When setting up your company, one of your top priorities is to create a shareholders’ agreement that will outline the roles, rights, and responsibilities of each shareholder.
This agreement will help prevent disputes among shareholders and ensure that key decisions are made in a structured manner, thus ensuring the company's long-term stability and success.
So, how exactly is a shareholders' agreement created, and what key components make it essential?
This article will walk you through the entire process, explaining:
What a shareholders' agreement is
Why shareholders' agreement is crucial for both majority and minority shareholders
How shareholders' agreement plays a critical role in preventing disputes
What is a Shareholders' Agreement?
Aside from capital and a good business plan and structure, when you start a business, another important thing you need to have in place is a shareholder agreement. A shareholder agreement can be likened to a prenup that couples sign before marriage to protect their investments when the marriage crashes.
For business partners, a shareholder agreement serves a similar protective function. This legally binding agreement is made between the shareholders and the company, and it outlines:
The rights, roles, and responsibilities of each shareholder.
How the company will be run or managed.
How disputes between the shareholders will be resolved.
What will happen to the investment of a shareholder after exiting the corporation.
The process involved in the introduction of new shareholders.
The importance of having a shareholders’ agreement in place cannot be overstated, especially considering how unpredictable the business world is. A shareholders’ agreement makes it easier and faster to resolve disputes or disagreements between shareholders and also serves as a guide for decision-making, ensuring that everyone is on the same page.
Key Components of a Shareholders' Agreement
While every shareholder's agreement should be tailored to the company’s unique needs, some key components often include:
Shareholder rights: The agreement must accurately state the rights and privileges that both majority and minority shareholders will enjoy in the corporation. This typically includes voting rights, the right to dividends, and more. Additionally, the agreement must also state the shareholders' obligations, such as required capital contributions, non-compete clauses (restrictive covenants), and more.
Share transfers: The shareholders' agreement must also contain rules guiding how and when shares can be sold or transferred.
Decision-making procedures: This is another key component of a shareholder agreement, which outlines the procedures for making decisions within the company. It specifies who has the authority to make certain decisions, such as appointing directors, organising meetings, and more.
Dispute resolution procedure: This component outlines the mechanism or method for resolving disputes before they escalate.
Exit clause: This clause outlines the guidelines for exiting the corporation. Exit clauses, such as buy-sell arrangements, can be included in the agreement to make it easier for shareholders to exit the corporation.
Financing: A shareholder agreement should also determine how the corporation will fund its operations. The agreement should indicate whether the shareholders will be responsible for funding the company’s operations or if debt financing will be provided by a bank or third-party lender.
Why You Need a Shareholders' Agreement When Setting Up a Company
As a new business owner, you need a shareholder agreement for many reasons, including:
Preventing disputes
Shareholders are individuals with their own personal goals, perspectives, and agendas, so it’s natural for disagreements to arise. However, it’s important that these disputes don’t escalate to the point where the company’s stability or the shareholders’ investment is jeopardised. This is where a shareholder agreement proves invaluable. It establishes a clear framework for resolving conflicts in an organised and structured way, ensuring that both the shareholders' interests and the company’s future are protected.
Protecting minority shareholders
Minority shareholders are those investors who hold less than 50% of the shares in a company. They typically have less power than majority shareholders, and their influence on the decisions made in the corporation, especially by majority shareholders, is limited. However, as a business owner, if you want to protect minority shareholders and make them have a say in significant decisions, such as the sale of the company or changes to the board of directors, then you need to create a shareholder agreement that will reflect this consideration.
The agreement can also include drag-along and tag-along rights, which protect the interests of minority shareholders during mergers or acquisitions.
Establishing exit strategies
As a new business owner, the last thing you want is an investor leaving your corporation without a clear exit plan. This could jeopardise the investment, lead to financial instability, disrupt business operations, and create uncertainty among remaining shareholders.
This is where a shareholder agreement becomes crucial. It typically outlines key exit strategies, such as a buy-sell agreement, ensuring that there are established procedures for managing their shares if a shareholder chooses to exit. This helps maintain stability and clarity, protecting the company and its shareholders from sudden shifts in ownership or control.
Clarifying decision-making processes
A shareholders' agreement can specify how decisions will be made for key issues such as raising capital, taking on debt, or hiring executives. It can require that certain decisions be unanimous or subject to a majority vote, ensuring everyone understands their role in the decision-making process and that it is carried out fairly and transparently.
