6 REASONS WHY YOU NEED A SHAREHOLDERS' AGREEMENT
This article explains 6 reasons why you should have a shareholders’ agreement.
- What is a shareholders’ agreement?
- Why create a shareholders’ agreement?
- 6 reasons why you need a shareholders’ agreement
- What you should do next
What is a Shareholders’ Agreement?
A shareholders’ agreement is a private contract between shareholders of a company. It should be written in clear, unambiguous terms, so that it is easily understood.
A shareholders’ agreement allows you to agree certain arrangements privately with your fellow shareholders, so that your affairs remain both private and secure. It is not a public document such as your company’s Articles of Association.
“A shareholders’ agreement can protect the interests of minority shareholders. It can also keep the affairs of the company private.”
Why create a shareholders’ agreement?
Setting up your company
Your company’s governing framework is set out in a key document known as the ‘Articles of Association’. This document gives detailed instructions on how your company and management structure works.
The Articles of Association enable the company’s directors and shareholders to work out whether any action you take is permitted.
Many of the issues covered by a shareholders’ agreement could be set out in your company’s Articles of Association.
Purchasing shares without a shareholders’ agreement?
If you do not set up a shareholders’ agreement you will purchase shares subject to the law set out in the Companies Act. This creates a binding, ‘statutory’ contract between the shareholders unless you create your own arrangements in a shareholders’ agreement.
6 reasons why you need a shareholders’ agreement
Here are 6 reasons why you might prefer to set up a shareholders’ agreement instead of letting the Companies Act dictate your affairs:
Usually, all that is required to change the statutory contract set up by the Companies Act is for 75% of the company’s shareholders to agree to the change. This makes the position of someone with a small stake in a company particularly vulnerable. It also means that a shareholder or group of shareholders with a majority stake can exercise huge control. That power might be open to abuse.
If you set up a shareholders’ agreement it can only be amended in writing and with the unanimous agreement of all shareholders. This would safeguard you if you own a minority stake and also limit the powers of controlling shareholders.
Your company’s Articles of Association is a public document. It is available to anyone if they pay a small fee via Companies House. In contrast, a shareholders’ agreement is not accessible to the public. This will suit you if you wish to keep your contract with your fellow directors and shareholders confidential.
If a shareholders’ agreement is altered without the assent of every shareholder, this will amount to a breach of contract. Any dissenting shareholders can make a claim in the courts for compensation.
Personal aspects of a relationship between shareholders
You may want to agree certain personal affairs that do not directly relate to the governance of the company. This could include an agreement for shareholders to keep the company’s affairs confidential. Alternatively, a shareholder who is also a director of the company may have agreed not to work for a competitor for a certain period of time after their employment comes to an end. Such matters are best dealt with in a shareholders’ agreement rather than in the company’s Articles of Association as even this information could be commercially sensitive.
One of the most important factors when entering into business with other people is what to do when you later want to terminate the relationship. How do you as shareholders retrieve the value of your investment? What happens if the relationships between the shareholders break down?
A shareholders’ agreement can include provisions that deal with how to value the shares of an outgoing shareholder. This could cover a shareholder who is also an employee or director of the company and is selling their shares because they are retiring. Alternatively this might cover someone who is dismissed for misconduct.
A shareholders’ agreement can specify that the shares of a shareholder who dies or becomes permanently unwell must be sold to the other shareholder(s). This avoids the administrative inconvenience of the outgoing shareholder’s family inheriting a stake in the company. This can be set up alongside an insurance policy to provide the necessary funds based on the valuation. In this case the remaining shareholders would get to keep running the company as they would like. The former shareholder’s family would get the value of the shares.
The method of valuing shares can be different from case to case. For example, it is not normally considered appropriate for someone who has been dismissed to be given the same amount of money as someone who has worked hard for and devoted their time and attention to the company up to and including their retirement.
What other things can a shareholders’ agreement cover?
Shareholders’ agreements can cover any number of different issues, from whether a shareholder can sell his shares to whoever he likes, to appointing a particular shareholder to a specific role (e.g. the company’s auditor) for a certain period of time.
A shareholders’ agreement can even include a promise to one shareholder by the other(s) to appoint a member of that shareholder’s family (e.g. son or daughter) as a director by the time he/she reaches a certain age. This could be particularly important to shareholders who wish to preserve their family’s interest and involvement in the running of a company.
What you should do next
If you run a small company with shareholders and directors, you probably need a shareholders’ agreement. Your first action should be to speak to business law specialist John Appleby at Leonard Gray LLP.
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About Dan Woodruff
Certified Financial Planner & Chartered Wealth Manager at Woodruff Financial Planning
Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.