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What is a Shareholder Agreement?
A shareholders’ agreement is an agreement entered into between all or some of the shareholders in a company. It regulates the relationship between the shareholders, the management of the company, ownership of the shares, and the protection of the shareholders. They also govern how the company is run.
It may be usual to combine the use of a shareholders’ agreement with a specifically drafted set of articles of association for your company.
Shareholders’ agreements are often used as a safeguard to give protection to shareholders, because (amongst other things) they can provide for what happens if things go wrong.
An agreement can provide for many eventualities including the financing and management of the company, the dividend policy, the procedure to be followed on a transfer of shares, deadlock situations, and valuation of the shares.
The absence of a shareholders’ agreement opens up the potential for disputes between shareholders. These agreements also contain provisions that pre-empt disagreements and set out appropriate ways for disputes to be addressed.
Often, people set up companies with friends and relatives and do not consider protecting their interests in the company until it is too late. The articles of association of the company may not offer a shareholder full protection.
Most importantly you need an advisor that understands the interplay between contract law (the Shareholder Agreement) and company law.
What different types of shareholder agreements are there?
Generally, in small private companies, there are usually few shareholders, and the shareholders are often the directors of the company. This is when a shareholders’ agreement becomes helpful because the minority shareholders, the majority shareholders, and those holding shares all equally want to ensure that their rights are protected, usually in ways that are not covered in the articles of association of the company.
Minority or equal shareholdings
A large number of shareholders’ agreements are designed to contain provisions intended to protect the minority shareholders (i.e. any person(s) with less than 50% of the issued share capital in the company) or those with equal shareholdings (i.e. 2 shareholders holding 50% each of the shareholding or a company with 3 shareholders who all hold 1/3 of the shares each).
A minority shareholder in a private company is a particularly vulnerable person. This is partly because there tend to be much fewer shareholders in a private company. This means it is more likely that control of the company will be held by one or two persons. There is generally no market for the shares of a private company, and a shareholder who is unhappy at the way a company is being run does not have the option of selling those shares. The concentration of control in one or two shareholders can lead to abuse of power, even where no single shareholder holds a majority.
For example, without a shareholders’ agreement, a shareholder who is also a director could be removed from his position as director, by a mere 50% of the other shareholders voting him out. This gives him little security and would leave him with a shareholding in a company in which he no longer has any management rights.
Majority shareholders agreements
Shareholders’ agreements are not just designed for those shareholders who hold less than 50% of the shares in a company. In many cases, such agreements are drafted for the majority shareholder.
The majority shareholder may wish to curb the powers of the directors if he does not have a majority representation at the board level, or if he does not take an active part in the running of the business.
In the alternative, the majority shareholder may not want to include any minority protection provisions but may want to be able to ensure that if a buyer for the company comes along he can sell all the shares in the company, forcing the other shareholder(s) to sell their shares. This would stop him from being held to ransom by a minority shareholder. He may also wish to consider appropriate noncompetition and confidentiality covenants and provisions requiring financial input from other shareholders.
As has been previously mentioned if a Shareholders’ agreement does not exist, then any disputes between shareholders/ directors will have to be settled by what is contained within the articles of association.
The articles of association (“the articles”) are one of a set of constitutional documents of a company. The articles set out the rules as to how a company is run; for example: setting out the division of power between the shareholders and directors and the rights which each will have.
The shareholders’ agreement gives a contractual remedy if its terms are broken, whereas articles may prevent the event from happening in the first place.
The major problem when there is no shareholders’ agreement and unamended articles of association are the potential for deadlock among directors where no shareholder has a majority removal of directors. Directors do not always act in the best interests of the Company or the other shareholders and this can be mitigated by amending articles and having a shareholders’ agreement in place.
For drafting an agreement we require the below information
- A copy of the latest Articles of Association of the company.
- Type of business activity.
- Registered address.
- Company secretary (if none exist we can help in this matter)
- Company accountants.
- Details of the shareholders
- Details of the share capital, types of holding, and amounts held by each.
- How shares are to be sold. (e.g. if a major shareholder wishes to sell, whether this can be forced upon minority shareholders, Whether this could be to a third party, or whether the company can buy the shares back).
- How the shares are to be valued in the future (e.g. by the company accountant or an independent valuer).
- Actions to be taken in the event of a shareholder’s death.
Shares types issued or to be issued.
- Ordinary (Most common, normal class of shares with voting rights).
- Preferred ordinary (No dividend until all other classes have received one).
- Redeemable (Gives the company the option to buy them back).
- Preference (Annual fixed dividend, ahead of ordinary).
- Cumulative preference (When a dividend is not awarded, underpayment is satisfied with next distributable reserves).
- Redeemable preference
- Details of directors
- Directors service agreements (if they exist).
- Restrictive covenants, (stops the starting of competitive businesses, protects the business).
- How often the board meetings are.
- Whether the chairman has the casting vote.
- The control of spending by the directors (e.g. individual items purchased over £5k needs board approval).
- Whether provisions are made for passing ordinary/special resolutions (e.g. The requirement of a unanimous majority of 75% for special decisions such as asset disposal or capital expenditure).
- How the business is financed and how capital is secured and to what limits, (e.g. bank loan on assets and debtors).
- At what level of profit do dividends get paid.
- Additional share issues, rather than share dilution, consideration may be for the preserving of capital against using new share capital for funding.
Our Shareholder Agreement Services
At Sinclairhill we can draft a Shareholders Agreement to reflect all of your needs and manage any and all requirements of shareholders. We can do this at the commencement of trading or, if your company has grown or is growing, once it has become established and on an ongoing basis.