Why you need a shareholders agreement
In a limited company, each share carries a prescribed number of votes. In most cases all the shares are of the same class - ordinary shares - and each carry one vote. That means that a majority (over 50%) controls the company.
There are many situations where the shareholders are not happy with such an arrangement and instead use a shareholders agreement, which provides a more equal distribution of power and / or protects a minority from exploitation.
The most usual situations where such circumstances arise are where:
- A small number of people all work together and wish to arrange for decisions to be taken unanimously, or nearly so;
- Some shareholders are not directors and therefore are not in any position to control the company's affairs outside of a general meeting. This may arise either because the shareholder does not want the burden of director responsibility or because he is not invited to be a director;
- One shareholder has lent money to the company, and has no personal involvement in management.
- Shareholders have formed a company for a specific joint venture. When the venture is -completed, they will wind up the company.
- The usual way to regulate the relationship between shareholders and to set out the limits of freedom of director-shareholders is through a shareholders agreement. Whereas the structure and operation of a company is set out by statute in very precise terms, the shareholders can agree virtually anything among themselves. What you put into a shareholders agreement is therefore entirely up to you. The starting point for your shareholders agreement should therefore be a "wish list" or agenda of agreed points.
Here are the important considerations and provisions:
- Find the right company structure
Many lawyers and accountants, let alone business managers, hesitate to enter the esoteric world of authorised and issued shares, ordinary, preferred, "A" and "B" shares. However, the management of the structure of a company is really very simple.
Companies operating a small business have three sources of money:
(i) Cash subscribed for shares,
(ii) Profits ploughed back and
(iii) Borrowings
Borrowings can be from directors, banks, trade creditors or a host of others. A new company will probably "arrive" with only two ordinary shares of £1 each, issued, most likely from an authorised share capital of £100. You can either leave the authorised capital at £100 or increase it to some larger sum. If you have a number of shareholders, then £1,000 obviously gives you more flexibility to deal in tiny proportions of the whole interest. Keep to round numbers if you want to be able to calculate voting power easily.
- Intellectual property
We place particular emphasis on intellectual property. Even if your business is based in bricks and mortar, or personal services or travel, we do advise that you incorporate suitable provisions to protect your intellectual property. Names, copyright, and many other forms of intellectual property often accumulate immense value.
- Exit strategy
How important is this to you? It may be very important - if you are a lender and want your money out within a given time frame; or it may be not important at all - if you are a shareholder in an ongoing business. Unfortunately, lack of knowledge of the future inhibits and restricts the arrangements you can make in advance! You can do just two things.
One alternative is simply to set down a statement of intention. This has no legally binding force, except perhaps in a supporting role, but it does act as a reminder that there is a time frame. It may be that a lender will have the benefit of a separate loan document, which does provide the right to enforce the action or proposal in the shareholders agreement.
The second alternative is to make provision for precise alternative events. They might include:
- Sale of the company
- Sale of the business out of the company
- Some shareholders buy the others out
- A public placing of shares is sought
- Other third party capital is sought.
- The assets are sold and the company wound up
Of course, you have to beware of severely damaging some interests in favour of others. A shareholder-lender is in a very strong position once the loan has become due for repayment. He may have added strength if the other shareholders have agreed to sell the company on a specific date - and he is the only buyer around!
The Net Lawman agreements incorporate several alternative ways to provide an exit route. However, in this area, every group of people will have a different solution, so do not hesitate to come back to us if you would like further drafting work for the best solution for you.
- Shareholders who are trading partners
Loan or share subscription money may be offered by trading partners or even competitors. There is nothing wrong with such a deal in principle, but existing shareholders should look very carefully at what knowledge and power they might accidentally give to some other person. The pleasant, easy-going person with who you deal today might be replaced next year by someone not so friendly.
A shareholders agreement may contain provisions linked to future trading with a shareholder or ownership of stock or other assets.
- Exactly what can the directors or the company do or not do without approval from all?
The purpose of the shareholders agreement is to restrict the freedom of action of the directors and other shareholders in order to protect the rights of one of more minority shareholders. So this list is crucial. All Net Lawman shareholders agreements cover a full list of possibilities. But in your business there may also be precise actions about which a minority would like to be consulted. What are they?
- What level of agreement is required?
The previous point depends on agreement as to what is a "majority" in the context of needing consent. Do the directors have to have 100% agreement; or is it to be only 75% or less? A lender with 5% of the shares might insist on 100%, but perhaps only for the most important matters. A group of shareholders working together may decide to restrict a wider range of decisions, but agree that it needs only 60% of them to make such decisions.
- Transfer of shares
Provisions relating to transfer of shares are often contentious. We are all naturally concerned about whom we work with and whom we work for. The shareholders agreement should provide very clearly what is to happen when one shareholder transfers his shares, whether by accident (death, bankruptcy) or intentionally (after argument or injury, or to pay off a debt elsewhere?).
- Old shareholder - new competition?
Do you intend to prevent a former colleague from setting up in competition? How will you do this? Although there may be linked employment issues here, the Net Lawman template documents provide full protection for the company and the continuing shareholders.
- Directors' rights and contracts
A director's service agreement is the same as a contract of employment. The days when directors did not need a contract of employment are gone. Recent law places an obligation on every company to provide directors with "terms of employment" and to provide disciplinary and grievance procedures which include directors, just as for other employees. So any rift among the directors is likely to result in an application to an employment tribunal. If you want to avoid the disturbance and expense, every director should have a suitable contract. Non-executive directors may or may not be employees. Either way, you will find the contract you need at http://www.netlawman.co.uk/director-docs.php
- Other documents you might need
Whilst you deal with the shareholders agreement, you will obviously have to hold formal meetings of directors and shareholders to record the "business" of the company in making the necessary changes to the share structure, share ownership and directors. The documents to deal simply with these matters are available from Net Lawman at http://www.netlawman.co.uk/company-documents.php
These considerations apply to a joint venture only
- What is the venture?
We have already made the point with regard to shareholders agreements that the venturers are able to decide exactly what the deal is to be, subject only to compliance with the general law. Because parties to a venture have been discussing together for some time, the detail of what is agreed is often overlooked - with disastrous consequences. In our experience, the only way to cover even the main alternative outcomes is to consider a multitude of possibilities.
We advise that you write down a list of assumptions, winnowed from your business plan, then for each, start asking "what if" questions, always with a view to how the different results will affect the shareholders / joint venturers. The key question is always "Who will have the power".
- Shall we help set your documents in order?
If you would like our help in drafting your edited changes into "the proper words" we shall be happy to do so. There is no formality, no appointment, no selling. How we charge. |
