Who needs a shareholders’ agreement
Company law rules generally provide that the directors of a company are responsible for day-to-day management of its business, and make most of the decisions. Only a few matters (such as changes to the company’s share capital, or to its articles) have to be referred back to shareholders for a decision. The shareholders have relatively few, but important rights to intervene, principal amongst which is the right to appoint and remove directors.
As between the shareholders themselves, company law rules generally provide that the will of the holders of a majority of the voting rights will prevail. A minority shareholder only has limited power to block shareholder decisions.
Shareholders in some companies will want to vary these usual rules. Circumstances in which this commonly happens are:
Companies are often set up on the understanding that, irrespective of their shareholdings, the shareholders will have a relationship akin to that of partners in a partnership – an equal say in how the company is run and how it develops, equal access to company information, and an equal share in the company’s success. Lawyers often call companies like this ‘quasi-partnerships’.
A shareholders’ agreement can be used to vary the usual company law rules, to provide equality.
Investors with a minority stake
An outside investor, such as a venture capital firm or a business angel, may be prepared to provide working capital to fund growth in your company in return for a minority shareholding. To protect the returns from, and value of, their investment, they will want more than the usual company law protections for minority shareholders.
A shareholders’ agreement (which, in this instance, may be called an investment, or subscription, agreement instead) can be used to vary the usual rules, to protect the outside investor.
Joint venture companies
Two businesses may set up a company to carry on a joint venture – maybe joint research and development, or a pooling of parts of their production, distribution or administration. Each takes half the share capital in the joint venture company, and each has the right to appoint half the board. They usually want to vary the usual company law rules so that neither investor can make any decision at either shareholder or board level without the consent of the other.
A shareholders’ agreement can be used to vary the usual rules, to create the required deadlock.
Shareholders in a quasi-partnership often consider a shareholders’ agreement unnecessary – they will rely on the closeness of their relationship with their business partners to solve future problems when they arise. Many also find it embarrassing or uncomfortable to discuss contentious ‘what if’ or worst case scenarios.
But many of the circumstances catered for in a shareholders’ agreement – circumstances that happen all the time – will arise when your business relationship has been strained or destroyed, so anticipating them now can save you significant time and money if they occur. Your discussions can also highlight areas where your expectations are not as similar to your partners’ as you thought. With your legal advisers helping to smooth negotiations, and making sure issues are raised and dealt with constructively, a shareholders’ agreement can be a worthwhile investment now, as well as valuable insurance for the future.
Many clauses in a shareholders’ agreement operate as voting agreements – the parties bind themselves to exercise their votes as shareholders to put into effect their agreed intentions as to how the business will be funded, run and developed. For example:
Rights of veto
Other parts of the agreement often provide that important decisions, whether or not they would ordinarily be taken by the directors or the shareholders, cannot be made unless all shareholders agree to them – so minority shareholders can veto them. Typically, these include decisions to:
Issue and transfer of shares
A shareholders’ agreement will often make specific provision for the procedure on issue and transfer of shares. On issue of shares, these provisions must balance the need for the company to be able to issue shares to raise further funds against the danger of a shareholder finding their shareholding has been diluted by an issue to other shareholders.
On a proposed transfer of shares, they must balance the value to shareholders of having a market for their shares if they want to sell them (or if they die and their estate wants to sell them), against the danger of other shareholders building up a larger shareholding than they previously held, or new, ‘undesirable’ shareholders being admitted.
If a pro-rata offer must be made, the agreement needs to provide a means of valuing the shares – by reference to an expert or arbitrator, or according to some formula in the agreement.
Rights to appoint directors
Shareholder agreements to protect outside investors may provide that they can appoint a director to the board of your company, to protect their interests. A venture capitalist, for example, may appoint a non-executive director, who takes little part in day-to-day management unless the company is not providing the promised return. A business angel may insist on being appointed to the board in person, and may play an active (and valuable) part.
Agreements may contain a mechanism for resolving disputes, such as referral to a third party expert or arbitrator, or a buy-out mechanism whereby, if a dispute occurs, one side buys out the shares of the other at a price determined in accordance with the agreement. It can even provide that, in the event of an unresolved dispute the parties agree to vote to wind the company up.
The issue of which party buys out the other, and at what price, can be extremely difficult to negotiate. Agreements can become quite complex. One solution, for example, is to say that one shareholder can offer their shares to the others at a price of their choosing. If the other shareholders accept, they pay the price that has been set. To stop the seller from setting an unrealistic price, the agreement also provides that, if the other side does not accept the offer, they become obliged to sell their shares to the original seller, who is obliged to buy them, at that price. The original seller will not want to set too high a price for their shares, because they may end up having to buy the other party's shares at that price!
Provisions in a shareholders’ agreement could, in many cases, be included in the company’s articles of association instead. There are technical differences between the two that mean that, very broadly, a shareholders’ agreement is appropriate if the arrangements you want to set up are for individuals involved with the company (or some of them) now. Articles are appropriate if you want the arrangements to apply to future shareholders too.
One key difference between the two is that, if properly drafted, a shareholders’ agreement is a confidential document, whereas the articles of association are a public document, available at Companies House for all to see.
There may be overlap between a shareholders’ agreement and, for example, the company’s articles of association or service contracts with directors and other staff. For example, a shareholders’ agreement and articles of association may both include provisions governing transfers of shares, and service contracts and shareholders’ agreements may both contain restrictive covenants prohibiting directors and employees from working for competitors, or disclosing confidential information.
Your legal adviser will tell you the best place for each provision, and ensure there are no inconsistencies between the various documents.
Once you have an idea of what points and issues you would like your shareholders' agreement to address, the agreement can be drafted in a few days. However, if there are issues which need to be negotiated, this will affect the length of time that the agreement will take to draft.
The costs for advising on and drafting a shareholders agreement will vary depending on the complexity of the issues involved and the length of negotiations.
Finally, remember it is important that you always take legal advice.
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