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. It will also govern the way in which 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. In this article, shareholders’ agreement UK, we consider the process and mechanism involved.
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Why should you use a shareholders’ agreement?
Each share in a limited corporation (whether public or private) typically carries one vote. If the owners who collectively control more than 50 percent of the shares at a meeting agree on a motion, the motion is passed regardless of the opinions of the others. If a single shareholder owns more than 75 percent of the company’s shares, he or she has absolute power and can veto the choices of all other shareholders.
How therefore can a minority investor be protected from having his investment controlled by a majority shareholder, and how can decision-making authority be distributed more equitably among the owners?
There are two options available under these circumstances: the use of different classes of shares or a shareholders’ agreement.
Share Classes
The first option is to create various types of shares with varying values and rights.
For instance, preference shares are frequently used to give their owners the right to receive dividends before holders of other classes of shares, but without conferring voting rights.
A corporation may issue various classes of preference shares, such as Preference A, Preference B, and Preference C, all of which have distinct rights. There are no restrictions on the names of classes or the privileges they provide.
If a shareholder sells or gives away his shares, the rights associated with those shares are transferred instantly to the new owner.
When shares are sold (since the selling shareholder’s interests are no longer in the long-term profitability of the company, but rather in the short-term value of the shares) or when a shareholder dies, the remaining shareholders are likely to suffer difficulty protecting their assets (because his beneficiary could be an inexperienced or uninterested family member).
The other shareholders have no authority over the transfer or over who acquires the rights.
Using a shareholders’ agreement
Using a shareholders’ agreement is by far the superior method for regulating the authority amongst shareholders and, in particular, for defining the limitations of director-shareholders’ freedom.
It is strongly recommended that every shareholder in every corporation utilise one of these agreements.
If you own 90 percent of the company’s shares, you will want to ensure that your minority shareholder will not rush to court to enforce his legal rights.
Obviously, if you are a minority shareholder, you will want to ensure that your co-shareholders are not trying to take advantage of you.
What are the main issues the agreement should address?
Things to consider:
- Share Transfer
- Potential conflict between director shareholders and non-director shareholders
- Roles and responsibilities of shareholders
- Change In business direction
- Where is the money coming from for the business
- Exit strategy
- Loan or share subscription money may be offered by trading partners or even competitors.
Who will make decisions – shareholders or directors?
Shareholders may be as active or inactive as they choose in business operations. However, they must clearly define their relationship with the directors. Clarity in decision-making is crucial. When a director-shareholder takes an operational decision that benefits him but not other shareholders, a conflict of interest may occur. Frequently, it is unclear whether he behaved as a director (responsible to all shareholders and subject to a duty of care) or as a shareholder (not accountable to his fellow shareholders).
A well-written shareholders agreement should specify the types of actions a shareholder-director may and may not make without the approval of others. Equally important is the disclosure of decision-making procedures. A shareholder-director may have the ability to make choices that are not revealed to the public. Defining what a director may and may not do without informing shareholders safeguards a shareholder-director from acting against the interests of the other members.
Use a shareholders’ agreement to describe the shareholder’s duty and a directors service contract to define the director’s job to define what a shareholder-director is and is not permitted to do. A service agreement for directors should also serve as an employment agreement, outlining disciplinary and grievance procedures. Each executive director is also employed full-time. This provides shareholder-directors with stronger rights than non-employed shareholders, as an executive director can risk major disruption and expense by bringing the matter before an employment tribunal.
Establish how shareholders’ voting power should be added up
Historically, one share “purchases” one vote. A shareholder who owns more than 50% of the company’s shares has the ability to make decisions and exert control over the business (for some decisions, holders of more than 75 percent of the shares must agree). This is not always desirable for shareholders: at times, it may be advantageous for everyone to have an equal voice, while at other times, it may be advantageous to provide a stronger voice proportionately to someone who has contributed more.
You must define what constitutes a “majority” in the context of obtaining consent. A shareholder-lender holding 5% of the shares may insist on unanimous consent for the most critical matters to him or her. A group of shareholders working together may resolve to restrict the range of decisions available to them, but agree that only 60% of them are required to make such decisions. Generally, keeping the equation simple is the best course of action.
How do you terminate a shareholders’ agreement?
You can terminate a shareholders agreement in one of three ways.
The first way you can terminate a shareholders agreement is by mutual agreement. This is when all of the shareholders decide that they no longer want to comply with the agreement due to various reasons. The reasons can be from dissolving the company, selling their shares in the company or the company itself or it can be deciding to leave the company. In a well-drafted shareholders’ agreement, these provisions should be included.
Secondly, the shareholders’ agreement may automatically be terminated if there has been a breach in the agreement by any of the shareholders. When this occurs the shareholders’ agreement will be terminated unless there are clauses in the agreement that sets out some form of mediation.
Thirdly, a shareholders’ agreement can be terminated if one of the shareholders want to leave the company. In this case, there will be certain provisions in the shareholders’ agreement to map out what should happen in this scenario.
How we can help
We have a proven track-record of dealing with shareholder agreements. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
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Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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