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Shareholders Agreements – the forgotten gem

When there is more than one shareholder in a company, a shareholders agreement is perhaps one of the most critical documents that that company can have, yet, more often than not, it is the one that is ignored or left for a future date.

All business partnerships start out with good intentions.  Each of them will vary in form, but they will all share one common characteristic – the ability to go horribly wrong!  The tensions and pressures of running a business, can and often do result in some of the strongest family members and best friends falling out.  If the worst does happen, then you could end up with nothing, or you might face the breakdown of a friendship, alongside a costly and acrimonious legal dispute.

When setting up a new company with family or friends, optimism is high and it is easy to assume that such relationships will remain rosy throughout the company’s lifetime.  As a result, and more often than not, an agreement which protects the rights of each shareholder; prescribes how disputes should be dealt with and governs how the company is run, is often overlooked.  A shareholders agreement is frequently perceived to be an unnecessary expense, especially when money may be tight.  Many people also worry that asking for a shareholders agreement sounds like they do not trust or respect their fellow business partners.

Arguably though, the prime time for establishing such an agreement is at the start when the excitement is high and relationships are strong.  Discussing difficult decisions at this time, will give rise to more pragmatic solutions and will lead to the shareholders working more amicably together.

If the need for a shareholders agreement is ignored or put off and a dispute arises, then this can, and often is, extremely disruptive to a business.  In circumstances where this is a deadlock, it can bring the business to a complete standstill through the inability to make decisions.

What do they do?

There is no legal requirement for a shareholders agreement so why are they important?  What do they actually do?

Disputes

A shareholders agreement can be a useful tool for avoiding and managing disputes.  Disputes can be very time consuming and expensive and can take everyone’s time and attention away from focusing on the success of the company.  When disputes do arise, there is often little in the general law that is of assistance and sometimes the only solution may be to dissolve the company, even if the company itself is successful.

By providing a structure for parties to work within, not only can disputes be resolved quickly and effectively, but conflict can be prevented before it begins.

Protection from personal circumstances

In many companies the individual shareholders are critical to the running of the business.  If such an individual were to die and his shares pass to a family member, then they will become a fellow shareholder, even though they may not know much about the business or have any interest in it.  Worst still those shares could be left to a third party who isn’t liked.  Furthermore, if a shareholder were to get divorced, then their former spouse may have a claim on the shares.  A shareholders agreement can prevent this by providing buyout options.

Deadlock

During the life of the company, shareholders/directors may not always agree on matters.  The result being that decisions cannot be passed due to their being no majority.  In such circumstances the business may lose out on lucrative business opportunities due to its inability to act.

A shareholders agreement can mitigate that risk by setting out provisions for what should happen where there is a deadlock between the parties.

Unknown parties

In the absence of anything to the contrary, shares are freely transferable.  There is therefore a risk that a shareholder sells or otherwise transfers his shares to an unknown person or even a competitor which could cause disruption within the business.

To protect against this, provisions can be put into an agreement which prevent the transfer of shares or requires that they be first offered to the remaining shareholders.

Critical Illness

If your business partner were to suffer a critical or mental illness which prevents them from working or being involved in the business for a sustained period of time, then the other shareholders may find themselves in a vulnerable position.  Many of you will take the chivalrous attitude of “Don’t worry, I will fill in and do whatever it takes”, but for how long?  What happens if it becomes a long term or permanent issue? Are you willing to carry out all the work for only part of the profits and capital growth?  A properly drafted shareholders agreement can provide buy back options at agreed valuations.

Majority Shareholder Protections

If a third party purchaser makes an approach to buy the company, the likelihood is that they will want to acquire 100% of the shares.  If the majority of the shareholders wish to sell, then it is unlikely that they would want this sale thwarted by a minority who is refusing to sell.  Yet in the absence of an agreement to the contrary this is exactly what will happen.  A shareholders agreement can instead introduce what are known as “drag-along” provisions, which will force the minority to sell.

On the flip side of this, if the majority decide to sell their shares in the company, then the minority may not want to be left behind.  As such “tag-along” provisions can be incorporated into a shareholders agreement.

Confidentiality

The shareholders of a company are likely to have access to highly valuable and confidential information about the company and will want this to remain confidential for the lifetime of the company.  As such confidentiality provisions within a shareholders agreement are vital.

Restrictions

A shareholder does not owe any fiduciary rights to other shareholders.  If a shareholder wishes to establish another business which potentially competes, whilst he holds shares within the company or after, then there may be little that the shareholders can do.  A shareholders agreement can however contain provisions which state that a shareholder cannot at any time, whilst they are a shareholder or for a period of time after they cease to be, carry on any other business that competes with the business of the company or entices away its clients, employees or suppliers.

Protection for Minority Shareholders

Without protection in a shareholders agreement, majority shareholders may force issues that are not in the minority’s interests, such as issuing further shares and diluting the percentages held by the minority.  A shareholders agreement can prevent this, by having certain decisions requiring unanimity before they can be passed.

It should now be apparent, that if you are a shareholder, a shareholders agreement comes highly recommended.  While it may be a touchy or awkward topic to proposition, the benefits to you and your fellow shareholders will be bountiful in the future.  So just like that doctors appointment you should probably have made over a week ago, get yourself covered with a shareholders agreement and don’t leave your business to suffer in the future.

For a more in depth look at the importance of shareholder agreements book your place on our business briefings here.

If you wish to discuss putting in place a shareholders agreement, or you would like to have your existing agreement reviewed and possibly updated, then please contact a member of our corporate team on 01524 548494 or 01228 552600.

 

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