If you’re in business with others, you have probably considered whether you need a shareholder agreement or whether your company’s articles of association provide sufficient protection. As the purpose and distinct provisions of each document can cause confusion, we thought it would be helpful to provide some clarity.
So, in this article, we’ll give you some information about the purpose of a shareholder agreement, the circumstances under which you need one and what specific eventualities should be provided for. And we’ll also flag up some of the problems that you may encounter if your shareholder agreement is poorly drafted.
What is a Shareholder Agreement?
A shareholder agreement is simply a contract between all or some of the shareholders of a company that sets out their rights and obligations in relation to that company and its business. A properly drafted shareholder agreement will give all parties confidence that the business and their investment are protected.
Does Every Business Need One?
A shareholder agreement is not a legal requirement and not all businesses need one, and we would advise you spend time thinking about the specific needs of your business rather than automatically going down the shareholder agreement route. Both the Companies Act and a company’s articles of association provide some shareholder protections which may be sufficient. If, however, you want to provide additional security to yourself and your shareholders then you should consider a shareholder agreement.
Every business and every group of shareholders has different requirements. If the arrangements you put in place are not tailored to the specific needs of your business, it can lead to considerable issues should a dispute arise. If you are unsure about what is the best option for you, please do get in touch. An investment in getting it right at this stage, could save you considerable time and money in the longer term.
What Terms and Conditions Would Normally Be Included?
A good shareholder agreement should set out expectations and provide a road map for when things go wrong, or shareholders exit the company.
Typical provisions include:
- The object and scope of the business
- What each shareholder is expected to provide to the business
- What information each shareholder will receive about the business
- The composition of the board
- How decisions are made
- Procedures for the issue and transfer of shares
- Details of the rights attaching to separate classes of shares
- Provision for resolving deadlock
- What happens if a shareholder wishes to leave
- Process for removing a shareholder that breaches the agreement
- Restrictive covenants
- Confidentiality clauses.
Limitations of Articles of Association
Some of the typical provisions mentioned above will be repeated in your articles of association (for instance, clauses dealing with the issue and transfer of shares, and share rights), but as they need to be registered at Companies House, and are therefore a matter of public record, your articles are inherently unsuitable for matters of a personal or confidential nature.
Common Problems with Shareholder Agreements
Though standard shareholder agreement templates are readily available on the internet, they have not been created with your business and your shareholders in mind and will not have all the information that is pertinent to your business. As such, they are unlikely to be fit for purpose. In the event of a dispute, it’s unlikely that an off-the-peg shareholder agreement will give you the tools necessary to progress to satisfactory resolution.
The most common disputes we see occur when business partners fall out and either there is no shareholder agreement, or the one in place does not provide an adequate road map to resolve the dispute. One of the shareholders might not be pulling their weight, or decide they want to leave, possibly to join or set up a competing venture.
Deadlock is a very real risk here. If business partners are unable to agree on a simple operational or managerial matter, the impact can be catastrophic, especially if the bank mandate requires the signature of more than one partner. If no agreement is reached, a company simply cannot operate, and the only remaining option becomes to wind down the business. A well drafted shareholder agreement should clarify each shareholder’s responsibilities, and what happens in the case of breach up to and including a mechanism to exit that person from the business with a forced sale of their shares.
Failing to make specific provision for the transfer of shares after the death or incapacitation of a shareholder can be problematic and it is important, however difficult, to have conversations about these scenarios when your shareholder agreement is being drafted. In the absence of this detail in the shareholder agreement, a person’s will determines who gets the shares and you face the prospect of a stranger having influence in your business. With proper planning you can put in place a compulsory sale provision backed by a life insurance policy to fund the purchase price.
Get in Touch
If you have any questions about the above, or would like any help drafting a shareholder agreement that is tailored to your needs and protects your interests, please contact us on 020 3056 8538 or info@thelegaldirector.co.uk.
And, if you would like to hear more about the topic, have a listen to this episode of our podcast ‘TLD Talks’, where Client Legal Director David Garland talks with CEO Ed Simpson to share some of his expert advice on the matter.
