Shareholders’ agreements and why your company needs one
Not yet had a shareholders’ agreement drawn-up for your company?
“You’re not alone,” said new member of the James Legal commercial team, Solicitor Byron Swarbrick. “It is a very common situation and it’s completely understandable that business owners focus on developing the commercial side of their company, rather than looking at the ‘drier’ legal aspects.
“However, it’s definitely worth investing the time and effort into creating a shareholders’ agreement at the outset rather than picking up the pieces later on, should relations between stakeholders turn sour.”
What is a shareholders’ agreement?
A shareholders’ agreement is a legal contract between shareholders in a limited company. Its purpose is to regulate their relationship and document in plain English what the company direction will be and how key issues will be managed.
Byron explained: “The shareholders’ agreement protects shareholders by spelling out what should happen if there is a disagreement, if someone wants to leave, or if things go wrong. It pays to spend a bit of time discussing these things at the outset and having a signed shareholders’ agreement in place so everyone is clear on what has been agreed.
“Although it’s not a legal requirement for a business to have a shareholders’ agreement, it is common practice. It’s a flexible tool and the content can vary as required.”
What could possibly go wrong?
Drawing on his experience advising a range of businesses, Byron can provide a number of cautionary tales that illustrate how putting in place a basic shareholders’ agreement could have prevented massive legal headaches and heavy financial costs.
Take the following, perfectly usual scenario:
Mr A and Mrs B were good friends and decided to start a software development business in 2010. They set up what we’ll call, for the purposes of this piece, ‘Northerntek’, as a limited company and adopted the default model articles of association provided by Companies House. Mr A and Mrs B are both directors, 50 per cent shareholders of Northerntek and always make important decisions informally between themselves. Mr A and Mrs B didn’t use solicitors when setting up Northerntek, but always intended to get their ‘legals’ reviewed and in order at some point. Mr A and Mrs B throw themselves into developing and selling their unique product. After a steady start, Northerntek, gradually builds a strong customer base. In 2013 they bring in Mr C as a senior employee. Mr C also receives a small shareholding in Northerntek to incentivise him.
Everything seems to be going to plan, but here are some typical examples of how easy it is to get caught out in scenarios like this one if you haven’t got a shareholders’ agreement:
1. Death of a director/shareholder
Mrs B unfortunately dies in 2015. Mrs B’s husband, Mr B, always wanted to get his teeth into his wife’s company. Following her death, Mrs B’s entire estate, including her shareholding, passes automatically to Mr B, who now has an equal shareholding in Northerntek with Mr A. Mr A hates the prospect of having to work with Mr B who finds him impossible to deal with at social events, let alone if he has to have a business relationship with him.
If Mr A and Mrs B had had their company’s articles reviewed and had a basic shareholders’ agreement put in place, on Mrs B’s death her shares could have been offered up to Mr A, who would have had first refusal to buy the shares, or the company could buy them back, before Mrs B’s shares were able to pass to Mrs B’s husband.
2. Director resignation
Mrs B feels like she has been putting her life and soul into Northerntek, while Mr A has been spending much of his spare time working on other projects. In 2015, Mr A resigns as a director of Northerntek and informs Mrs B that he is setting up another software company. He tells Mrs B that he wants to keep hold of his shares in Northerntek, as he has been happy receiving a dividend. On the other hand, he says he is also thinking of selling his shares to whoever offers him a fair price.
If Mr A and Mrs B had had their company’s articles reviewed and had a basic shareholders’ agreement put in place, then on resigning as a director Mr A would have been required to offer up his shares to Mrs B, or the company could buy back his shares, before Mr A is able to freely offer his shares to the wider world. This would also avoid Mr A trying to ‘sit on’ his shares, while having nothing to do with the day-to-day running of Northerntek. In addition, a shareholders’ agreement could have included ‘restrictive covenants’ preventing a director or shareholder from leaving and immediately setting up in competition.
3. Sale of the company
In 2015, Mr A and Mrs B are approached by a large American company, which wants to buy Northerntek and makes Mr A and Mrs B a very good offer for Northerntek’s shares. Mr A and Mrs B are more than happy to sell. Mr C, however, says he is happy with the status quo and refuses to sell his small shareholding. The American company pulls out of the deal, as it only wants to own all of any company that it buys.
If Mr A and Mrs B had had their company’s articles reviewed and had a basic shareholders’ agreement put in place with Mr C, then on Mr A and Mrs B agreeing to sell their company, as long as Mr C was offered the same price (pro-rata) for his shares as Mr A and Mrs B then Mr C would also be required to sell his shares to the American company, even if he did not want to.
If you would like to talk to Bryon about shareholders’ agreements or any other requirements, including a free review of your company’s articles of association, call (01482) 974513 or email firstname.lastname@example.org