What is a shareholders’ agreement and do I need one?

As a start-up you might not be thinking about what happens when a major shareholder leaves the company, which is understandable, but it is vital to have something in writing.

Shareholders’ agreements can establish:

• Who the exiting shareholders have to offer their shares to, is it the other shareholders first?
• At what price should the shares be offered?
• When do you have to sell your shares?
• Voting rights – is shareholder majority or unanimous voting required for certain big commercial decisions so that the minority shareholders have some protection?

It pays to be pragmatic

As a romantic you might not think that a pre-nuptial is a good idea but it pays to be pragmatic in business and you could view a shareholders’ agreement as the business world’s answer to pre-nuptial agreements – there just in case things change in the future and go your separate ways.

There is no law requiring a shareholder agreement when incorporating a company at Companies House but you do need constitutional documents – Articles of Association. Off the shelf Articles can be used. However, these basic off the shelf articles and the Model Articles, rarely include everything you may need.

What if a shareholder leaves the company?

If someone leaves the company, they may be moving abroad, settling down elsewhere in the country, or simply want another challenge, and if you only have off the shelf articles they can keep the shares and don’t have to offer them to the other shareholders. You need either more sophisticated articles or a shareholders agreement to have a clear path forwards.

How do you value the shares? If it is a small private company that isn’t listed then you may need to ask accountants what the market value is, assuming that the company isn’t being sold. But how should the accountants value the shares? There could be wide ranging valuations of a business, giving big differences in share values. There could also be an argument made that there should be an excess for a majority shareholder, given their greater influence, and less value given to minority shareholders as their influence on the business is less.

Having these principles agreed and in writing could save a lot of time and money when it comes to determining the value of the shares.

What happens when a shareholder doesn't want to sell their shares?

They don’t have to sell if you have basic articles. It is as simple as that. However, a shareholders’ agreement or new articles of association can stipulate that they do have to at least offer them up for sale and who the shares should be offered to when the time comes. The remaining shareholders would want to be offered the chance of a buyout first and also have a say in who they are working with.

They will probably not want a shareholder who is leaving the business to keep his shares and benefit from the future growth of the business.

Bad leaver provisions

If a shareholder leaving the business should be forced to offer their shares for sale you might want to consider a provision to say that a “bad leaver”, someone who is in serious breach of his contract, should not get full market value for their shares.

The remaining shareholders do not want someone that has been dismissed for breaching their contract to profit from the success of the company. A provision could be written into the shareholders’ agreement or new articles about bad leavers to ensure that they do not profit having been dismissed for a serious breach of contract.

Without a shareholders’ agreement or new articles, there is nothing in the basic articles to say that a shareholder who is a bad leaver has to sell at a reduced rate.

Big commercial decisions

Do you want to leave big commercial decisions just to one or two people or would you want approval from a larger majority or even by a unanimous decision? This could be when it comes to borrowing a large amount of money, signing a very, very large contract or changing the direction of the business. Having it in writing who can make these big decisions and the approval required is very sensible.

Restrictive covenants

You have restrictive covenants in employee contracts and can also have them in a shareholders’ agreement. This could potentially help protect your business for a longer period of time and is certainly worth looking into. These covenants are to ensure that shareholders, both during the time they hold shares and for a period of time after they are no longer shareholders, are prevented from competing with the business.

How can Blake Morgan help?

If you need more information on what a shareholders’ agreement is or why you need one to make sure that you have everything covered, contact our corporate lawyers. We can put together a shareholder agreement that will ensure that all eventualities are covered and that it is fair to all parties.

This article is part of Private Client Issues – March 2021