Share­hold­er Agree­ments: When And How To Best Use One

Run­ning a busi­ness is excit­ing and demand­ing. An entre­pre­neur­ial adven­ture filled with many pos­si­bil­i­ties and a chance to stake a sig­nif­i­cant claim in the busi­ness world. Ask any entre­pre­neur, and they’ll tell you it’s a roller coast­er ride of highs and lows, suc­cess and fail­ures and innu­mer­able dai­ly challenges.

But it’s impor­tant to remem­ber every suc­cess­ful glob­al busi­ness start­ed with just an idea and a few enthu­si­as­tic peo­ple with a vision. And the most suc­cess­ful com­pa­nies recog­nised the impor­tance of putting the cor­rect legal­i­ties in place from the outset.

One of these essen­tial areas is a share­hold­er agreement.

What Is A Share­hold­er Agreement?

In short, it is an agree­ment between the share­hold­ers and the com­pa­ny and reg­u­lates how the share­hold­ers, com­pa­ny and direc­tors will act and inter­act day to day and when cer­tain trig­ger events occur, e.g. a breach, dis­pute, depar­ture, death, share trans­fer etc.

Writ­ten and autho­rised cor­rect­ly, a share­hold­er agree­ment is a legal­ly bind­ing doc­u­ment that comes into play under pre-defined cir­cum­stances. The agree­ment will out­line the rights, respon­si­bil­i­ties, lia­bil­i­ties and oblig­a­tions of each share­hold­er, and may include how the com­pa­ny con­tin­ues to operate.

A share­hold­er agree­ment is a legal con­tract, but there is no require­ment to reg­is­ter it with Com­pa­nies House in the same way as a company’s Arti­cles of Asso­ci­a­tion. Indeed, a share­hold­er agree­ment may con­tain sen­si­tive infor­ma­tion that a com­pa­ny would not want in the pub­lic domain.

Why Does A Busi­ness Need A Share­hold­er Agreement?

As well as focus­ing on com­mer­cial objec­tives, it’s vital­ly impor­tant the busi­ness is well struc­tured and sup­port­ed by a com­plaint and sup­port­ive legal strat­e­gy. Legal process­es and poli­cies are an often untapped resource for deliv­er­ing and max­imis­ing the com­mer­cial objec­tives of a busi­ness, and a share­hold­ers agree­ment is one of the first things com­pa­ny stake­hold­ers should consider.

A share­hold­ers agree­ment is an essen­tial tool to artic­u­late and embed the dif­fer­ences between man­age­ment and share­hold­er respon­si­bil­i­ties. This is espe­cial­ly impor­tant as share­hold­ers don’t have default duties or oblig­a­tions to the com­pa­ny by law.

The agree­ment should clear­ly out­line the rights, duties and oblig­a­tions for stake­hold­ers in the busi­ness includ­ing set­ting out what approvals are need­ed in a vari­ety of circumstances.

What Issues Does A Share­hold­er Agree­ment Cover?

There are sev­er­al fore­see­able cir­cum­stances in which a share­hold­ers’ agree­ment comes into play and should con­tain explic­it guid­ance to man­age these scenarios:

  • A share­hold­er wants to exit the busi­ness, becomes ill or dies. It’s unfor­tu­nate, but it hap­pens. The stan­dard approach is that the remain­ing share­hold­ers or the com­pa­ny have the right to buy the shares before they are offered to third par­ties such as fam­i­ly, exter­nal investors or anoth­er business.
  • Where a share­hold­er is declared per­son­al­ly bank­rupt or is barred from hold­ing a com­pa­ny direc­tor­ship. Again, a typ­i­cal res­o­lu­tion is the remain­ing share­hold­ers have the first option on buy­ing the shares.
  • The major­i­ty of share­hold­ers want to sell the com­pa­ny. This pro­vi­sion may well include drag along’ claus­es that pre­vent minor share­hold­ers from scup­per­ing a sale. In effect, it grants the share­hold­ers with the most sig­nif­i­cant hold­ings the right to sell the com­pa­ny, assum­ing it’s in the inter­est of all stakeholders.
  • To pro­tect the firm when a share­hold­er leaves — some­times known as a Restric­tive Covenant. This part of a share­hold­er agree­ment pre­vents those exit­ing the com­pa­ny from start­ing a rival con­cern or approach­ing estab­lished clients for an agreed peri­od. This will depend on the indus­try involved but is usu­al­ly some­where between 6 months to a year.
  • The agree­ment may also deal with areas such as rais­ing fur­ther share cap­i­tal, intel­lec­tu­al prop­er­ty, dis­tri­b­u­tion of cash and cap­i­tal, when buy­ing or invest­ing in anoth­er busi­ness or when exter­nal investors take a stake­hold­ing in the firm.

The list of pos­si­bil­i­ties is not exhaus­tive. It would depend on the com­pa­ny and what it does. What is vital here is to ensure pro­fes­sion­al legal advice is sought. Expert advi­sors will make sure all the rel­e­vant aspects are con­sid­ered and includ­ed in the agreement.

When Should A Share­hold­er Agree­ment Be Drawn Up?

It’s always advis­able to cre­ate a share­hold­er agree­ment at the out­set of a busi­ness or as soon as there are more than two shareholders.

It’s equal­ly essen­tial to review the agree­ment reg­u­lar­ly and always when the firm’s share­hold­ing pro­file varies or grows. Changes will inevitably occur in all suc­cess­ful com­pa­nies as they expand and explore new com­mer­cial ideas. The busi­ness may need to respond to changes in its strat­e­gy or changes in the mar­ket. As cru­cial the agree­ment can help as inter-per­son­al rela­tion­ships in the exec­u­tive team devel­op pos­i­tive­ly or otherwise.

It’s impor­tant to have a good share­hold­er agree­ment and asso­ci­at­ed Arti­cles that can be referred to as a ref­er­ence to guide the busi­ness through these situations.

What Are the Wider Ben­e­fits Of A Share­hold­er Agreement?

It would be easy to see a share­hold­er agree­ment as a demo­ti­vat­ing doc­u­ment. Looked at objec­tive­ly it seems to be a process that for­malis­es the rela­tion­ships in a busi­ness in a rather ster­ile, pro­ce­dur­al way.

How­ev­er, well-con­ceived share­hold­er agree­ments should strike the right bal­ance between pro­tect­ing share­hold­ers and their invest­ment and pro­vid­ing the direc­tors with the man­date and scope to run the busi­ness using their best judge­ment. The con­tract should there­fore offer ample free­dom for direc­tors to deliv­er the firms’ strate­gic goals and gen­er­ate val­ue for all stakeholders.

If seen from this point of view, a share­hold­er agree­ment becomes a sup­port­ive doc­u­ment, one that aligns all stake­hold­ers to a com­mon pur­pose and strat­e­gy. At its core, a share­hold­er agree­ment estab­lish­es trust and, cru­cial­ly, frees the direc­tors and share­hold­ers to con­cen­trate ful­ly on the future suc­cess of the company.

That’s why a pro­fes­sion­al­ly com­piled share­hold­er agree­ment makes a good deal of sense.

For a dis­cus­sion on draft­ing a share­hold­er agree­ment or any of the legal advi­so­ry ser­vices the Lex team can offer your busi­ness, con­tact us direct­ly at chris@​lexsolutions.​com or manu@​lexsolutions.​com or call 0203 7451574.

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Further reading