Why do you need a shareholders’ agreement?

Many limited companies are started each year by friends, family members or former colleagues who have a great business idea and a desire to create a successful business.

In the excitement to get the new business off the ground, the new business owners can often overlook  potential problems they are storing up for themselves, by not having a formal agreement in place to establish the ground rules for their ownership of the business, or provide a method for resolving disputes.

Rebecca Robinson, director in the company commercial team at Wake Smith Solicitors, looks at the importance of a shareholders’ agreement.

This article covers:

• What is a shareholders’ agreement?
• What can a shareholders’ agreement help with?
• What is included in a shareholders’ agreement?
• Examples where a shareholders’ agreement would have prevented problems
• Your next move and how Wake Smith can help

What is a shareholders agreement?

Decisions affecting the business, the company or its assets are made either by directors or by shareholders.

The division of powers between directors and shareholders is a fundamental aspect of company law.

Directors have control of the day-to-day running of the business while shareholders govern the internal management of the company, for example, they have the power to change the business objects of the company, to allot shares and to ultimately distribute the proceeds and liquidate the company.

A shareholders’ agreement allows the members of a company to agree a range of matters relating to their involvement in the company. This allows them to know what will happen in certain circumstances, rather than there either being nothing to govern those circumstances, or having a default position implied which might not be that which they would choose. It is therefore a means of ensuring the company and its affairs are run as you wish.

Furthermore shareholders’ agreements are private documents (as opposed to the articles of association which are published online at Companies House) and can therefore be kept from the eyes of creditors and employees of the company.

What can a shareholders’ agreement help with?

Even though the parties will start off thinking they have common goals and ideas as to how to reach them, those views can diverge over time.

One may want to re-invest any profits and grow the business; others may wish to reap the rewards personally by taking out those profits by way of dividends.

If personal circumstances change or, for example, there is an age difference, one may wish to sell his/her shares, whilst the others want to carry on.

The leaver may want to keep their shares or may want to sell them for the highest possible price and may not be concerned who buys them.

Those staying on might not want the leaver as a ‘sleeping partner’ and want to be able to acquire the leaver’s shares at a fair price, but without prior agreement they would have no right to do so.

Without an agreement, they could otherwise be faced with a new owner of those shares with whom they have no previous relationship or knowledge.

In a private company the value may be difficult to assess. The shareholders’ agreement can set a procedure and formula, as well as giving the remaining shareholders a right of first refusal on any sale which they would not otherwise have and can include circumstances where a transfer may be required.

What is included in a shareholders’ agreement?

Some of the main issues which might be addressed in a shareholders’ agreement include:

Management of the company: Decision-making at Board and shareholder level: The default Company Law position will often not automatically allocate control, protection or rights as the shareholders intend. Often it is sensible to agree a list of matters that cannot be carried out by the company unless a specific number of shareholders give their consent.

Dividend Policy: Will all profits be re-invested or distributed? How are profits to be applied and in what proportions or amounts? For example, different classes of shares can be created (A, B, C etc.) with differing dividend rights attaching to them (to avoid problems with income shifting).

Share Transfers: In most private companies the members will want to retain control over the shares, so that rather than members being able to transfer them to whoever they want, there will be a mechanism for anyone wanting to transfer their shares to give the other members the first right to buy them accompanied by a formula to value them if the price cannot be agreed.

Certain events can trigger those rights e.g. an employee shareholder resigning, a shareholder being in breach of the agreement, death or ceasing to be actively involved in the business, or if a majority of the shareholders want to sell the company to a third party.

Disputes: These are certainly not uncommon and dealing with a dispute without a starting point for resolution is usually a lot more difficult and expensive. If members cannot agree, there are various options which can be written into the shareholders’ agreement to deal with the situation.

Examples where a shareholders’ agreement would have prevented problems

A and B, friends from University, are 50:50 shareholders. After a few years A stopped coming into work and now shows no interest in the business. B continues to operate and expand the business alone. Without a shareholders’ agreement A is still entitled to 50% of all dividends and 50% of the value of the business on the eventual sale of the company. 

C and D, father and son, are 50:50 shareholders in the family business which has been in existence for over 100 years. C dies and under his will the shares are transferred to his girlfriend who has no interest in the business.

E, F & G, former business colleagues, set up a new company after being made redundant by their previous employer. After a few months E & F spot some financial irregularities and realise that G has been padding invoices. E & F can remove G as a director as, together, they own 70% of the shares (as agreed at the outset), but they cannot remove G as a shareholder.

H had been running his company alone for many years but hit hard times and asked J for help. J invested a large sum of money in return for 35% of the shares. H made some bad decisions regarding the operation of the company and it continued to lose money. J knows she can help turn things around but H does not listen.

K holds 65% of the shares in a company and is hoping to retire soon, L, the other shareholder, wants to continue in the business. K names a price for his shares but L thinks the price is too high and cannot afford it. K finds a third party purchaser who wants to buy all of the shares in the company. L does not want to sell his shares but the third party does not want to work with L.

M owns 90% of the shares in a company and N and O have the remaining 10% between them. M, N and O are all directors of the company. M is frustrated that he keeps getting outvoted on board decisions.

Your next move, and how we can help

Wake Smith Solicitors is experienced in advising businesses on shareholders agreements.

If you would like to discuss this further, please call 0114 226 6660 and ask to speak to a member of the Company Commercial team.

Find out more about our Company Commercial services

Published 06/10/2023