A shareholders agreement is a way of planning for the future. The document redistributes decision making power on matters that are important to certain owners, and sets out what happens in certain circumstances.
Unlike with articles of association, there is no legal requirement to use a shareholders agreement. However, you’ll find that your investment in your company is much better protected if you do put one in place.
You don’t need to use a solicitor to draw one up. Often the best way of creating one is to use one or more templates as the foundation of the mutual written agreement between all owners.
Your agreement does need to be written within the framework of company law. For example, you can’t override the statutory requirement under the Companies Act for shareholders holding at least 75% of the voting shares of the company to approve changes to the articles of association.
So what should your shareholders agreement cover?
Decision making by directors as opposed to shareholders
Directors run the company on a day to day basis on behalf of the shareholders. Directors usually have an equal say on matters at board meetings. So if you have three directors, if two directors vote for a motion, it will be passed.
However, when directors are also shareholders, the directors might have unbalanced power compared to the shares held. Going back to the example above, if all directors were also shareholders, and the shareholdings were in the ratio 55:25:20, then the shareholder with the majority ownership might find that the other two shareholders (in their position of power as directors) were able to force a motion.
Of course, in the example above the majority owner could sack the other two directors, but while that might be possible in law, in a real world working relationship, removing the directors is unlikely to be practical or desirable because (a) they remain owners and (b) their skills and knowledge is probably needed to make the business successful.
Grant of rights to lenders who are also shareholders
The situation becomes more complicated if one of the owners has lent the business money. A lender has no rights at all, but might have a significant interest in the business as a result of the amount of his lending. Buying shares in return for the investment might not be possible, so one way of protecting his additional investment is for all shareholders to agree in a shareholders agreement that the lender is to be able to have greater voting rights in certain matters related to his loan.
Transfer of shares
One of the advantages of incorporation – of creating shares in a business – is that those shares can be sold or given to someone else. The downside of being able to sell shares is that in doing so, an owner gives away control. He or she probably doesn’t mind too much. But the other shareholders might. Transfers of ownership may upset relative power. They might transfer power to other owners, or they might transfer power to newcomers.
You can’t ban a shareholder from selling or transferring his shares. But you can agree (together, in advance) to limit the transfer of power.
You might agree that before any shareholder sells to an outsider, other shareholders might have the right to buy at the price the outsider will pay. This is known as a right of first refusal.
You might agree that if any shareholder sells to an outsider, the acquiring owner must also buy the shares of any other shareholder who also wants to sell at that price. This is known as a tag-along right.
You might agree that if any of the shareholders die, then the shares can pass to his or her family members, but those family members do not have any decision making power (other than that granted by law) until all the remaining original shareholders vote unanimously to give it to them, or unless that new shareholder has worked in the business for more than two years. That might prevent a rash, young beneficiary with little experience from upsetting the business. You can’t prevent who inherits someone else’s shares easily, but you can limit what the new shareholder can do.
Planning for exit
When you found a company, you don’t think of selling it. But your other shareholders might have different ideas. They might want to sell within four years, for example, so that they can set up the next big project.
One thing you can do is to set out a statement of intention. This is simply your intention at the current time about what you will do in the future. It is not set in stone, and is not legally binding on you. But it might give other shareholders confidence that there is a plan, and that they can expect their money back from the venture one day.
The next thing you can do in your agreement is to specify what happens in precise exit scenarios. For example, what would happen if the company was approached by a competitor?
Some shareholders will benefit more in certain circumstances than others, so your agreement needs to cover what happens to each (in broad or specific terms).
Working with other businesses and people
Your business will interact with many other people and businesses. Those relationships may be more beneficial to other shareholders than to you.
For example, one shareholder may insist that your business appoints another of his businesses (in which you have no interest) as a “preferred supplier”. That other business might give your business beneficial prices by passing along a bulk discount, but it might also charge above market rates. In either situation your fellow owner might profit. However, you only profit in one of them.
A fellow shareholder might insist that you hire his friends or family to work in the business. Again, this might be fine if they have the right qualifications and experience, but it might be disastrous if his family members are promoted to senior positions because of their relationship status rather than because of their suitability.
Lastly, you may find that your shareholders decide to compete with your business. Perhaps your company has grown from being a single service provider to being a multi-service provider. One of your fellow shareholders might see that one of the new services gives high profit margins, and poaches several key staff working in this service area to set up a new company with him. Your shareholder agreement should cover what happens if a shareholder does compete (perhaps the supply of operational information is limited if a shareholder is deemed to have conflicts of interest, or perhaps his voting rights on certain matters are reduced).