating smoothly even when disagreements arise. These provisions should be tailored to your company’s specific needs.
8 – Death of a Shareholder
When a shareholder passes away, their shares typically pass to their estate. The model articles that apply to companies and the Companies Act provide minimal provisions relating to the transmission of shares.
The upshot is that this could result in an outsider taking control or disrupting the company’s management.
A shareholder agreement should outline:
- Whether shares are transferred back to the company or to the remaining shareholders.
- Whether the deceased’s shares are sold at market value or another agreed-upon price (e.g., fair market value).
- A process for how shares will be handled in the event of a shareholder’s death.
This ensures continuity and avoids unnecessary complications for the surviving shareholders. Any clause dealing with a deceased shareholder’s shares should ensure that the value of shares upon the death of a shareholder is fair and agreed in advance.
9 – Access to Information
While shareholders have a right to receive annual accounts and other basic information under the Companies Act, they may not have unrestricted access to all company records. A well-drafted shareholder agreement can grant shareholders more comprehensive access to company information, such as:
- Financial reports
- Board minutes
- Other operational records
This ensures transparency and allows shareholders to make informed decisions about their investment. However, one should remain mindful of protecting sensitive information and balancing shareholder rights with the company’s need for confidentiality.
10 – Further Financing
A shareholder agreement should include provisions for future financing requirements, specifying whether existing shareholders will be asked to provide additional funding (e.g., through shareholder loans or new equity contributions).
This ensures that the company can raise capital without immediately resorting to external funding sources like banks or other investors and helps keep control of financing within the existing shareholder base. In this respect, it is important to clearly define the terms under which shareholders are expected to contribute additional financing, including their rights and obligations.
Conclusion
A comprehensive shareholder agreement is vital for the smooth operation and longevity of any business. It not only sets out how the company will be governed but also provides protection for shareholders in various future scenarios, from disputes to exits and financing.
At Branch Austin McCormick, our specialists in corporate and commercial law can advise on shareholder agreements as well as a range of other business needs. If you’d like to talk to us about this and find out more, please contact Harender Branch on +44 (0) 20 7851 0109 or hkb@branchaustinmccormick.com.