Could a Shareholder Agreement save your business?

shareholder_agreement.jpgHere at The Legal Director, we’ve recently come across a business where the two co-founders have fallen out -- one is now leaving, in order to set up on his own, in direct competition with his former co-director.

Under the circumstances, the company’s bank account has been frozen—it needed both co-directors as signatories—and the business has more or less stopped trading while the complications are sorted out.

In another instance, a co-director has suddenly died. Encouraged by her parents, his wife—over twenty years younger, and with a background in coaching tennis rather than in electronic engineering—is proposing to sit on the board and assume a pro-active interest in the business.

Of course, neither circumstance had ever been envisaged at the time that the two businesses were set up. But in each case, and to the obvious discomfiture of those involved, an unexpected development looks set to see shareholder value put at risk.

Yet it doesn’t have to be like that. A simple piece of paper could have prevented both situations.

Fire extinguisher

To us, the analogy that best comes to mind is perhaps that of a fire extinguisher. It sits there, doing nothing, perhaps prompting people to wonder why on earth it’s there in the first place.

But in the event of a fire, it promptly comes into its own, putting out the blaze, and making people glad that they had it. In short, when there isn’t a fire, you don’t need a fire extinguisher—but when fire does break out, it’s almost certainly the only tool to hand that will do the job.

So too with shareholder agreements. For the vast majority of the time, they’re not needed, and—like a fire extinguisher—they just sit there, do nothing. And the simple fact is that many businesses—indeed, the vast majority—will never need one.

Yet when fire breaks out, in the form of significant shareholder disagreements or uncertainty, then a shareholder agreement comes into its own.

So what is a shareholder agreement?

At its most basic, you can think of a shareholder agreement as simply a set of rules, governing how the business is to be managed.

Who can make decisions about the business? Which decisions have to be unanimous, or carried out through weighted majority voting? What procedures are to apply in the case of any proposed transfer of shareholdings? Are existing shareholders to be offered the right to buy? How is the price to be calculated? What happens when a shareholder dies, or is incapacitated, or simply wants to retire?

Such questions, at their starkest, are the questions that will most trouble many businesses. But they’re also the very questions that a shareholder agreement can do a lot to assist with, should there be a dispute about the best way to address them.

Simply put, the shareholder agreement sets out the way forward, eliminating uncertainty and doubt, and providing a solid framework for constructive dialogue and action.

Protecting shareholder value

More to the point, perhaps, the shareholder agreement is more than just an understanding or an agreement—it’s an understanding that is enshrined in a legally-binding document.

So should your business have a shareholder agreement? In our view, it’s certainly a sensible precaution, just like that fire extinguisher.

Because no matter how well partners know each other, and how closely they work together at the outset of a business venture, that close cooperation can’t be guaranteed to continue.

And in such a situation, a shareholder agreement provides a set of rules to govern what happens, in a way that isn’t detrimental to the business, and which protects shareholder value.

Sensible investment

That said, it’s important that the shareholder agreement is properly constructed in a way that is appropriate for the business in question, and appropriate for the parties involved. Which is why it’s best to be cautious about some of the ‘off the shelf’ templates that are out there.

Typically, we reckon that a properly drafted shareholder agreement involves a couple of days’ work—talking to the various parties, establishing their wishes, and enshrining these in a legally-binding document.

And in our view, it’s a very sensible investment for a business to make.

At The Legal Director, we specialise in providing preceisly this kind of clear-cut legal advice, and in business-friendly language.

To find out more, get in touch by calling Ed Simpson on 01709 641 711.

Posted Monday, December 1st, 2014 by Warren Ryland



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