• Shareholder-agreement
  • October 26, 2020

Why Shareholder Agreements Are Important?

Many people who set up a company do so with people they know – whether colleagues, family or friends. From the outset, these relationships are assumed to be solid and well natured. Therefore, the idea of legally formalising the relationship can seem unnecessary. 

However, having a robust shareholder agreement in place will help protect your existing relationship. No matter what your business and how strong your ties with your fellow shareholders, you may experience tough times and disagreements can  occur. Without a shareholder agreement, you could risk damaging your relationship, your business and you may end up fighting a costly and stressful legal battle.

Having a shareholders agreement can help ensure your business is well run, keep clear lines of communication between the shareholders and add value to your business if you are ever looking for investment or to sell.  Hopefully, you may never need to rely on your shareholder agreement for this reason, but if a dispute occurs, a well-drafted agreement is worth the investment. 

What is a shareholder agreement?

A shareholder agreement is a private contract between some or all of the shareholders of the company.  All companies have rules based on company law set out in their articles of association and these apply to all shareholders of the company and are publicly available at Companies House.   A shareholders agreement sits alongside your articles and can set out a framework between the shareholders who sign up to it for dealing with all matters relating to owning shares in the company, the rights of shareholders (whether they are minority or majority shareholders), how the company will be run, and outlines the dispute resolution in a deadlock situation.  While these matters can be set out in the articles many companies prefer to have bespoke arrangements between the shareholders set out in a separate document which only they have sight of.  The shareholders agreement can also provide the framework for other contractual documentation that the shareholders may wish to put in place such as service agreements or arrangements in relation to intellectual property ownership and provide for any arrangements personal to particular shareholders.

What is included in a shareholder agreement?

For your shareholder agreement to cover all your company's requirements, it is best to work with an experienced company law solicitor. They will take the time to find out about your business and company needs to draft an agreement that incorporates them.

Shareholder agreements will commonly:

  • state the shareholders' rights and responsibilities
  • regulate how shares can be bought and sold
  • set out the principles for how the company will be run
  • provide protection for defined  shareholders and set out matters that can’t take place without their consent
  • set out dilution rights
  • state a policy for dividends
  • provide for intellectual property assignment
  • state a dispute resolution process
  • Can a shareholder agreement help avoid a deadlock situation?

If the shares in your company are held in equal proportions, it is possible that a disagreement leads to deadlock. This prevents the organisation moving forward and can lead to litigation. 

By including a deadlock resolution clause in your shareholders' agreement, damaging deadlocks can be avoided.

What if a shareholder dies or becomes incapacitated?

Complications can quickly arise in the event of death or mental incapacity of a shareholder and having the procedures to apply in such situations clearly documented can avoid unnecessary stress and confusion.   Without clear provisions an executor or attorney [1] may become involved in the company in a way that was never envisaged by the original shareholders.  A shareholders agreement can allow surviving shareholders the option of purchasing the deceased or incapacitated shareholder’s shares allowing the continued smooth operation of the company. 

Top 5 tips and hints

A shareholders agreement can include any provisions that the parties agree but the following 5 things should not be overlooked:

  1. Relationship between the shareholders and directors – if the shareholders want to have approval over certain matters in the day to day running of the company it should be set out in the shareholders agreement.  The shareholders can also have the right to appoint (and dismiss) individuals as directors.
  2. Key issues for the shareholders and voting rights in relation to these.  For example, there may be certain things that are so important to the shareholders they don’t want them to happen without unanimous consent.
  3. Dividends – in what way are the profits of the company to be distributed.  There may be shareholder debt which is a priority or the shareholders may want to specify an amount for reinvestment annually.
  4. Leaving the company – what if a shareholder wants to sell their shares or in what circumstances will they be required to sell their shares, at what price and who to? These provisions are often described as good leaver and bad leaver provisions and are best agreed before any need to transfer shares arises.
  5. Deadlock – while no-one wants to imagine disagreements between the shareholders when they are starting business it can happen.  A clear procedure to deal with this can protect the company, allow the shareholders to keep working together and maintain personal relationships.

Final words

Although you may have many administrative matters to attend to when starting your company, where more than one shareholder is involved it is important to add a shareholder agreement into the mix. Not only will it protect your business and relationships, it will show future investors that your company is well organised and takes its success seriously.

[1] An attorney in this context refers to a person appointed under a Lasting Power of Attorney to manage the financial affairs should the creator of the document become mentally incapacitated.

Further Readings on Shareholder Agreements

What is a shareholder agreement?
Why You Have Everything to Gain From a Shareholder Agreement

Updates on Brexit

Brexit is not anticipated to have an immediate impact on shareholders agreements between shareholders of private limited companies incorporated in the UK.  There may be implications for UK companies that operate in the EU which are outside the scope of this article.

In closing

Nothing in this article constitutes legal advice on which you should rely. The article is provided for general information purposes only. Professional legal advice should always be sought before taking any action relating to or relying on the content of this article. Our Platform Terms of Use apply to this article.

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