Although it is not a legal necessity, it is recommended practice when starting a business with more than one shareholder to get a shareholder agreement drawn up. The shareholder agreement is a contract that regulates business between the shareholders, setting out their rights and obligations. Unlike the company’s articles of association, it is not a public document and does not need to be lodged with Companies House. While there is therefore no prescribed form, it is sensible to make the agreement as comprehensive as possible, to ensure fewer conflicts between shareholders, and to help manage any disputes that do arise. Below we set out the main reasons your business will benefit from a shareholder agreement.
Rights and Responsibilities
The shareholder agreement should set out very clearly and precisely what the responsibilities of each member are and what their financial commitment is. A shareholder’s right to vote is their most important right and the shareholder agreement will outline voting rights for appointing new directors, mergers and acquisitions and so on. It may also describe the mechanism for voting.
Protection of Shareholders
A shareholder agreement can protect minority shareholders so that they are involved in major decision-making for the company. Without a shareholder agreement a simple majority, ie 51% of the votes, is sufficient for decision-making. The shareholder agreement can list particular areas of corporate life where majority voting would not be appropriate, for example a change in the business direction of the company, and can provide a veto for each member so that, for example, one majority shareholder is not able to make all key decisions without all members being on board.
The shareholder agreement should detail how shares are to be transferred. Without restrictions as set out in the shareholder agreement, shareholders can transfer shares to anybody, including competitors. Transfer provisions may include a need for consent from other shareholders before any transfer. Often the shareholder agreement will ensure control over who own the shares by giving existing shareholders the first option, or right of refusal, for any share transfer, normally at a pre-agreed price.
A shareholder agreement can include terms that link shareholding to employment. Often companies attract the best staff by offering them shares in the company. If and when they leave you may not wish for them to have any rights in the company. However, without a shareholder agreement there is nothing you can do. Where employment is terminated, the shareholder agreement should expressly state how the shares are transferred back to the company. Equally if a director of a company, who owns significant shares, decides to leave the business you may not want them to continue owning such a proportion of the shares.
Selling the business
Without a shareholder agreement making express reference to how the company is to be sold, a minority shareholder could block the sale of a business at the last minute.
Removal and Death
The shareholder agreement can include provisions that where a director or shareholder is behaving inappropriately or not doing what is expected of them, they may be removed from office. Equally, if a shareholder dies, any shares are passed automatically to the beneficiaries of their estate, so for example a wife or child may become a shareholder in the company. The shareholder agreement should address this eventuality.
We all know disagreements frequently occur over money. The shareholder agreement should address how the company is to be funded including future capital raising methods. The shareholder agreement should consider whether there will be an expectation on the director to provide a personal guarantee for any bank loans, and whether the shareholders will be obliged to provide cash injection to the company or further loans.
The reality is that at some point a disagreement between members and/or directors is bound to arise and shareholder disputes have caused more than one small business to collapse. Setting out in the shareholder agreement how such disputes should be managed, for example via mediation or an independent third-party decision-maker, can ensure a more harmonious and speedy resolution.