Shareholders' Agreement

Shareholders Agreements: What’s the Point?

Starting a business is challenging, exciting and usually expensive so we’ll forgive you for pushing the legal issues down your list of priorities. Although you might not want to hear it, it really will benefit you in the long term to consider the legal issues that come hand in hand with running a business rather than wishing you had done so earlier, if something goes wrong (I know, hard to believe when you’re going into business with someone you trust)!

1. What is a shareholders’ agreement?

A shareholders’ agreement is a private contract between the shareholders of a private company limited by shares. It regulates the various aspects of ownership of the business, how the business is run and protects the owners on a day to day basis.
Whilst there isn’t a legal requirement to have a shareholders’ agreement, we strongly recommend one if you’re going into business with someone else, whether it’s a friend, family member or investor. Many funding providers make it a condition of any facility that such an agreement is in place and we suspect that this practice will become widely enforced in the future.

So, why are shareholders’ agreements so important?

2. The fall out

In the first instance, the agreement will regulate what happens if something goes wrong. These situations are hard to foresee, especially when you’re going into business with your close friend, right? Unfortunately, we all know what happened with Zuckerburg and the Winklevoss twins and it wasn’t pretty. Therefore, dealing with the ‘divorce’ at the outset can be easier and more cost effective in the long run. Ultimately, minimising conflict in this way will prevent the business being in a stalemate position and allow the business to progress should a dispute arise.

3. Decision making

Most businesses are not split 50/50; they have minority and majority shareholdings in various percentages. The agreement can be drafted in a way to protect minority shareholders from being outvoted or prejudiced, or in the alternative, allow majority shareholders to take action without the consent of all shareholders. By outlining the process, it will make decision making quick and efficient.

4. Management

The day to day decision making of a company is undertaken by the directors, rather than the shareholders (who may be the same people). A shareholders’ agreement can hold the directors accountable for certain actions and can require the directors to seek shareholder consent on running key decisions. Whilst shareholders are able to take a step back from the day to day dealings of the company, the shareholders’ agreement will provide for situations in which the shareholders must be consulted, enabling the owners of the business to retain control.

5. Dividends

We all like to get paid for the blood, sweat and tears that go into building a business, right? Shareholdings in a company can be linked to financial contribution or investment in the company or perhaps performance through mechanisms such as a share option scheme. There are a range of different options for how company profits can be distributed – the details of which may be contained in the shareholders’ agreement.

6. Confidentiality / Restrictions

No one wants their co-founder to stroll over to their biggest competitor, taking all their trade secrets with them… do they?

It is extremely important to adequately protect the business and this can be done by placing restrictions on the shareholders during their involvement with the business and for a period of time after their departure. Restrictions can be imposed to protect intellectual property rights, trade secrets, suppliers, customers and employees from being taken from the company, along with restrictions on setting up a competitive business.

In summary, a shareholders’ agreement can be used as a safeguard to protect the shareholders because (amongst other things) they can provide for what happens if things go wrong. The agreement can provide for many eventualities including the financing or re-financing of a company, the management of the company, the dividend policy and deadlock situations. The absence of a shareholders’ agreement opens up the potential for disputes and disagreements which may, ultimately impact on the success of the business

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