Shareholders’ Agreement

Guide to the Shareholders' Agreement

Overview

A shareholders’ agreement is an agreement between some or all of the shareholders of a company intended to regulate their relationship and certain related matters. Although they are often drafted in conjunction with the company’s articles of association, they have certain advantages over the articles of association including:

  • they are a private contract and therefore can be made confidential;
  • they can impose obligations on shareholders beyond those permitted under the articles of association; and
  • they can be a more flexible document than the articles of association.

We would always recommend that where there is more than one shareholder of a company, they give serious consideration to entering into a shareholders’ agreement in order to regulate their proceedings. The time and effort involved in agreeing a shareholders’ agreement is often more than repaid by the savings resulting from reduced disputes and tensions later in the life of the company.

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Key provisions

The different form and provisions of a shareholders’ agreement are numerous and we could not hope to set them all out here. However, we have included some of the more common features of a shareholders’ agreement for your information.

Equity investments

A shareholders’ agreement is often tied to an investment by one or more of the shareholders and the shareholders’ agreement will often double as an investment agreement setting out the terms and manner of the investment.

Financing of the company

As well as any initial equity investment of the shareholders, the shareholders’ agreement may provide an indication of where further financing of the company will come from.

This may come from further equity and/or loans from the existing shareholders; potentially enticing equity investment from new shareholders; or bank debt.

Business of the company

Private companies can generally undertake any comercial business that the directors believe is in the best interest of the company. The shareholders’ agreement may therefore set out the nature and extent of the company’s business proposition so that it is limited to the area the shareholders originally contemplated.

Decision making

Under company law, day to day business decisions are generally made by the directors and the shareholders are not involved. The shareholders’ agreement can set out key areas which the shareholders’ wish to have control over and possibly veto rights and/or weighted voting provisions.

The shareholders’ agreement will often also set out rights to appoint directors; if shareholders wish to have representation at board level.

Shareholder director’s salary

It is not uncommon for a shareholder (or a related party to a shareholder) to be a director. This puts them potentially in a very strong position to decide their own salary. This will potentially be to the detriment of the other shareholders as the salary will reduce the  amount available for dividends.

The shareholders’ agreement can set out the director’s initial salary and a mechanism for review of the salary.

Information rights

Pursuant to the Companies Act 2006, shareholders have very limited rights to information about the day to day running of the company. For example, they are entitled to see the annual accounts, but do not have the right to see monthly management accounts. The shareholders’ agreement can set out specific information rights for the shareholders in order to monitor their investment.

Non-compete provisions

Shareholders in private companies are likely to know the business and customers of the company intimately. The shareholders’ agreement can include provisions restricting the shareholders from competing with the company during their time as shareholders and for a reasonable period afterwards.

The restriction should be limited in geography and in the scope of the non-compete.

Non-solicit provisions

For many companies, their staff really are their most valuable asset. The shareholders’ agreement can therefore include provisions to restrict a shareholders ability to poach key staff from the company. This can apply for the duration of their time as a shareholder and for a reasonable period after.

Dispute resolution

Shareholders can fall out and disagree on the direction of the company. If a deadlock is achieved (ie no shareholder(s) can outvote the others) this can often paralyse the operation of the company. Having an effective dispute resolution procedure is essential to avoid the company stagnating and/or being wound up.

Depending on the nature of the dispute, the shareholders’ agreement can provide for a variety of different options from expert determination and mediation through to put and call options to allow one group of shareholders to buy the other out at a fair price.

Share transfer restrictions

Shareholders often form a joint venture because they know and trust the other shareholders. They wouldn’t want the shares to be transferred to just anybody and have to deal with a party they may not know or get on with. On the other hand, this needs to be balanced with a shareholder’s desire to transfer their shares and realise value for their investment.

The shareholders’ agreement will therefore generally provide for a series of mechanisms setting out when and how a shareholder can transfer their shares.

Exit provisions

For many shareholders, the ultimate aim is to sell the company to a third party. In order to facilitate this, a shareholders’ agreement generally includes ‘drag’ and ‘tag’ provisions.

Drag provisions will allow a group of shareholders (generally exceeding a certain percentage) to force the remaining shareholders to sell their shares on the same terms and at the same time as the main group. These provisions often benefit the majority shareholder(s).

Tag provisions allow shareholders in certain circumstance to force a buyer to buy their shares on the same terms as they are buying other shares. These provisions generally benefit the minority shareholders, allowing them to avoid being ‘left behind’ when the other shareholders sell their shares.

The information provided in this article is intended as a general guide to assist people in understanding the main provisions of a shareholders’ agreement under English and Welsh law. It does not purport to be comprehensive and should not replace bespoke advice. If you are in any doubt, please speak to one of our experts.