If you are a shareholder in a limited company, you may have entered into a shareholders’ agreement upon (or after) becoming a shareholder. A well-drafted shareholders’ agreement is vital for the smooth operation and protection of your limited company – and failing to have one in place could leave to disaster later down the line.
What is a Shareholders’ Agreement?
Put it simply, a shareholders’ agreement is a private contract between the shareholders in a company, governing their relationship as shareholders of that company. The company itself is often also a party to the agreement so that it (acting by its directors) can later enforce the terms of that agreement against the shareholders, or any of them if ever required.
A well-drafted shareholders’ agreement manages risks in a limited company, amongst other things, in relation to share ownership, control and exit. The agreement will also regulate, and set out the company’s processes for, matters such as:
- voting rights and decision-making powers;
- transfer, issue and sale of shares (including restrictions on the same);
- compulsory transfer of shares in certain circumstances;
- dividend payments;
- confidentiality;
- dispute resolution; and
- exit strategies
Essential Provisions in Shareholders’ Agreements
It is always advisable to have a shareholders’ agreement prepared by an experience corporate lawyer, as they can ensure that the agreement is bespoke to your company’s needs; however, below are some of the key provisions that are essential for every shareholders’ agreement:
1. Pre-emption rights
These provisions protect existing shareholders by giving them a right of first refusal to buy or subscribe for any shares proposed to be allotted or sold in the company, before they are allotted or sold to third parties.
2. Drag and tag provisions
These are important where you have lots of shareholders, particularly minority shareholders. Drag along provisions allow the seller(s) of the majority of the shares in a company can compel the other (minority) shareholders to sell their shares too. This is important as it prevents minority shareholders from otherwise blocking a sale of the company.
Tag along provisions work similarly to drag along provisions; however, in this case, for the benefit of the minority shareholder, who can compel a third party proposing to buy a majority shareholding in the company to also buy out the minority shareholder’s interest on the same terms (for example, for the same price per share).
3. Good and bad leavers (and other compulsory transfer provisions)
These provisions deal with circumstances where a shareholder is also an employee in the company. Typically, you do not want an individual involved in a business after they have resigned or been dismissed as an employee. We can include provisions in your shareholders’ agreement to require the employee to sell their shares back to the company (in some cases, not for full market value) whether they want to or not, thus preserving harmony amongst shareholders.
There are usually also other instances when a company may wish to require a shareholder to sell their shares (to the remaining shareholders, or to the company itself), such as when a shareholder dies. Again, we can include provisions to deal with this.
4. Decision-making and deadlock provisions
There are various provisions that will be needed to regulate decision-making; however, one of the most common is a set of “reserved matters” that require unanimous or special majority approval. This can also include preventing certain decisions being made at a director level; instead, requiring those decisions to be passed up to the shareholders to deal with at a general meeting or by written resolution.
We often also include procedures for resolving deadlocks, such as mediation or share buy-back mechanisms; particularly where there a company has two 50:50 shareholders, meaning that, in the event of disagreement, neither shareholder can pass an ordinary resolution alone, griding the company to a halt. This is one of the most important things you can deal with in a shareholders’ agreement and could save you tens of thousands of pounds in legal fees in the event of a shareholder deadlock.
5. Confidentiality and non-compete
These provisions protect the company’s sensitive information and prevent shareholders from competing with the company in any capacity.
6. Exit mechanisms
As well as regulating who shares can be sold to, or when they might compulsorily be offered for sale by a shareholder, a shareholders’ agreement should also address how shareholders can exit the company, including valuation methods and timelines for sale.
Drafting Tips
When drafting a shareholders’ agreement, it is important to ensure consistency with the company’s articles of association. It is therefore advisable to have your shareholders’ agreement prepared by an expert corporate lawyer who can ensure that the provisions in your agreement do not conflict with your company’s articles of association.
It is also important to:
- avoid ambiguous language – clarity reduces disputes;
- consider future business scenarios, including capital raising or new shareholders; and
- include dispute resolution clauses specific to shareholder issues.
Need Help with Shareholder Agreements?
A well-drafted shareholder agreement is key to protecting your business/investment and maintaining harmony amongst shareholders. Having a shareholders’ agreement preparing by, and obtaining tailored legal advice from, an expert corporate lawyer ensures that your shareholders’ agreement is clear, fair, and enforceable.
At Neathouse Partners, we have lawyers specialising in shareholder agreements so, if you need help drafting or reviewing a shareholders’ agreements, speak to one of our corporate and commercial lawyers for expert help to find out more.
FAQs on Shareholders’ Agreements
Q: Is a shareholder agreement legally binding?
A. Yes, a shareholders’ agreement is a legally enforceable contract between the shareholders of the company. If the company is party to the agreement, it will have the ability to enforce the agreement against the shareholders also.
Q: Can a shareholders’ agreement override the company’s articles of association?
A: A shareholders’ agreement cannot override a company’s articles or any statutory provisions, such as those set out in the Companies Act 2006; however, the agreement can provide additional protections and obligations between shareholders. For example, the shareholders’ agreement may include a provision stating that, in the event of a conflict between the terms of the shareholders’ agreement and the company’s articles, the shareholders will procure that the company’s articles are amended to remove any such conflict.
Q: What happens if shareholders disagree on how to run a company?
A: If a company has a well-drafted shareholders’ agreement, that agreement is likely to include dispute resolution clauses that may assist in resolving issues efficiently.
If the company is in a deadlock position, the agreement may also regulate how such deadlocks are avoided/resolved – this may include mediation but could also be a provision requiring one shareholder to buy the other out.
Without deadlock provisions in place, if the shareholders are at a deadlock and cannot resolve their issues, the only option available to them may be to petition the courts for an order that the company be wound up (as a just and equitable winding up petition). Clearly, this is not a fortunate position to be in and it is likely to result in lengthy legal challenges and racked up legal fees – a well-drafted shareholders’ agreement can prevent this though.
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