How to draft a shareholder's agreement
Owning and running a business alongside a number of other parties, who all have their own opinions and views on the direction and running of the company, can prove extremely difficult.
However, a shareholder agreement can help to promote compromise among shareholders and confront any concerns held by any parties head on.
Although creating a shareholder agreement is not absolutely imperative for the successful running of a business, having one in place can give each party the peace of mind that legal issues will be avoided further down the line.
In this guide, we will explain the process of creating a shareholder agreement, explaining its importance and helping you to resolve any disputes that may arise when putting one in place.
What is a shareholders’ agreement?
A shareholders’ agreement is, simply put, an agreement between the shareholders of a company.
It can be between some or all of the shareholders, and its purpose is to protect the investments shareholders make into the company, while also establishing a fair relationship between the shareholders and outline how the company should be run.
A shareholders’ agreement should:
- state the rights and obligations of the shareholders
- outline how the company will be run
- regulate the sale of shares in the company
- define how important decisions should be made
- provide protection for minority shareholders on the company
How does a shareholders’ agreement help a majority shareholder?
In the event that a majority shareholder wants to sell their shares, but a minority shareholder will not agree, it is important to include a provision to force that shareholder to sell their shares.
This is known as a “drag along” provision, and will allow the majority shareholder to release their investment at a time and price they feel is appropriate.
Further to this, a majority shareholder will want to prevent minority shareholders from passing on confidential company information to competitors or setting up rival businesses. Both can be included as a provision within the agreement.
When should a shareholders’ agreement be put in place?
It is normally best practice to put a shareholders’ agreement in place when a company is first formed.
Doing so can be a positive exercise in establishing a common understanding of shareholder expectations for the business.
In these early stages, shareholders should have similar hopes for the company. If any major differences are identified at this early stage, it could send a warning to fellow shareholders.
In some cases, investors choose to defer discussing shareholder agreements to a later date, preferring to focus their time on establishing the business.
Although they may have every intention to return to this important matter at a later date, the longer it is left, the more likely it is to be forgotten.
One potential downside of a shareholder agreement is the suggestion that if all decisions need to be unanimous, problems can arise.
For instance, a minority shareholder may want a provision included that states if someone is willing to buy the shares of a majority shareholder, that a shareholder can only sell those shares if the same offer is made to all shareholders - including minority shareholders.
Often referred to as a “tag along” provision, this should then ensure that minority shareholders can receive the same return on their investment as other shareholders.
What should be included in a shareholders’ agreement?
There are no requirements for what should be contained within a shareholders’ agreement.
The document can cover a variety of issues, or just one or two.
There may be a very specific matter that one or more shareholders want to be included that may be unique to their situation, or a series of more general matters.
The contents of a shareholders’ agreement will depend on the number of shareholders and their shareholdings.
However, the provisions that should, more often than not, be included relate to:
- the issue and transfer of shares - including provisions to prevent unwanted third parties from acquiring shares, as well as what happens to shares in the event of a shareholders’ death and how shares can be sold
- any ‘tag along’ or ‘drag along’ provisions
- paying dividends
- providing protection for holders of less than 50% of the shares
- restrictions on competition
- procedures for dispute resolution
Although shareholders’ agreements are specific to a particular company, there are a number of provisions that feature regularly. These have been outlined below:
- Reserved matters A shareholders’ agreement will usually set out things that the business should not do without first seeking the approval of all signatories - known as reserved matters. This will give shareholders the chance to disagree with certain transactions if they feel they are going to impact their interests.
- Directors and board meetings A shareholders’ agreement will often detail how often the members of the board should meet. In many cases, it is quite common for the document to outline any additional named directors to be appointed.
- Guarantees and indemnities Guarantees and indemnities are a typical way in which creditors protect themselves from the risk of debt default. If all signatories have consented to the company entering into a loan agreement, it is likely that the shareholders will want to limit their liability in proportion to the number of shares they have.
- Deed of adherence A document by which a person becomes party to an existing shareholders’ agreement. This means that any new shareholder will become bound by the same agreement that all the original shareholders are still bound by.
- Share capital and share transfers Shareholders agreements often deal with matters related to funds raised by a company in exchange for shares, as well as the transfer of shares to new shareholders.
- Limits on variation A provision by which the shareholders’ agreement can only be varied if there is written agreement of all parties.
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