What You Need to Know About Shareholder Agreements

If you are thinking of setting up a Company with Shareholders, be sure to have all rights and responsibilities agreed in writing.  A good contract will protect your interests and help you avoid disputes or crises.

You will need an agreement which sets out the basis on which shareholders will own, fund and manage the business and which will have a procedure for dealing with the sale of shares and for resolving differences of opinion.

Don't play Russian Roulette with your business - get everything agreed in writing

Don’t play Russian Roulette with your business – get everything agreed in writing

When a Limited Company is formed in the UK, it will usually have the model Articles of Association that are available on the Companies House website.  The Articles contain the constitution of the company – but for most people setting up a company this is not enough.

A shareholders agreement in the UK is a private contract and, unlike the Articles of Association, it is not available for anyone to access at Companies House.

Sometimes a shareholders agreement will be signed before the company is formed, but it can also come later.

Key Points to Look For in a Shareholders Agreement:

  • Parties to the Agreement

In a private company with between two and ten shareholders, it is usual for all of them to be parties to the agreement.  But this is not essential.

If, for example there are three people each with 25% of the shares and 10 other shareholders with only a small nominal shareholding, the agreement might be made between only the three main shareholders.

  •  Capital, Shares and Funding

The Agreement will normally set out the number of shares to be taken up by each shareholder, the amount payable, and whether the shares carry any special voting rights.  If shares are to be issued in return for non-cash assets – e.g. technical know-how – this will be specified.

The agreement may also stipulate that additional funding that is needed will be provided by loans from shareholders proportionate to their shareholdings; or else that the company will seek funding form an external source such as a bank.

In order to have some certainty, sometimes a business plan indicating what capital will be required, who will contribute it, and when it will be required, will be added to the shareholders’ agreement for a new company.

  • Management

Management of a company is generally undertaken through the board of directors; it is therefore important that the shareholders agree how many directors there are to be, who the first directors are, how they are to be appointed and removed and whether the holders of different classes of shares have any particular power to appoint them.

It is usual for each of the principal shareholders to have the right to appoint at least one director to the board and, where a shareholder is an individual he or she may also be a director.

Once appointed, directors may be given authority to determine how often they meet, the quorum for meetings, how their decisions are made and other matters relating to matters such as the conduct of the meetings.

Alternatively, the shareholders may wish to decide these matters themselves and set out the rules in the shareholders’ agreement.  This is especially likely to be the case when, for example, there is one major shareholder who wants to be sure that only resolutions that have his vote will be passed by the board or at a shareholders’ meeting.

Another aspect of management which the shareholders should address at the outset is the extent of the directors’ powers; the shareholders may wish to reserve certain important matters to a decision of the shareholders in general meeting of the Company.

These reserved matters may cover, for example:

  • the issue of new shares,
  • borrowing by the company above agreed limits
  • any change in the nature of the company’s business,
  • capital expenditure above an agreed amount,
  • hiring and firing of senior staff
  • joint ventures with other companies.

Specific day to day management issues may also be covered – especially if there are some special arrangements, for example where one of the shareholders provides office premises for the company.

  • Transfer of Shares

The shareholders will usually want to prevent other shareholders from disposing of their shares to third parties without having first offered them to existing shareholders.  This is normally accompanied by wording that requires the shares to be valued by an independent accountant if the sale price is not agreed.

The shareholders may also wish to provide that in certain circumstances, e.g. the death or permanent incapacity of a shareholder, that shareholder’s shares are to be offered to the other shareholders.   In the UK, it is usual for tax reasons to give shareholders the option, but not the obligation, to acquire shares of a deceased shareholder.

  • Dividend Policy

Shareholders often provide in the shareholders’ Agreement for:

  • the means of calculating net profits;
  • a percentage of the net profits that must be distributed annually;
  • any restrictions on distribution of net profits – e.g. no distribution until certain loans have been repaid.
  • Confidentiality

The agreement will usually contain a restriction on any shareholder disclosing confidential information about the company to outsiders, not only during the agreement but also after it comes to an end.

  • Default

If a shareholder become bankrupt or commits some serious breach , the agreement will usually provide for him/her to be bought out at a price fixed by the agreement.   If a shareholder who is forced out under this clause is a director of the Company, he should also be required to resign as a director.

  • Restriction on Competition

It is common practice to prevent shareholders from having an interest in a competing business and to prevent any shareholder who sells his shares to set up in competition or poach any of the company’s staff for a specified period.

  • Management Disputes

When, on issues of importance, the shareholders (either through their directors on the board or in general meeting) cannot agree, what occurs is what is known as a deadlock.  It is often agreed by the shareholders at the outset what will be done in such a situation.

A solution that is often adopted is for a shareholder to offer to sell his shares or purchase the other shareholders’ shares at a particular price.   These solutions are sometimes known as “Russian Roulette” or “Texas Shootout” provisions.

ContractStore has several useful downloads for shareholders:

This entry was posted in Guidance Articles, Online Legal Templates, Running an SME, Setting Up Business and tagged , , , by Giles. Bookmark the permalink.

About Giles

Giles is the founder and managing director of ContractStore. It was his idea to set up a company selling documents online and he has played a major part in the company's development. He is an English solicitor, with over thirty years' experience of drafting and negotiating commercial and construction contracts in the UK and overseas. Giles has long been convinced that there is a quicker and simpler approach to the delivery and supply of most contracts, and he is an active proponent of the use of plain English in legal documents. He specialises in the drafting of construction and engineering contracts and as well as contributing contracts to the ContractStore website, he is co-author of the JCT Constructing Excellence Contract and of 'Exporting Made Easy' with Simon Bedford.

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