Do we really need a shareholders’ agreement? 7 reasons why you just might!
As you’re busy establishing your new business, often your accountant will suggest that you have a shareholders agreement between you; but as these are not legally required, why should you bother?
Below, we’ve outlined 7 common scenarios that you or your business might face; a well drafted shareholders agreement seeks to cover or resolve these issues with the minimum of fuss, and certainly without the need to call on the lawyers!
- Appreciating the business objectives and each person’s role in its success: A clear understanding of the company’s business, its objectives and the specific roles and responsibilities of each of those involved will help to avoid disagreement and ultimately a dispute centered around one or more shareholders not pulling their weight. We also recommend that restrictions, applicable to a departing shareholder, are included to protect the ongoing business against unfair competition once someone has left.
- Handling loans to the business and agreeing dividends: If a shareholder has provided loans to the company, should these be repaid before dividends can be declared between each of the others? There might, understandably, be an expectation that dividends will be paid as soon as the company is profitable. Agreement about dividends, retained working capital and whether such loans contributed to the business by one or more shareholders should be repaid first, can be considered and then clearly set out.
- Ensuring rights of first refusal on a share transfer: If a shareholder/director decides to leave the company, the others will clearly not want to find themselves in business with someone they do not know, or perhaps even someone connected with a competitor! A shareholders agreement will include rights of first refusal, known as ‘pre-emption’ rights, to ensure existing shareholders have an opportunity to buy out the departing shareholder, or to block a share transfer in certain circumstances.
- Preventing the exercise of power by a militant minority shareholder: Without agreement otherwise, a minority shareholder (even one with less than 1%) could prevent the sale of the company, as a buyer usually seeks 100% of the shares; ‘drag-along’ and ‘tag-along’ rights prevent this and seek to treat all shareholders fairly – a minority shareholder will be compelled or may elect to sell their shares, at the same time and for the same price as the majority holder, allowing a smooth transition of the business to proceed.
- Protecting a minority shareholders’ investment: On the flip side, a minority shareholder may want a say in certain key decisions about the business and a shareholders’ agreement can outline what these decisions are; a minority may not be happy if the business is suddenly taken in a different direction, for example; particularly if such a plan is seen as flawed.
- Removing a shareholder whose association might damage your reputation: If a shareholder, who is perhaps also a director, damages the reputation of the business or is perhaps no longer fit to participate in its affairs, that shareholder can be removed, with their shares being purchased either for a fair price or for a discounted price taking account of a shareholder who is a ‘bad-leaver’; without this, the company will have limited options to remove that person as a shareholder and even removing them as a director will necessitate the laborious statutory procedure under the Companies Act 2006.
- Using time wisely to plan for a successful future: Finally, the time spent considering these issues can help in planning for the future growth of the business and will go a long way in overcoming potential problems in the future.