Reasons why your company should have a shareholders’ agreement in place

When you’re starting your business, you’ve got ideas and tasks coming out of your ears. Do you really need to add “get a shareholders’ agreement in place” to your ever-expanding to-do list?

Legally, you’re under no obligation to have a shareholders’ agreement in place. It’s not a compulsory requirement, like having articles of association. But, (and that’s a big ‘but’) we’d always recommend that you do have a shareholders’ agreement if your business is a company with two or more shareholders.

That’s the case even if your shareholders are your close friends, or family, or people you trust implicitly. It’s just good sense for a growing business, and here’s why.

Share the profits fairly, in accordance with your contributions

The default position under the standard articles is that each shareholder has the same class of shares, and they are entitled to equal profits.

But in reality, that doesn’t necessarily reflect the effort that each shareholder puts into the business. If you’d like to remunerate your shareholders for their level of input, then you can vary the dividend rights in the shareholders’ agreement.

The agreement gives you a mechanism to have different classes of shares, with different voting rights and dividend rights attributed to them. You’ve got a lot more flexibility to run the business in the way that suits you, and the people who drive the business forward.

Don’t hand over your hard-earned know-how and clients to your competitors

While it may be unthinkable now, it’s not impossible that your loyal shareholders could up sticks and take the best bits of your business with them. They have all the exposure to your business secrets and your clients, which means they’re within the law if they pinch it all and begin their own competitor business.

That’s not fair at all is it? Protect against that worst case scenario and draft a shareholders’ agreement that contains restrictive covenants. It’s not ruling with an iron fist. It’s just sensible business acumen.

Minimise the risk of disagreements, which can stall and debilitate a company

One of the main functions of the shareholders’ agreement is to set out in writing how you’re going to run the company.  You agree at the outset which matters require shareholders consent, and how to transfer shares. You’ll decide how new shares will be issued. Can they go to any Tom, Dick or Harry, or will they be offered to existing shareholders before third parties?

If you don’t create a policy for these important issues, you run the risk of grinding your company to a halt while you hash out the issues with the other shareholders. By that time, you probably have conflicting positions and you’ll reach some sort of compromise in which nobody is actually happy.

Treat the shareholders’ agreement as the ‘how-to’ manual. It’s your agreed guide to running the business, and you can point to your signatures as prior agreement that you all thought the provisions were a good idea at the time.

Unlike your articles of association, the shareholders’ agreement is not publicly available, so you can rest assured that all those important decisions are confidential.

Resolve troublesome disputes in the quickest possible way

However, despite all your best intentions, you might come to blows with another shareholder. Say for example you want the business to enter into a particular contract, which another shareholder objects to.

If you have a majority shareholding (over 50%), then the default position is that you can over-rule any dissenting opinion of a minority shareholder. But if you’re a minority shareholder who’s active in the business, being continually over-ruled may quickly become tiresome.

You can decide which business decisions require equal input from all shareholders and draft an appropriate provision in the shareholders’ agreement. An example of one of those decisions could be amending the company’s articles of association.

What happens if you both hold equal shares, in a 50:50 ratio? How can you resolve a disagreement when neither party has the casting vote? These scenarios can cause standstill in a business, and cost you time and money to resolve. While the shareholders’ agreement can’t make these disagreements any less knotty, it will set out an agreed course of action to resolve the deadlock and speed things up.

Recourse for mischievous breaches of your agreement

You can’t control every decision a shareholder makes, but you can get suitable recourse for unconscionable decisions. For example,  if a shareholder decides to sell their shares in a way that’s not permitted by the agreement.

Without a shareholders’ agreement in place, you’re left cobbling together some form of ‘agreement’ for share sales through emails and un-documented chats.

But if you’ve drafted an agreement, you’ll have a clear action for breach of contract. You’ll still have to go through a dispute resolution process, but it will be considerably more straightforward and inexpensive than a dispute with no agreement in place.

You’ll also have an agreed mechanism for resolving disputes, which may be expert resolution or arbitration. These can have certain advantages over a court process such as speed and confidentiality.  

Sell the business when you want to

Even if you’re just starting out, you’ll have a long-term goal for your business. After spending years pouring time, money and expertise into your business, you probably want to sell it when you’re ready to move on.

Did you know that a minority shareholder has the power to block the sale of your business?

You can counteract that with drag along rights in the shareholders’ agreement. That means that for big decisions like the sale of the business, so long as the majority of shareholders are agreed, the dissenting voices get ‘dragged along’ with the decision and can’t kibosh the whole plan.

Practical takeaways

You’re not mandated in law to have a shareholders’ agreement in place, but you expose your company to unnecessary risks if you don’t. A few practical takeaways for growing businesses:

  • Review your existing shareholders’ agreement to make sure it reflects the way you want to run your business now and in the future.
  • Ask a professional to review your agreement to spot any weaknesses or omissions.
  • If you don’t have a shareholders’ agreement in place, speak to a lawyer about drafting a robust agreement for you.

If you’d like any help, we’re here at the end of the phone (01386 641 928) or you can drop us an email at info@smecomply.co.uk.

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