10 reasons why you need a Shareholders Agreement
If you are a business owner, director or shareholder, do you need a Shareholders Agreement? The simple answer is yes, you probably do. Paul Hardman is a corporate and commercial lawyer with expertise in helping businesses plan for the future. Here, he explains his 10 reasons why it’s so important to consider putting a Shareholders Agreement in place.
Without a Shareholders Agreement…
There is no right to be bought out of a company
One of the key features of a company is that it continues even if its shareholders change. If you and your fellow shareholders go your separate ways or if you cannot continue to work through incapacity or death, your shares are unchanged. This means you become a passive shareholder in the company dependent on the management of the company for any dividends or future sale value
There is no right to be involved in the management of a company
At the start of a new venture, you may have an understanding with your fellow shareholders that you will always be involved in the business. If you have a falling out that understanding will be tested and unless it is written down, you may find yourself having to take legal action to enforce your rights. That can be very expensive.
The value of your shares is directly dependent on the rights that attach to them
A share is simply a bundle of rights in a company which may be asserted against the company and your other shareholders. Whether or not those rights will turn into hard cash completely depends on where those rights stand with regard to the company’s other priorities and the rights of those other shareholders. One of the key rights you will need to understand as a shareholder is whether on a sale of your shares your shares are valued pro rata to the value of the total company. Or, a value a willing purchaser would pay for your holding recognising that a the value to a would be buyer of a minority holding in an unlisted company is substantially less than its pro rata value.
There is no right to be offered the shares of another shareholder if they sell
A shareholder can normally sell, gift or otherwise transfer his shares to anyone he or she chooses even to competitors.
A small minority can block a sale that the majority all agree
If you are thinking about selling your company your buyer will want to buy 100% of the share capital in almost all cases. The Companies Act provides that in those circumstances a minority representing 10% or less can be ‘squeezed out’ but you may want a more simple process than the Act provides and to set that minority at a different level.
With a Shareholders Agreement…
You can decide the key decisions that need special voting arrangements
As a group you may all agree that there are key decisions that should be taken by or with the consent of named individuals or a higher than the normal simple (50% plus) majority.
You can decide what is to happen if you have a deadlock
Where you have a 50:50 company you may create a deadlock situation where neither shareholder is able to move forward with a key proposal. The shareholders agreement can provide how that is to be resolved including by a cross sale mechanism known as a ‘Mexican stand off’ or ‘Russian roulette’ clause and if that doesn’t work requiring the company to be wound up.
You can decide that if a shareholder/director leaves the company they have to sell their shares
For many SME companies, the share capital is used to tie in and to reward key management individuals. Where one of the management team leaves unless they have an obligation to sell their shares back their replacement will not have the same share reward mechanism unless new shares are created to dilute everybody.
If you are using tax planning to spread share ownership (for instance between husband and wife) you can agree when those arrangements are to be unwound
Whenever tax planning advice concludes that shares should be spread to maximise tax exemptions or savings the shareholders agreement can regulate matters if those arrangements need to be unwound.
You can bring employees into share ownership
The shareholders agreement can be combined with special classes of shares such as ‘growth’ or ‘flowering’ shares so that employees are rewarded for future value that they create in the company but owners can be confident that they can get those shares back if they leave.
Specialist Shareholder Agreement legal advice
To speak to us about making a Shareholders Agreement, and other ways of protecting your business interests with a Business Life Plan, call 0117 906 9400 or email firstname.lastname@example.org
If you are still not sure that you need one, take a look at our Shareholders Agreement checklist. It’s designed to help you start thinking about the decisions you’ll have to make to draft an agreement.