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Why should you invest in a shareholders' agreement

View profile for Thomas Emmett
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Business owners have no problem organising business insurance to protect themselves against known potential risks, yet not all shareholders choose to protect themselves against the known risks involved in owning shares in a company.

With all the day to day matters involved in running a company it is very easy to overlook the importance of, or to even feel awkward about considering and discussing, necessary protections for you as a shareholder – however large or small the interest may be.

Shareholders often forget that once shares are issued, without an agreement or provisions added to the company’s articles of association, those shares remain in the recipient’s ownership and they cannot (other than in very limited specific circumstances) be forced to sell or otherwise dispose of those shares. This can be a problem for a majority shareholder wishing to sell the company, sometimes enabling a minority shareholder to hold the deal to ransom.

For minority shareholders, without agreeing certain protections, their shareholding can be diluted and, if they are also a director, they can be removed from the board. It will, of course, depend upon the circumstances surrounding the issue of shares as to whether a minority shareholder is able to negotiate protections, but certainly you should ensure that appropriate arrangements are made to provide them if you are so entitled, or you at least understand the implications of not having such protections – in particular if you are giving up other rights in connection with the issue of shares.

As soon as you know how the company ownership is going to be divided, whether individual shareholders are going to have different rights within the company, what they are (such as with regards to voting, dividends etc.), who the board members are going to be etc., it is time to consider drawing up a shareholders’ agreement.

The primary purpose of a shareholders’ agreement is to regulate the relationship between the individual shareholders, address succession planning and ultimately to protect shareholders in the event of a dispute. It can also assist in regulating day to day activities ensuring that shareholder/directors, who otherwise would be regarded as having authority to bind the company to contracts and liabilities, have to have shareholder consent to commit the company to certain types or level of liability. 

So what matters will a shareholders’ agreement address? 

  1. Minority protection – ensuring certain matters require shareholders’ consent (e.g. variation to the company’s articles of association, alteration of the rights attaching to the shares, issuing further shares and others);
  2. Share transfer arrangements – these include ensuring continuing shareholders have a right of first refusal to acquire the shares and avoid them being transferred to a family member or third party. It will also involve the consideration of life policies to assist with the purchase on death or critical illness;
  3. Deadlock arrangements; and
  4. Matters concerning the rights and procedures of departing and incoming shareholders – a good agreement will balance the rights of the departing shareholder against the impact on the business and the continuing shareholders.

What matters will the company’s articles address?

  1. Different share rights;
  2. Drag along/tag along rights ensuring a minority shareholder is required to sell their shares if the majority wants to sell the company. The minority is protected as these provisions ensure they are entitled to receive the same value per share as the majority;

We strongly recommend that shareholders protect themselves by putting appropriate arrangements in place as soon as possible following a company formation for their own peace of mind, or before issuing shares to new shareholders.

For assistance with shareholders’ agreements or articles of association contact our Commercial and Corporate Finance Team. I am based in our Basildon office and can be contacted on 01268 244 141 or veronika.koenig-roach@birkettlong.co.uk.

 

 

 

 

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