A shareholders’ agreement will be one of the most important legal documents that your SME can enter into when setting up a new business, and an important foundation for any business relationship. It can help you to protect the future of your start up, and prevent any difficulties between co-owners from impacting on its future success.
Disagreements between owners account for an estimate 62% failure rate among start-ups. Some amount of conflict is inevitable in any business relationship, so you need to come up with a pre-emptive plan that will give you a blueprint of how to resolve these issues cleanly.
In a SME, the law states that the directors are accountable to the shareholders. Even if all shareholders currently get along, the business may encounter changes later on which could affect that relationship. It is also useful for investors to be aware how they’ll be able to exit the business well in advance of investing into it. A properly drafted shareholders’ agreement will provide an invaluable exit mechanism when the time comes.
To give you a better understanding of shareholder agreements and why they’re so important, we’ve answered some of the most pressing questions on the subject. So read on to find out about this widely misunderstood, but fundamental, document.
What actually is a shareholders agreement?
A shareholders agreement is an agreement between the owners of a company that sets the rules of your business and the expectations of each owner, including the management of the company, restrictions on the selling of shares, and the process for resolving disputes.
A shareholder agreement amounts to a contract between shareholders as to how the company is run and deals explicitly with their respective rights in relation to each other, all set out in a private document. Such agreements offer a flexible way of recording matters and setting certain parameters which can cover a diverse range of issues.
Why set up a shareholders’ agreement?
When you’re setting up a business there are a great many things to take care of, from sorting out premises, assessing risks, employing staff and finding funding. Because of this, the shareholders’ agreement can often get overlooked. However, although it might seem like a mere technicality, creating a shareholders’ agreement enables a proper meeting of minds and avoids future disputes. Ensuring all parties are on the same page can help to avoid accusations of wrongdoing later on.
How do shareholder agreements work?
A shareholder agreement is a legal contract that works to govern business relationships and arrangements. It sets out the rights, responsibilities, liabilities and obligations of each shareholder, and outlines how a business is to operate, particularly in the beginning.
Having this agreement in place to regulate the relationship between shareholders can help to prevent issues and resolve any that do arise, as the legal document outlines the original intended agreement between parties. A shareholder agreement can also prevent any party from exploiting or manipulating the business relationship.
What should I include in a shareholders’ agreement?
Each shareholders’ agreement should contain clauses that fit the purpose of the agreement. For example:
– Who are the shareholders?
– Who are the directors and what is each director’s role?
– What are the limits of an individual director’s authority?
– Information about business succession
– What happens when a shareholder passes away, files for personal bankruptcy, resigns etc.?
– Policies concerning distribution of profit
– Long-term strategy
– What happens if a shareholder wants to leave or there is a falling out – are shareholders entitled to be paid for their shares and leave when they wish? Can the majority force a minority shareholder to sell?
– What happens to a departing shareholder’s shares? How are they valued and paid for?
Many clauses in a shareholders’ agreement provide that taking certain actions require majority agreement, while other clauses may require unanimity for important decisions or those that might prejudice a particular shareholder or group of shareholders.
Top tip for drafting up your shareholders’ agreement
It’s a good idea to invest in a specialist legal firm when drafting up your shareholder’s agreement. By doing so, you can be safe in the knowledge that your agreement is legally compliant and tailored to your business, covering the key issues you might face and outlining what should happen in each scenario.
Remember: once the agreement is written up, don’t just file it away and forget about it. It needs to be regularly reviewed. For example, an agreement suitable for a start-up will no longer be as appropriate once that business has matured.
What does a shareholders’ agreement mean for both minority and majority shareholders?
For someone looking to acquire minority shareholding in a business, a shareholders’ agreement provides a way to protect yourself as a smaller shareholder by conferring powers to:
- appoint or remove directors
- agree a favourable dividend policy
- have access to information which otherwise you wouldn’t necessarily have
For majority shareholders, an agreement offers suitable protections from an uncompromising minority; a problem which many majority shareholders face within a small business.
Also, it can help to resolve fundamental ownership issues, such as interest from a potential buyer.
“In anticipation of any future offer to buy your business, the inclusion of drag along provisions could be advantageous; ensuring that you as the majority shareholder can force the minority to sell their interest in the company, provided that certain conditions are met.”
One of the best things about shareholders agreement is that they’re flexible and can be crafted to fit each business’s specific needs. They can include many other provisions, such as:
- shareholder financing provisions
- share vesting provisions
- non-compete clauses for departing shareholders, mechanisms to value the business
- provisions dealing with dividends
When starting up a business, it’s easy to get caught up in the excitement and ignore the problems you might encounter further down the line. By introducing a shareholders’ agreement when beginning a business relationship with your investors, you can make sure that all the difficult questions are raised and negotiated rather avoided, right from the outset.
Spending time and (some) money on a well thought-out and carefully drafted shareholders agreement will allow you and your team to focus on what you do best: growing your company.
And remember, when it comes to legal advice and help, you should always seek professional help.