A shareholder agreement is one of the most crucial legal documents for businesses with multiple stakeholders. In short, it defines the rights, responsibilities, and obligations of shareholders. In this guide, we’ll explore everything you need to know about shareholder agreements - why they’re important, how they work, and key terms you should include to protect your business interests.
What is a shareholders agreement?
So, what exactly is a shareholders agreement? A shareholder agreement is a contract between those who own at least one share of a company. It details the rules on how the company must run and how to issue and transfer shares. A shareholders agreement also covers the rights and responsibilities of each shareholder.
Is it legally required?
No, a shareholders agreement is not required by law in the UK. However, it’s strongly recommended as it protects the interests of shareholders. This agreement acts as a safeguard. It can offer clarity and protection by setting out what happens if disagreements arise, how shares are handled if a shareholder passes away, and other key aspects like voting rights. It also helps ensure everyone knows the rules for making decisions and working together - it’s like having a solid framework to keep the business running smoothly.
Who signs a shareholders agreement contract?
All shareholders of the company must sign the agreement. This ensures that everyone with a stake in the company agrees to abide by the terms outlined in the document. If a new shareholder joins the business, they should also then sign the agreement and follow the set terms.
For companies with different levels of shares, you could add the different rights and obligations for each level. For example, voting rights and any dividend entitlements (payments of profits).
When does it need to be created?
It’s best to create a shareholders agreement when first starting a business. You could also create it when there is more than one shareholder. Having an agreement in place early helps to provide clarity about shareholder roles. It covers how you will tackle decisions and profits and losses. If you do create a shareholders agreement after the company first begins, all parties should agree to the terms before signing.
When does it need to be amended?
You need to update a shareholders agreement when there are significant changes in the company or its shareholders. Common examples include:
A new shareholder joining the company
A shareholder selling or transferring their shares
Changes in the company’s structure, such as mergers
Amendments to the company’s goals or business model
Disputes that require clearer terms
What are the main terms in a shareholders agreement contract?
A shareholders agreement includes the following key terms:
Shareholder rights and responsibilities: It clarifies voting rights, dividend entitlements and other obligations.
Share transfers: The process for selling or transferring shares, including pre-emption rights. This is the right of existing shareholders to buy shares before they’re offered to other parties.
Decision process: How to make major business decisions, including the required voting thresholds.
Profit distribution: This explains how to distribute the profit among shareholders.
Dispute resolution: Provides ways for resolving disagreements, such as mediation.
Exit strategies: Exit strategies for a shareholder could include buyout options and valuation.
Confidentiality and non-compete clauses: This protects the company’s sensitive information.
How will a shareholders’ agreement help a minority shareholder?
For those shareholders who own less than 50% of a company’s shares, they will have limited control over business decisions. A well-constructed shareholders’ agreement can protect those shareholders with a smaller vote. This protects their interests against those with larger shares.
Here are the benefits of a shareholders’ agreement for minority shareholders:
Protection against unfair decisions: The agreement can include clauses that all shareholders must approve major decisions. This could include selling the company, issuing new shares, or changing the company structure.
Pre-emption rights: These allow minority shareholders the chance to buy extra shares. This is before external parties which could reduce the percentage of the minority shareholder's own share.
Fair dividend distribution: With rules for profit-sharing, the dividends can be fairly distributed.
Exit strategies: A minority shareholder may struggle to sell their shares without the majority’s vote. A shareholders’ agreement can set out buyout rules or protections to make exits smoother.
Dispute resolution mechanisms: These clauses will prevent disputes between shareholders. It can help to resolve issues, preventing mistreatment of minority shareholders.
How will a shareholders’ agreement help a majority shareholder?
The majority shareholders, who hold more than 50% of the company’s shares, have more control over the company’s direction. This position comes with risks, including disputes with minority shareholders. A shareholders’ agreement helps protect majority shareholders and helps the company operate well.
Key ways a shareholders’ agreement benefits majority shareholders include:
Streamlining decision-making: The agreement helps clarify the process for making business decisions. This can stop delays caused by disputes or disagreements with minority shareholders.
Protecting against minority interference: Clauses can prevent minority shareholders from blocking decisions.
Facilitating share transfers: Majority shareholders can ensure that share transfer rules are fair. This may include pre-emption rights so minority shareholders sell their shares during a company sale.
Ensuring control over profit allocation: This can explain how to distribute and reinvest profits. This can give majority shareholders confidence in the financial direction of the company.
Avoiding legal disputes: This agreement reduces the chance of a costly and time-consuming legal battle. It addresses potential conflicts.
For majority shareholders, a shareholders’ agreement protects their leadership. This agreement also creates a fair and functional framework.
Shareholder agreements in practice: An example
Imagine a small tech start-up with three co-founders, each holding equal shares. They create a shareholders agreement that outlines:
Each shareholder has an equal vote on major business decisions.
Shareholders should get a fair chance to buy shares first before selling to an external party.
Invest profits back into the business for the first three years, with no dividends paid.
Resolve any disputes through arbitration to avoid lengthy court battles.
If a co-founder leaves, the remaining shareholders can buy their shares at a pre-agreed valuation process.
This agreement ensures all shareholders share the same company’s goals. They will have clear rules to follow in the event of disputes or changes.
What’s the difference between a shareholders agreement and articles of association?
Both documents explain how a company operates, but they serve different purposes:
Shareholders agreement: This is a private contract between shareholders. It helps shareholders set rules on share transfers, dispute resolution, and profit distribution.
Articles of association: This is a public document filed with Companies House. It sets out the rules for running the company, such as director responsibilities, voting procedures, and issuing shares. A memorandum and articles of association are legal documents when starting a business.
How a solicitor can help
Drafting a shareholders agreement requires you to consider legal, financial, and operational factors. A solicitor can help by:
Ensuring the agreement complies with UK laws.
Reflect the unique needs of your company and shareholders.
Identifying and addressing potential areas of dispute
Reviewing existing agreements to ensure they remain relevant
Advising on amendments when changes occur in the business or shareholder structure
FAQs
Can I write my own shareholder agreement?
Yes, you can draft a shareholders agreement, but we recommend consulting a solicitor. A poorly written agreement can lead to misunderstandings or disputes. To make sure it’s enforceable, we can make sure it’s compliant and comprehensive.
Is a shareholder agreement legally binding?
Yes, a shareholders agreement is legal once all shareholders sign. It is then a contract under UK law, and any breach of its terms can lead to legal consequences.
Final thoughts
A well-drafted shareholders agreement is a vital tool for businesses with multiple shareholders. It protects shareholder interests, whether you are a minority or majority shareholder. Whether you’re starting a new business or reviewing an existing agreement, we're here to help. Get in touch today to see how our small business solicitors can help.
References
Running a limited company by gov.uk
Shareholders and guarantors by gov.uk
Disclaimer: This article only provides general information and does not constitute professional advice. For any specific questions, consult a qualified accountant or business advisor. Bear in mind that tax rules can change and will differ based on your circumstances.