A Brief Guide to Shareholders Agreements

A shareholders agreement is a contract made between all shareholders of the company, or can be made by just some of them (for example between two shareholders who each have a large shareholding in the company).

The shareholders can be individuals or corporate bodies. A shareholders agreement can be made at any time during the lifetime of the company but it is most commonly made when a new company is set up because it establishes areas of agreement, at an early stage, between those involved with the company.

Advantages/Disadvantages of Shareholders Agreements

The advantages of having a shareholders agreement include:

  • Unlike the Articles of Association of the company, the shareholders agreement is private and only those who are party to it know what is in the agreement.
  • Certainty of rights amongst shareholders.
  • Protection of each shareholders’ position.
  • Reduces likelihood of disputes – it is easier to enforce your rights under a shareholders agreement than in action pursuant to the Articles of Association.
  • Can provide minority shareholders with certain rights.

The disadvantages of having a shareholders agreement include:

  • As with any other contract, you need unanimous consent of all the parties to the contract in order to amend the agreement.
  • New shareholders must expressly agree to be bound by the agreement. This is usually done by a deed of adherence which a new member signs on buying/receiving shares.
  • The tax position of all shareholders needs to be considered at the outset to avoid any adverse tax consequences for shareholders who are “connected” (eg spouse, civil partner or a “connected company”) and in relation to employment related securities.
  • A shareholders agreement needs to be drafted carefully in order to avoid deadlock situations. Although certain events might be thought of as unlikely to happen at the outset, no one can predict the future and therefore it is prudent to consider all potential areas of dispute at the start of the business.

Below is a list of issues that a shareholders agreement can deal with (this list is not exhaustive):

  • Management issues such as the regulation of the relationship between management and shareholders who are not involved in the day to day running of the company.
  • A set procedure requiring shareholders’ consent before the company becomes a party to any loan, makes any borrowings, enters into a mortgage and/or guarantee in excess of a specified monitory limit.
  • Employing senior staff
  • Commencing or settling any substantial litigation.
  • Deadlock situations for example one shareholder might be given the casting vote in certain situations, a matter can be referred to arbitration, the shareholders agreement could have various mechanisms such as a Russian Roulette or Texas Shoot-out clause (see below) to resolve deadlock situations.
  • The shareholders agreement will contain provisions relating to transfer of shares. Special rules can be inserted to prevent transfer to certain competitors, or for shares to be offered to other shareholders on the death of a shareholder. In fact, there are numerous situations in which the founding shareholders/existing shareholders of a company might want to restrict transfer of shares and it is a good idea for these to be fully discussed with the company’s lawyer in order to understand how the desired outcome can be achieved with the minimum amount of fuss.
  • If shares have been issued to a person because he is an employee of the company, it is advisable to include provisions that if he ceases to be an employee he must offer to sell his shares. Shareholders agreements sometimes go one step further than this and insert provisions whereby the value of the employee’s shares will depend on whether he is a “good” leaver (e.g. someone who ceases employment because of incapacity, death, retirement, redundancy or mutual agreement) or “bad” leaver (e.g. someone who is dismissed because he has breached his contract of employment). However, classifying an employee in this way and determining the value of their shares is such a manner, could violate the rules of most HMRC approved employee share schemes.

A Russian Roulette clause is a mechanism which is sometimes used to deal with valuation issues when a member disposes of his or her shares. Shareholder (1) may serve notice on the other shareholders offering to transfer all of his shares in the company to another shareholder (2) at a price specified by shareholder (1). Shareholder (2) must then accept shareholder (1’s) offer and buy the shares at the stated price or he must sell all of his shares to shareholder (1) at the same price per share.

A Texas Shoot-out clause is another mechanism to resolve valuation issues. If more than one person wants to buy the shares of a particular shareholder, the selling shareholder asks for sealed bids to be made to an independent person. The person making the highest bid is entitled to buy the sale shares at the price contained in his bid.

It is important to remember that the average life of a shareholders agreement is usually between about 3 to 5 years for a typical private company. Therefore, it is sensible to review any agreement you have drafted after a maximum of five years to make sure it is still appropriate or whether it requires updating to meet the needs of the current shareholders and management of the company.

CONTACT VINCENT

If you would like more information or advice relating to this article or a Corporate law matter, please do not hesitate to contact Vincent Billings on 01727 798104.

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Every care is taken in the preparation of our articles. However, no responsibility can be accepted to any person who acts on the basis of information contained in them alone. You are recommended to obtain specific advice in respect of individual cases.