Why you should have a Shareholders’ Agreement

6 Minutes

A Shareholders’ Agreement is an arrangement amongst a company’s shareholders describing how the company should be operated and the shareholders’ rights and obligations. It includes information on the regulation of the shareholders’ relationship with each other, the management of the company, ownership and transfer of company shares and the obligations and protections of shareholders. A properly drafted Shareholders’ Agreement should ensure that all shareholders are treated fairly and that their rights are protected.

When a new company is first incorporated, the initial shareholders set rules about how the company is to be run by way of the Memorandum and Articles of Association, a legal statement signed by all initial shareholders confirming that they agree to form the company and establishing some initial rules.

However, Memorandum and Articles of Association documents (hereafter called the “Articles”) are often generic in nature, the so called ‘Model Articles’ that many companies are incorporated with, are rarely altered or even discussed much by the initial shareholders and whilst they do indeed offer some protection to the shareholders, and amended Articles can be adopted by Special Resolution, a Shareholders’ Agreement allows many more control mechanisms to be put in place.

Below is a non-exhaustive list of some reasons why you should put in place a Shareholders’ Agreement rather than just rely on the Model Articles:

    1. Confidentiality: The Articles is a public document that can be viewed from Companies House online whereas a Shareholders’ Agreement is a private document and is therefore a much more suitable document to address sensitive or internal company issues.
    2. Scope: The Model Articles provide only basic rights to Shareholders whereas a Shareholders’ Agreement will be tailored to the needs of the shareholders to address their unique situation.
    3. Minority Interests: Minority interests, i.e., shareholder(s) holding less than 50% of the company’s shares, are not well protected under the Model Articles but under a Shareholders’ Agreement they can receive proper protection and can still take an active role in the decision-making process of the company. A Shareholders’ Agreement can also bolster the rights of minority shareholders to offer them pre-emption rights on the transfer and issue of new shares to ensure their shareholding is not diluted.
    4. Better binding effect: The Articles can only bind a Shareholder in their/its capacity as a Shareholder and they may be amended by the passing of a Special Resolution which could disadvantage a minority shareholder. By contrast, a Shareholders’ Agreement is subject to all the usual principals of contract law and cannot be amended unless agreed between all the shareholders.
    5. Finance: The Model Articles do not address how the company will be financed outside of the initial share capital that the shareholders inject into the company when they subscribe for their initial shares. A Shareholders’ Agreement on the other hand provides for future financing such as loans from the shareholders or directors of the company, or from third party debt such as a bank loan, or from the issue of new sales to existing or new shareholders.
    6. Transfer of shares: The transfer of shares can generally be vetoed by the directors of the company, however terms can be added to a Shareholders’ Agreement to regulate when and how shares can be transferred and how the price should be calculated.
    7. Tag-along and drag-along rights: A Shareholders’ Agreement can provide for “tag along rights” meaning that if the majority shareholder sells their shares in the company, the minority holders have the right to join the deal and sell their shares at the same terms and conditions as would apply to the majority shareholder(s). Note also however that a Shareholders’ Agreement can also provide for “drag along rights” that enable a majority shareholder to force a minority shareholder to join in the sale of a company at the same price, terms, and conditions as the majority shareholder(s).
    8. Dividends: Under the Model Articles there is no need for a company to pay dividends unless the Board of Directors authorises it whereas a Shareholders’ Agreement could record a dividend policy such as, for example, paying out of all profits of the company to the Shareholders in the proportion of their shareholdings subject to the company retaining enough cash to operate the business.

If your company has more than one shareholder, I would recommend that you put in place a Shareholders’ Agreement. There are many matters to take into consideration and each Shareholders’ Agreement needs to be tailored to the specific requirements of the shareholders.

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