30 Sep 2019
shareholder agreements

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 an 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.