Going into business with shareholders? Do you have a Shareholders Agreement? Do you need one?
Typically, the relationships between individual shareholders, and between shareholders and the company itself, are governed by the Articles of Association. In many cases, it will be sufficient to rely solely on the Articles to regulate the affairs of the company with a shareholders agreement.
However, in certain circumstances, a shareholders agreement may be desirable. Such agreements are most commonly used where there are complicated shareholder structures, or where there are differing classes of shares resulting in a differential treatment of shareholders.
Shareholders agreements will typically deal with the following matters (inter alia):
- regulating the proceedings of directors;
- regulating the activities undertaken by the company;
- resolution of deadlocked votes;
- rights to veto certain decisions;
- details as to whom shares may/may not be transferred;
- protection of minority shareholders; and
- how the dissolution of the company is to be conducted.
However, the parties to an agreement will be free to decide and agree the terms of the agreement and, as such, can in theory touch upon any matter that may arise between shareholders and/or the company. Whilst there is no legal necessity whatsoever to enter into such an agreement, there are numerous reasons why it will be a good idea to do so.
Advantages of shareholders’ agreements
In general terms, such agreements are private documents whose terms are known only to those shareholders who are party to the contract. The Articles of Association, by contrast, are registered and thus are available for public registration. A key advantage, therefore, is that the contents of shareholders’ agreements are confidential.
Shareholders’ agreements provide real flexibility and can be rapidly and easily updated and amended. Particularly where small businesses are concerned, the company’s position may shift quite rapidly. Shareholders’ agreements can, with the necessary consent of those involved, be changed as regularly as necessary and ensure that the company is governed in the most appropriate fashion as it develops. Such agreements will also inevitably be ‘tailor made’ to the needs and desires of shareholders, ensuring that the specific idiosyncrasies of the company, and the relationship between the company’s members, are taken into account.
Disputes are regrettably all too common amongst business partners. Failure to have an agreed mechanism in place in this regard can easily be fatal to a business. Agreements allow the parties to set out exactly how, and by whom, any disputes are to be settled. Deadlock provisions are also highly useful in this regard. If shareholders become locked into an intractable dispute, having a method to allow one party to buy out the shareholding of another can be the only possible way to sustain a business as a going concern.
Non-compete clauses are valuable for any fledgling business. Placing limitations on the actions of shareholders to prevent them using their knowledge of the company to obtain a competitive advantage over it, is essential to protect business interests.
Restrictions on share transfer provide a method of controlling the ownership of the company. If a shareholder seeks to sell their stake, other members may be anxious that a rival may take it over and cause difficulties within the company. By agreeing certain restrictions, the shareholders have a measure of control as to whom they do business with. Again, in small businesses inter-personal relationships will be vital and it will often be in the interests of the company to have a degree of control over the process of transferring shares.
Minority shareholders may be particularly keen to strengthen their position in a company. An agreement can allow them to exert an influence that is disproportionately large relative to the size of their shareholding. Typically minority shareholders may seek the right to appoint a director, giving them a measure of control. Crucially they may seek pre-emption rights, which can play a vital role in ensuring that their shareholdings are not diluted as the company grows and issues new shares.
Do you require a shareholders agreement?
Whether or not your company would benefit from a shareholders agreement will depend upon the circumstances of your business. In general, it is advisable to ensure, from the word go, that all parties know where they stand, and crucially that there are clear procedures in place for the resolution of disputes. Consequently, it would be advisable in the majority of situations to put a shareholders agreement in place.
There may be a reluctance to do so in certain situations, such as in a family business, but just because one is related to other shareholders, this does not mean there is no scope for disputes. Whilst a husband and wife may commence a business on good personal terms, the lack of a shareholders agreement can cause severe complications post-divorce. In business, it always pays to err on the side of caution, and it is a mistake to imagine that a flourishing company will not run into trouble later on.
Whilst there will certainly be costs involved in engaging a lawyer to draw up an agreement, and those starting a business may be more focused on matters other than corporate governance, certainty in this regard is invaluable. Should relations between shareholders deteriorate and there be no clear rules in place as to how disagreements are to be resolved, the business may stagnate and may even collapse. As ever, prevention is better than cure, and a well drafted shareholders agreement can be the difference between a growing company and a doomed enterprise.
Carl Parslow | Partner | Jersey Business Legal Services
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