March 27th 2018

8 Reasons Why Every Company Should Have a Shareholders’ Agreement in Place.

What is a shareholders’ agreement?

A shareholders agreement is a contract entered into between all of the shareholders of a company and, normally, the company itself, to govern the relationship between the parties and to include the personal rights and obligations of shareholders. Together with the Articles of Association of the company and the Companies Act 2006, this will form the rules and requirements by which the company, directors and shareholders are required to act in relation to each other and the company itself.

Even though there is no legal requirement to have a formal shareholders agreement, here are 8 reasons why every shareholder of a private company should have such an agreement in place.

In short, the shareholders agreement provides certainty in circumstances where otherwise shareholders may be unclear as to what they should do to protect their interests.

Unlike the Company’s Articles, the provisions of the shareholders agreement are private as between the shareholders and their advisers, and is not a publicly accessible document.

1. Disputes

Despite everyone’s best intentions, during the day to day operation of the company the shareholders and/or the directors may run into a dispute. Disputes can be time consuming and expensive and can take everyone’s attention away from focusing on the success of the company. When disputes do arise, there is often little in the general law that is of assistance and sometimes the only solution may be to dissolve the company, even if the company itself is successful.

A shareholders agreement can be a very useful tool in avoiding and managing such disputes and can include provisions setting out a mechanism for the parties to resolve disputes without dissolving the company. Sometimes to resolve a dispute, one or more shareholders may agree to sell their shares to the other shareholders. A shareholders agreement will often include valuation provisions to ensure a clear valuation mechanism for those shares and avoid a further dispute regarding the price to be paid.

2. Deadlock

Sometimes during the life of a company the shareholders and/or their representative directors may not see eye to eye on certain matters, and agreement on certain issues with a required majority cannot be reached. This is especially the case where shareholders own the shares equally, 50/50, for example.

A shareholders agreement can mitigate this risk by having provisions which set out what should happen where there is a deadlock between the parties, including bespoke mechanics for the parties to buy each other out. There are a variety of these available.

3. Investor protection

It is common for smaller companies to have a group of shareholders who are considered to be investors, in the sense that they have injected money into the company for working capital or other requirements in exchange for an equity stake in the business.

Investors are taking a risk on their investment as they may not recover the monies which they invested into the company and so they often require the shareholders to agree certain provisions designed to protect their position. For example, they might require performance targets for the company to meet within a given time and if those targets are not met, the investor has the ability to require certain actions to be taken, or has the opportunity to take control of the company. These provisions are often found in a shareholders agreement.

4. Unknown parties

The starting position at law is that shares are, unless agreed otherwise, freely transferable and so there is a risk that a shareholder may decide to sell or transfer their shares to a completely unknown person or even a competitor. That new shareholder may introduce uncertainty as to the future of the business or act in a way to frustrate the success of the company.

To protect against this there are often provisions in the articles of association of the company and/or a shareholders agreement to ensure that if a shareholder proposes such a transfer then the other shareholders are offered the leaving shareholder’s shares first at an agreed price.

If the other shareholders do not take up that offer then the shareholders’ agreement should also contain a requirement for the recipient of those shares to enter a “Deed of Adherence” whereby the recipient agrees to be bound by the terms of the shareholders’ agreement. This gives the other parties to the shareholders’ agreement comfort in knowing that any new party has to act in accordance with the provisions of the existing shareholders’ agreement.

5. Confidentiality

The shareholders are likely to have access to valuable confidential information about the company by reason of their involvement in the business. Whilst the general law provides that a person who has received information in confidence cannot take unfair advantage of it, most shareholders are not prepared to rely on this alone. A shareholders agreement containing confidentiality provisions is the best way for a company to ensure that the shareholders will keep information about the agreement and about the company confidential during the life of the agreement and following its termination.

6. Restrictions

A shareholder may wish to establish another business that potentially competes with the existing company, but that won’t often sit well where the parties have gone into a venture together and have shared information, knowledge, clients etc. A shareholders agreement may impose a series of restrictions on each shareholder to the effect that he will not, at any time when he is a shareholder, and for a specified period of time after he ceases to be a shareholder, carry on any other business that competes with the business of the company or entice away customers, employees or key suppliers of the company. These restrictions can be stricter than may exist in any employment contract and can be very valuable in protecting the interests of the company and avoiding conflict.

7. Minority shareholder protection

A shareholders agreement may provide protection for minority shareholders by reserving certain decisions for the unanimous consent of all the shareholders, for example decisions to vary the articles of association or permit the registration of any person as a new member. This will effectively give the minority shareholders veto rights and ensure they cannot be adversely prejudiced by the majority shareholder(s).

The shareholders agreement may also contain “tag along” provisions, which say that if the majority wishes to sell their shares to a third party buyer, that buyer would be forced to offer to buy the minority shareholders’ shares on the same (or better) terms. This will enable the minority to leave the company if they do not want to continue under new management and control.

8. Majority shareholder protection

For investors, exit from the company at a price whereby they realise value for their investment is of particular importance. A “drag along” provision operates where the majority shareholders in particular wish to sell their shares to a third party but the third party is only willing to purchase 100% of the shares in the company. In those circumstances, the selling shareholders can “drag along” or force the minority shareholders to also sell their shares to that third party on the same terms. This ensures that the majority is not left without an exit route.