When starting or operating a business with more than one shareholder, it is essential to establish clear rules to protect the interests of all of them. Below are six reasons why it’s important to have a shareholders’ agreement to provide certainty to what happens in situations which may arise.
What happens to their shares if a shareholder dies?
Shares are the personal assets of each shareholder. The shares don’t belong to the company. As such, if a shareholder dies, the default position is that their shares would pass to their beneficiaries, for example, their legal partner or children. In the first place, the beneficiaries may not wish to be involved with the company but have this thrust upon them. In the second place, the continuing shareholders may not wish for third parties to be involved in the running of the company.
It’s therefore possible to include a clause which states that the deceased shareholder’s shares are transferred to the continuing shareholders in return for the continuing shareholders paying to the deceased’s estate the fair value of those shares. This means that the continuing shareholders keep control of the company but that the beneficiaries get the monetary value of those shares instead of the shares themselves.
What happens to their shares if a shareholder wishes to retire or leave the business?
In this situation it’s common practice to include a ‘pre-emption’ right in the shareholders’ agreement which states that the continuing shareholders have the right to buy the leaving shareholder’s shares. This is so the continuing shareholders can keep control and not allow a third party who they may not know to be involved in the business. If the continuing shareholders can’t, or don’t want to, buy the leaving shareholders’ shares, the leaving shareholder can sell those shares to a third party. It’s important that the leaving shareholder is able to sell their shares to a third party if needs be so that they ultimately have a way out of the business.
Without including the pre-emption right clause, each shareholder’s shares are freely transferrable, generally speaking.
How often will dividends be paid?
The shareholders’ agreement can set out how often dividends are to be paid. It can also state that if, for example, a shareholder or director has made loans to the company, no dividends are paid until the loans have been repaid. This is because it’s potentially unfair for the other shareholders to be paid dividends while the shareholder / director who made the loan is out of pocket.
How do you safeguard the company’s customers and staff if a shareholder leaves?
We would suggest including clauses in the shareholders’ agreement imposing restrictive covenants on the shareholders so that they are prevented from poaching customers or key staff if they leave. If this clause isn’t included then generally speaking they can do so which could have a serious effect on the company being able to continue trading.
It’s important that the restrictions are reasonable otherwise the courts will say they are unenforceable against the shareholder who has breached them meaning that they aren’t actually bound by them. We can assist you in drafting those clauses.
Can you force a shareholder to sell their shares in certain circumstances?
Yes, you can if the agreement says so. For example, the agreement may say that, if the shareholder commits a criminal offence or does something that seriously harms the reputation of the company, they are forced to sell their shares.
In such a scenario, the shareholder is often deemed to be a ‘bad leaver’ which means that they only receive the nominal value of their shares rather than what the shares are actually worth. The reason for that is because it is potentially unfair for a shareholder to profit from their wrongdoing. However, the agreement can be drafted to say that they do receive the actual value of their shares if you wish.
What about key company decisions?
The shareholders’ agreement can include provisions which state that certain key decisions require the consent of the shareholders. For example, borrowing over a certain amount, taking on a lease or buying a property because these tie the company into potentially lengthy or costly contracts.
Most day-to-day decisions of a company are made by the directors but the shareholders can require certain decisions to be discussed with them and for the shareholders to have the final say before the transaction proceeds.
The above are the main clauses to be included but each shareholders’ agreement can be tailored to your particular requirements. There are though other clauses which can be included too such as:
- ‘Drag and tag’ clauses – whether minority shareholders can be forced to sell their shares if the majority shareholders find a buyer for the company (drag) and where the minority shareholders can join in with a sale and force the majority shareholders’ buyer to buy the minority shareholders’ shares too.
- ‘Termination clause’ – there should be a clause which states what is to happen if the shareholders are unable to work together whether that’s that one shareholder buys the other shareholder’s shares or that the company is wound up and closed.
We have dealt with numerous shareholder agreements so have a sound understanding of the law governing them. We also get to know each company we prepare shareholder agreements for so that they are tailored to each company’s situation. There is not a one-size-fits-all approach.
Do not wait until conflicts arise to try and put in place a shareholders’ agreement. At that stage it’s unlikely that the shareholders are able to work together to reach agreement meaning that they end up spending much more on legal costs to resolve the situation that relying on what is already documented in an agreement. Investing in a shareholders’ agreement now can protect your business and its shareholders for the long term. If you need assistance with your shareholders’ agreement, please call our corporate team on 0345 209 4701.
Please note that this article is for information purposes only and it is not intended to be legal advice. You must always obtain independent legal advice from a solicitor before you sign any documentation.
Chris Morgan, Senior Associate, Corporate and Commercial