If you decide to set up a limited company with other people – either for contracting purposes or to run another type of business, how do you ensure that all of your shareholders (including yourselves) are protected in case something goes wrong? A well-drafted shareholders’ agreement might be the answer.
Why create a shareholders’ agreement?
When you incorporate a company, you need to adopt Articles of Association which act as the company’s rulebook. Most contractors simply use the model articles provided by Companies House.
Although the Articles cover most aspects of running a company, they are governed by company law and must be lodged with Companies House, and be available for public inspection.
A Shareholders’ Agreement, which will often be created in conjunction with the Articles, offers a great deal of flexibility for making future changes and adjustments to the rules which govern a company. Unlike the Articles, they provide a lot more detail on the rights of shareholders.
They are also very helpful in protecting the rights of minority shareholders, who would otherwise be at the mercy of the majority. They also address familiar issues such as – how do you value shares of an individual who wants to sell, what if there is a dispute between shareholders, and what happens if someone offers to buy the company?
Often, a limited company may be owned by just 2 shareholders with 50:50 holdings. A shareholders’ agreement will address what happens if the relationship breaks down (‘deadlock’).
Significantly, these are private documents and don’t need to be provided to anyone outside the company.
What should you include in a shareholders’ agreement?
Unlike the Articles of Association, there is no fixed format for a Shareholders’ Agreement, however, most will contain details on the following areas of administering a company:
- How are directors appointed and removed from office?
- Can shareholders also be directors, or vote to appoint and remove other directors?
- Which decisions will require shareholder approval (if any)?
- What is the structure of the company’s board of directors?
Issuing new shares
- How will new shares be issued? As this may dilute existing shareholdings, this is likely to require shareholder approval rather than being a decision left to the directors.
- Will any new shares be offered to existing shareholders first?
Transfering existing shares
- Will share transfers require the approval of other shareholders, or are they freely transferable?
- Should existing shareholders have the right of first refusal on share disposals?
- What happens if an existing shareholder dies?
- How do you value shares if a shareholder dies, or wants to exit the company?
Access to information
- How much company information will shareholders have access to? This will include accounts and business planning documents.
- Which shareholders will have access to various levels of information?
- How often will dividends be paid to shareholders?
- Will dividends only be paid subject to certain performance targets?
- Will dividends only be paid to holders of specific share classes?
Drag and Tag rights
- ‘Drag along’ rights will force all shareholders to sell their shares at a certain price if a majority decide to sell their holdings
- ‘Tag along’ rights protect minority shareholders by ensuring they receive the same terms as all other shareholders in the event of a company takeover.
- Are standard voting rights sufficient in all situations, i.e an ordinary resolution requires the votes of at least half of shareholders, whilst a special resolution requires the votes of 75% of shareholders to be passed.
- If not, what percentage of shareholders have to vote to pass a motion.
- How much will the directors be paid? This provision ensures that shareholders decide upon directors’ remuneration, to avoid an obvious conflict of interest.
- What procedures should be put in place to review directors’ salaries on an ongoing basis?
Conflict resolution / deadlock
- What happens if things go wrong?
- If disagreements arise, should shareholders seek external help?
- If an agreement cannot be made, what buy-out procedures are in place to enable shareholders to buy each other out.
- If a ‘deadlock’ situation exists, where no agreement is possible (typically between 2 equal shareholders), how will a dispute be resolved?
Protecting the company from shareholders
- Shareholders should keep any information they have about the business confidential
- They should not launch ventures which compete with the company’s business whilst they are shareholders, or for a prescribed time after ceasing to hold shares.
- They should not entice away staff from the company whilst they are shareholders, or for an agreed period of time after selling their shareholdings.
How to draft a Shareholders’ Agreement
From our experience, many new businesses don’t seek to put anything in place until a potential conflict arises, as they’re often too busy building the business to consider how to deal with future problems.
For obvious reason, we would suggest you pay a legal expert to create an agreement as early as possible – which will typically be drafted in conjunction with new Articles of Association.
You can download agreement templates for under £50 from various online legal sites, but for a robust agreement, you really should consider paying for specifically tailored advice.
For a typical small company with a few shareholders, the costs obviously vary from firm to firm but expect to pay between £300 and £750 + VAT for a tailored agreement.