Why use a shareholders agreement
Having a shareholders agreement in place is essential for both majority and minority owners.
The reason is not one of compliance with the law, but for protection of your personal interests - even if you own more than half of the total share capital.
Minority shareholders are likely to want greater control over the decisions that influence the value of their holding than the law gives them by default.
Majority owners may wish to make sure that minority shareholders cannot sell their shares easily to anyone who may have different ideas about the direction the company should take.
In short, a shareholders agreement sets the framework for how the owners will manage their company together.
The Companies Act 2006 provides the over-arching rules under which all companies must operate. Below that, the articles of association set out how an individual company is run by the directors and the shareholders. This document records how the owners control and manage the business between themselves, providing the basic business structure. Subject to that joint framework, there is enormous further scope to decide who may do what, and under what circumstances.
The type of business you carry out is not important. A shareholders agreement is about control and power. It is very easy to add industry-specific provisions, but they still tend to boil down to questions of power or policy.
Although you can include strategy and objectives, it is a mistake to fill your agreement with matters that should best be covered in your business plan - a level even lower down the structure.
Every agreement balances different shareholder interests in different ways, including:
protecting minority owners who otherwise do not have a great influence on decisions
protecting a founder entrepreneur or lender who has a small shareholding but a large interest in the company
setting out who can be a board member and therefore influence decisions taken by the directors that are not put to the shareholders
controlling the appointment and termination of directors
providing options for exit provisions
Specific matters covered in all our shareholders agreement templates
Clarification of decision making
Executive directors are employees, accountable to the company and its shareholders. Where directors are also stock holders, as is so often the case, a director may be able to make decisions that benefit himself as a shareholder, but which are not in the interests of his fellow owners.
A shareholders agreement fulfils the role of an operating agreement. It allows you to set the limits of director power, and clarify what matters should be referred to the share holders for a decision. Doing so helps to ensure that owners are kept informed, and that the most important decisions are made by them as a group, and not by the directors.
The converse applies too. An agreement can also define what decisions a shareholder-director may take freely, without requiring a shareholder meeting, allowing confident, decisive action when it is needed.
Rebalance shareholder power on issues that are important to you
By default, voting power is in proportion to shares held. Your agreement can over-ride this basis, allowing you to specify the rules as to how decisions on subjects important to you are made. Minority shareholders can be given more say on certain issues.
For example, you might give every shareholder an equal vote on decisions relating to appointment of directors regardless of proportionate ownership. In some circumstances you might decide that each shareholder may be a director or appoint some other person to be a director. Another burning issue could be sale to a third party.
Decisions on different subjects could be decided in different ways depending on the importance of each subject to each shareholder. You can go as far as to completely separate ownership and control: useful if some share holders may not have experience or knowledge to allow them to make effective decisions. For family businesses and companies where some shareholders hold shares only as an investment, this is likely to be a useful feature.
Protect the value of your investment
A written shareholders agreement can help prevent other owners reducing the value of your investment by their actions. It can do this by setting out:
requirements for disclosure and for approval for certain actions such as large asset purchases
how assets, time and expertise brought into the business should be valued on sale
Guard your privacy relating to management
Some aspects of management can be set out in the company's articles of association. However, unlike the articles, your agreement is a private document that you don't have to file with Companies House or make publicly available. Only you and other owners will know the arrangements you have. How your company is managed remains confidential.
Reduce the likelihood and cost of disputes
Disputes between owners and other stakeholders are expensive and can be disruptive and detrimental to the on-going operation of the business.
Many matters are likely to be discussed at each annual general meeting of the members. Some will require immediate action and therefore will be voted on. Others will come under strategic or contingency planning, such as under what circumstances owners agree to a merger if approached. The likelihood is that over a period of time, consensus might be forgotten on any single issue if it wasn't something that required a vote. Discussing these matters at the outset when starting a new business or when a new shareholder arrives and then recording them in writing limits the scope for a single member to scupper the plans of the other stockholders by claiming that he or she has never been involved in such decisions.
In other words, having a shareholders agreement written in plain English means that shareholders are less likely to dispute what was agreed when the document was signed.
The inclusion of a dispute resolution procedure (which could be arbitration or mediation) within our templates makes resolving any that do occur easier.
Retain control in difficult situations
A shareholders agreement allows you to plan for the worst so as to keep the business going. Within it, you can set out what would happen should certain events occur, whether the sudden departure of a key founder or the withdrawal of a source of funding.
Writing one, together with the other owners, is a process that allows you collectively to evaulate the risks to each of you. It can help with business planning.
Practical matters covered
Format and layout
Like all Net Lawman documents, our shareholder agreement templates are in Microsoft Word format. The main advantage of a Word document is that you are not restricted in what you can edit - you really can create an agreement that fits your business. Of course, as your business grows, you can also revisit the document and amend it as necessary. Features within Word such as Track Changes allow you to collaborate with other owners easily.
The law in these shareholders agreements
The law relating to these documents is both corporate law and commercial contract law. Our guidance notes make it clear which paragraphs you can safely edit or delete, and which we recommend leaving as drawn.
However, your agreement is always subject to the articles of association. If you are putting one in place, it is usually a good time also to review and update your articles to make sure that there are no conflicts between the two documents.
Templates in plain English
Our templates are written in plain English by a solicitor who specialises in commercial drafting and who has practical experience of resolving shareholder disputes.
As a former director of numerous private and publicly listed companies, he includes practical, “real world” considerations. These agreements are comprehensive in the cover of legal and management issues.
Special provisions covered
For various reasons many start-ups want vesting provisions. That is, a shareholder can cash out his equity only after an agreed period has passed, or when his performance is satisfactory or when a certain event occurs.
This provision is covered only in our version for a new company. The document includes very specific notes on this.
However, we advise that you do not decide vesting provisions may be a good idea on reading this. You need to be certain you want to use them. If you do want this structure then shares’ classes, transfer or forfeiture terms must be first set out in the articles.
Shares valuation on exit
All these documents include provision for valuation of the shares of a departing shareholder by reference to a valuation based on your instructions to an accountant. The valuation depends on the parameters used, so your instructions are critical. We have provided a comprehensive version which you can edit according to the deal you wish to strike with a selling shareholder.
Tag along, drag along and right of first refusal
These provisions are included in our agreement for an institutional investor because it is in that situation where they are most sought after, but the presence of an institutional investor is not a pre-requisite for using them.
Tag along and drag along provisions are essential if you anticipate a sell out to which not all shareholders might agree.
They provide that:
no shareholder can sell a majority shareholding unless the same deal is also offered to the minority.
if the majority want to sell and the buyer has offered the same deal to the minority, the minority must accept and sell.
Right of first refusal can help protect from an unwanted outsider buying into the business if one of the other shareholders decides to sell.
A professional investor will nearly always require these provisions so that his exit route is clear.
Choice of limited company
The limited liability that a incorporated business structure affords is an enormous advantage for startups, a small business or a nonprofit over a general partnership or sole proprietorship because as its own legal entity, it reduces personal liability for losses. However, that should not be confused with removing responsibility or obligation entirely.
Directors have specific responsibilities under law.