Ensuring proper governance of the company
Shareholders, as their name implies, only buy shares in the company to invest in it; they don’t actively run the company's day-to-day operation. So, when starting a company, you need to prepare a shareholder agreement, as this agreement will clearly define the roles of shareholders versus those of the company’s management.
Key Considerations When Drafting a Shareholders' Agreement
Below are some vital considerations when drafting your company’s shareholders’ agreement:
Customising the agreement to fit your company’s needs:
There is no one-size-fits-all shareholder agreement because every company has their own unique structure, goals, and dynamics. So, if you are just setting up your business, you need to avoid using a generic shareholder agreement and instead draft one that will be tailored to the specific needs of your business and shareholders. If you’re unsure how to draft the agreement, you can hire a corporate attorney.
Legal compliance
Your agreements must also comply with relevant company laws and regulations. In the UK, the shareholders' agreement for your company must align with the Companies Act 2006 and other corporate governance laws. Again, hiring a solicitor to help draft the agreement is wise if you're unfamiliar with these regulations. This ensures it’s legally enforceable while protecting your business and your shareholders.
Review and update regularly.
You need to update your agreement to reflect changes in your business. For example, when a new stakeholder joins the corporation, you might be required to update the agreement. Additionally, updates should be made when there are regulation changes or company structure adjustments. Keeping the agreement current ensures it stays relevant and can help prevent future conflicts. Regular reviews will protect your corporation and its shareholders by properly addressing all legal and business developments.
Risks of Not Having a Shareholders' Agreement
It can lead to shareholders’ disputes.
Without a shareholders' agreement, misunderstandings between shareholders are more likely to occur. If these issues are not managed carefully, they can escalate into serious disputes, potentially resulting in costly litigation. In some cases, unresolved conflicts can even lead to the breakdown of the business. A well-structured agreement helps prevent such outcomes by outlining clear rules for decision-making, ownership rights, and dispute resolution, protecting the business from unnecessary risks.
Uncertainty in share transfers
If a shareholder wishes to sell their shares, the absence of a shareholders' agreement can create significant uncertainty. Other shareholders may be concerned about the identity of the new buyer or whether they have any say in the transfer. This uncertainty can lead to tension and disrupt business operations. However, a shareholders' agreement that outlines a clear process for transferring shares can remove these concerns, ensuring transparency and control over who joins the company as a new shareholder while protecting the interests of all parties involved.
Lack of protection for minority shareholders
Without a shareholders' agreement in place, minority shareholders often have limited influence, as the majority shareholder can make key decisions unilaterally, such as nominating directors or controlling other vital aspects of the company. A well-drafted shareholders’ agreement helps balance power by ensuring that all shareholders, regardless of their ownership percentage, have a voice in significant company decisions.
FAQs
What should be included in a shareholders' agreement?
Some key clauses included in a typical shareholder agreement include voting rights, decision-making processes, share transfers, dispute resolution mechanisms, minority and majority shareholder rights, and source of funding for the company.
Can a shareholders' agreement be created after the company is formed?
Yes, a shareholder agreement can be created anytime, but it's best to establish it as soon as the company is registered. Drafting it early ensures that all parties have clear expectations and guidelines from the start.
Shareholders' agreement vs. articles of association: how do they differ?
The articles of association and shareholder agreement are not the same thing. While articles of association are public and required by law, shareholders' agreements, on the other hand, are rather optional. That is, there is no legal obligation for business owners to draft one. Also, it only covers specific internal matters.
What happens if shareholders can't agree on the terms of the agreement?
If shareholders can’t agree, they may seek mediation or legal assistance. Drafting the agreement when relations are amicable is crucial to prevent disputes.
Is a shareholders' agreement legally binding?
Yes, once signed, a shareholders' agreement is legally binding and enforceable by law.
Conclusion
Although there is no legal requirement for this type of contract, a shareholders' agreement is still highly recommendable, especially for a new company. Aside from helping to establish clear rules and expectations, it will also help reduce the potential for disputes and protect the interests of all shareholders and your company.
That said, if you have successfully registered your company with Companies House and you need expert advice and help in drafting a shareholders' agreement tailored to your specific needs, our team of corporate solicitors is more than ready to assist you. At Lawhive, our goal is to provide the solutions you need to ensure a solid foundation for your company.