A shareholders’ agreement is a vital tool for shareholders to regulate the relationship between themselves and the company. Here are the top 10 tips for shareholders (and future shareholders) to consider before entering into a shareholders’ agreement.

  1. Think why you need one

Despite it not being a legal requirement to have a shareholders’ agreement in place, they are helpful to avoid disagreements becoming costly disputes. Without a shareholders’ agreement there can be significant uncertainty. A shareholders’ agreement helps sets expectations and provides a structured framework for decisions and disagreements, especially if deadlock is a possibility.

  1. Privacy

All companies have articles of association. These are the publicly visible rules for how the company will be run, filed at Companies House.

In contrast, a shareholders’ agreement is a private and legally binding agreement. Shareholders will often want to include detailed provisions in a shareholders’ agreement and may not want the public to know their affairs. It is not uncommon, for instance, to see a dividends policy or detailed financial arrangements set out in a shareholders’ agreement, which the shareholders would like kept off the public record.

  1. Working with the company’s articles of association

There can be significant overlap between a company’s articles of association and a shareholders’ agreement. A shareholders’ agreement should not contradict the articles as this would cause unnecessary confusion and counteract the consistency and clarity that a shareholders’ agreement can provide. A good shareholders’ agreement compliments the company’s articles of association.

  1. Cost effectiveness

Disputes are inevitable in business, and a shareholders’ agreement should be seen as a worthwhile investment for the future. Whilst there may be time and cost involved in negotiating and drafting a shareholders’ agreement, the objective should be to ensure that there is a simple and cost-effective means to manage potential disputes in the future, and to minimise the risk of having to resort to costly litigation.

  1. Important decision making

A shareholders’ agreement often sets out certain key decisions which can only be taken with approval of some or all of the shareholders. This provides a check on the broad power of the directors to run the company, and ensures that the company is being run in the way that shareholders require. Shareholders will need to consider what issues they consider to be commercially important to accurately reflect the concerns of the business.

  1. Deadlock

Shareholders should pay particular attention to how they envisage resolving deadlock if they cannot reach agreement and there is a risk of the company grinding to a halt. A clear strategy for how the deadlock will be broken is essential. Sometimes mediation can help focus minds, but a means for a compulsory sale or purchase of shares is also not uncommon.

With any mechanism for the compulsory sale or purchase of shares, it’s important to think carefully about how transactions will be funded.

  1. Restrictive covenants

It is common for shareholders to be subject to restrictions on what they can do both whilst they are shareholders and for an agreed period afterwards. This can, for instance, stop a shareholder using their knowledge of the company’s affairs to set up in competition with the company for their own benefit. These kinds of clauses are sometimes called restrictive covenants and need to be carefully considered and clearly drafted as it can sometimes be legally difficult to enforce these restrictions.

  1. No one left behind

A shareholders’ agreement can include “drag along” provisions to ensure that if a set percentage or certain shareholders want to sell their shares they can require the other shareholders to also sell up. This can help as part of an exit strategy or ensure that minority shareholders cannot hold the majority to ransom by stopping a sale.

On the flip side, shareholders’ agreements often contain a “tag along” right which requires those wishing to sell their shares to ensure that a potential buyer makes an offer to buy the shares of the minority shareholders on the same or specified terms.

  1. Good and bad leaver

It is not uncommon for shareholders’ agreements to contain detailed provisions for the transfer of shares. In some cases, shareholders may be required to offer to sell their shares to the other shareholders if certain “triggers” occur – such as serious illness or death.

A distinction is often drawn between “good leavers” who may leave through no fault of their own, and “bad leavers” who leave through their conduct. It is not uncommon that the continuing shareholders can buy the shares of a bad leaver at a significant discount compared to what is payable for the shares of a good leaver. A shareholders’ agreement should set out clearly how the value of shares should be determined.

  1. Planning for the future

When deciding on the terms of a shareholders’ agreement it is also a good idea for shareholders to review their Wills and to consider putting in place a Lasting Power of Attorney. This ensures that there is always someone able to take decisions in relation to a shareholding, if the shareholder cannot.

Also consider whether life insurance or key person insurance should be taken out in respect of shareholders or key employees. This can help with funding an acquisition of shares, or as part of a contingency plan for managing disruption.

If you would like to discuss any aspects of the above please contact either James Hopgood or Catherine Turner, Solicitors in the Corporate and Commercial Team 01603 677077.