Shareholders’ agreements: what they can do for you

The importance of a shareholders’ agreement

We see time and time again businesses who do not have adequate protection or appropriate provisions governing the relationship between different shareholders. The consequence of this can be expensive and disastrous to both businesses and individuals.

What is a shareholders’ agreement?

A shareholders’ agreement is a private document used to outline the obligations and rights between the different shareholders of a company. Without a shareholders’ agreement, the relationship between the shareholders is governed by the articles of association which, importantly, is a public document.

What can a shareholders’ agreement cover?

There is nothing that prescribes what should be included in a shareholders’ agreement, as it is personal to each relationship. Typically, however, a shareholders’ agreement will outline:

• How specific business decisions are to be made
• How the company will be run
• Provisions relating to company share sales, transfers, and issuing and allotting shares
• What happens to a shareholder’s shares when they die
• What would happen if one of the shareholders leaves for any reason
• What would happen if the shareholders could not reach agreement on a decision

The above is by no means an exhaustive list but gives a flavour of the different provisions that should be considered.

Why do I need a shareholders’ agreement?

Now you have a brief outline of what a shareholders’ agreement is and the types of things that could be covered, why does your company need one? There is a magnitude of reasons for doing so, some of which I have touched on below.

Decision making

Although the running of the company is generally left to the board of directors, there may be certain matters and decisions that the shareholders believe requires their approval. Provisions can be inserted to this effect to ensure important decisions are not left to the discretion of the directors.

Employees who are shareholders

You may have or wish to award shares to your employees. When doing so, it is important to consider what would happen to their shares should they leave the business. A mechanism can be inserted into the agreement to ensure a person’s shareholding is linked to their employment so should they leave they must also part with their shares.

If this provision was not included there is danger an employee could leave the business and continue to benefit through the holding of shares from the dedication of those who remain within the business.

The amount the employees receive for their shares can also be prescribed within the shareholders’ agreement and can be linked to whether they leave on good or bad terms. For example, if the employee was dismissed for reasons of gross misconduct, they would only receive nominal value for their shares to ensure the business was not rewarding the employee.

Deadlock

What would happen if a business had two shareholders both holding 50% of the entire issued share capital and they are unable to reach agreement regarding a decision? The shareholders’ agreement can include specific provisions for these circumstances which may include a referral to mediation or to an independent arbitrator.

Breakdown in communication between shareholders

Unfortunately, disagreements between shareholders are common and, although at the beginning of a business relationship it seems impossible, it is important to think about. It may be that the provisions of a shareholders’ agreement are never thought about after they have been agreed. However, if things were to breakdown between the parties, it provides a vital and clear position of what is expected from each shareholder, in times when you are not necessarily seeing eye to eye.

Offers minority and majority protection

If you are a minority shareholder there are certain protections that should be considered. For example, you may wish to have the ability to ensure your shareholding is not diluted by imposing restrictions on the ability of the company to issue further shares.

Similarly, if the majority shareholders wish to sell their shares to a third-party purchaser, tag along provisions should be considered. These allow the minority shareholder to participate in the sale on the same terms as the majority shareholder.

On the other hand, as a majority shareholder you may wish to include drag along provisions. If you were to receive an offer to buy all the shares in a company, the majority shareholders would be able to force the holders of the remaining shares to participate in the sale on the same terms so they do not suffer any loss.

Death of a shareholder

The shareholders’ agreement can contain provisions of what should happen to a shareholder’s shares should they pass away. Should the shares be able to pass to the deceased shareholder’s beneficiaries? This could mean the remaining shareholder is forced to make decisions and run the company with the deceased shareholder’s distant cousin (not always the most practical!)

Should the deceased shareholder’s personal representatives have the ability to force the remaining shareholders or the company to purchase the shares, so the beneficiaries receive the monetary benefit of the shares? There are many options that can be considered and should be discussed at the outset of the business relationship.