Why have a Shareholders' Agreement and what to include

You’ve worked hard to develop a business idea, you’ve researched the market, and you’ve incorporated a company with business partners, you can now secure banking facilities, acquire domain names and other tools. Everybody is nervous and excited about what the future will bring once trading starts, but a vital element could be missing from the framework, which could greatly assist in navigating future issues arising between those partners and others they work with – a shareholders’ agreement. 

This is a document that can set out a framework for the shareholders to be able to work effectively, helping them to avoid pitfalls and unnecessary disagreements. Any company will already have a constitution, its articles of association (Articles), but without tailoring the Articles to the particular needs, or without a shareholders’ agreement that builds on its contents, the relationship between the company’s shareholders will be largely unregulated, or might not be a suitable framework for their needs.

A shareholders’ agreement, often combined with alteration to the Articles, is likely to include some or all of the following elements:

• Statement of shareholders’ rights which perhaps go beyond or constrain each shareholder’s statutory rights
• Entitlements to appoint and remove directors, and what constraints should be imposed on authority? How often should directors meet, and how should they report back to the shareholders?
• What information should be provided to shareholders and when?
• How is the business to be financed?
• Dividend policy?
• Decisions that are reserved to shareholders
• Should there be a defined dispute resolution procedure?
• Regulation of share transfers
• What should happen on the death or incapacity of a shareholder?
• Should anything change upon a shareholder getting divorced?
• On departure, should a shareholder be restricted from being involved in a similar business or otherwise competing with the company?

Any of the points above can lead to conflict, which can have the effect of destabilizing an otherwise successful business so long as it remains unresolved.

Among the most important aspects to control is the manner in which shares may be transferred. Some mechanisms can become fairly complex, but some fundamental points to consider are:

• Should shareholders be able to transfer shares to any person?
• Should there be a formula for valuing shares? Should this vary over time?
• Should shares be offered first to existing shareholders before somebody else?
• Should a shareholder director who ceases to work in the business be forced to sell their shares, and should there be other compulsory sale triggers?
• Should an offer that is attractive for one shareholder’s shares have to be extended for all shares, or should a selling shareholder have the right to force the sale of all shares?

A shareholders’ agreement may also refer to further documents that have an impact on the running of the company and its business, for example service agreements for directors; a business plan to set out the shareholders’ wishes for the business and which is reviewed on a regular basis; or should there be a set of rules that dictates what should happen in the event of death or incapacity of a key person?

Beyond this however, there may also be provisions that are not referred to in a shareholders’ agreement itself, but which will have an impact on the ownership or running of a private limited company.

Company legislation provides that a director who loses mental capacity but is still alive would likely be removed from that office. However, if they hold shares in the company, they will continue to own those shares. What should happen regarding voting rights? Unless such a shareholder grants a Lasting Power of Attorney to authorize someone to make decisions on their behalf in the event of incapacity, nobody can act for that person without a Court Order.  

The will of any shareholder is of course more of a private document, but should ideally set out what should happen to that person’s shares upon death. Care should be taken to ensure that the shareholder’s wishes don’t conflict with any share transfer provisions set out in a shareholders’ agreement or the Articles, or at least that the value attaching to the shares ends up in the right hands, allied perhaps with a suitable life insurance policy. Certainly it is worth shareholders considering in advance what should specifically happen to their shares or the value attributed to them in the event of death, rather than simply leaving it to their executors to deal with that aspect as part of the residual estate. Surviving directors and/or shareholders may not wish to work with former colleagues’ family members, who might not be familiar with the dynamics of this particular business or might have demands or an agenda that differs from the status quo. It is clearly vital for directors and shareholders to have some kind of succession plan in place.

Shareholders and directors might also wish to put in place a non-binding set of guidelines for management of the company in the event of incapacity or death of a key shareholder or director, which can avoid confusion at a critical time. There is no perfect or prescribed framework for this, and each business will have its own unique characteristics to accommodate, but thought given to certain key areas can guide those involved and might avoid issues arising when the company’s management are at their most vulnerable.

If you have a question relating to a shareholders’ agreement, please contact Ben Madden, a partner in our Corporate and Commercial team on 01689 887845 or email ben.madden@cwj.co.uk.