Shareholders’ Agreement – friend or foe?

When investing in a company, or incorporating one from new, it is easy to get caught up in the excitement and overlook the negative ‘what ifs’. Consequently, by paying little attention upfront to what might occur should the worst happen, shareholders risk losing out on an opportunity to realise the full value of their investment and in some cases disputes may arise.  One of the main benefits of introducing a shareholders’ agreement is the opportunity to discuss with other shareholders their expectations of the business, as well as how the company should be run, the relationship between the shareholders, and how disputes can be resolved to the satisfaction of all parties.

What is a shareholders’ agreement?

A shareholders’ agreement is, as the name suggests, an agreement between the shareholders of a company.  Its purpose is to protect the shareholders’ investment in the company, establish a fair relationship between the shareholders, pre-empt any disputes and govern how the company is run.

How does a shareholders’ agreement help me as a minority shareholder?

In the absence of a shareholders’ agreement, minority shareholders have very little or no say in the running of the company, with control of the company often resting with a single or small number of individuals.

It is often the case that minority shareholders ask to incorporate a ‘tag along’ provision into a shareholders’ agreement. A tag along provision gives minority shareholders the right to have their shares bought on the same terms, and for the same price, as majority shareholders. This ensures that minority shareholders are afforded the same opportunities as majority shareholders to realise the full value of their investment.

As a minority shareholder, when issues arise that require shareholder approval, the articles of a company usually stipulate that such decisions be made on a majority basis. This means that as a minority shareholder you may have little or no say in the decisions affecting the company. A shareholders’ agreement can strengthen your voting power, with provisions which prohibit certain actions being undertaken without the approval of all of the shareholders, for example the issue of new shares that would dilute your holding, or the change in the main trade of the company.

How does a shareholders’ agreement help me as a majority shareholder?

Shareholder agreements are not solely for the benefit of minority shareholders; in most instances the introduction of a shareholders’ agreement is at the request of the majority shareholder.

The two main concerns for any shareholder are the control they may exercise over a company’s activities and the realisation of their investment in a company, the latter of which is often only achievable by selling the shares. Any proposed purchaser will wish to acquire the whole of the issued share capital free from any minority interest, which gives rise to a scenario where as a majority shareholder you may be unable to realise the full value of your shares if a minority shareholder is unwilling to sell their shares. A shareholders’ agreement can pre-empt this scenario by including a ‘drag along’ provision which compels minority shareholders to sell their shareholding when the majority shareholders sell theirs.

In addition to the above, as a majority shareholder you may wish to restrict the transfer of shares by minority shareholders. In the absence of a shareholders’ agreement, majority shareholders may have very little power in preventing minority shareholders from transferring their shares, even if they are transferred to competitors or persons you may wish not to be involved in the company. The shareholders’ agreement may stipulate who shares may be transferred to, at what price and on what terms.

What effect can Shareholders’ Agreement have on employee-shareholders?

A shareholders’ agreement can compel employee-shareholders to sell their shareholding at a certain value, should they for whatever reason cease to be employed by the company. These types of provisions are referred to as ‘leaver provisions’.

A departing employee-shareholder’s shares can be valued on a different basis dependant on whether they are deemed to be a ‘bad leaver’ or a ‘good leaver’. For example, a bad leaver could be defined as an employee-shareholder who has materially breached the terms of the shareholders’ agreement or their employment contract, and their shares could be valued at less than the full value. Whereas a good leaver, for example someone who leaves due to retirement, could receive full market value for their shares.

What else may be included in a shareholders’ agreement?

A shareholders’ agreement will commonly provide for the following:

• restrictions on shareholders selling their shares;
• agreeing a calculation for the amount of profit to be declared as a dividend;
• the ability to force certain shareholders to sell their shares to the others in agreed circumstances (for example, death or bankruptcy);
• rights of shareholders to nominate a director of the company;
• restrictions on issuing new shares;
• incurring any borrowing beyond a certain amount or the expenditure of capital beyond a certain amount, without the approval of all of the shareholders;
• restrictions on what shareholders may do outside the company, for example restricting a shareholder’s interest in a competitor company;
• procedures for avoiding ‘deadlocks’ in the decision making process; and
• a method of calculating the price to be paid for shares should a shareholder wish to leave the company.

What next?

If you are a shareholder and want to discuss the benefits to you of introducing a shareholders’ agreement, speak to one of our corporate law experts today on 0113 225 8811.  Our corporate team cover all of our offices in Leeds, Wakefield, Huddersfield, Halifax, Morley, Pudsey and Horbury, and are offering a 10% discount on all fees for any instructions received in January 2017.