It is unlikely that you will enter into business with someone who you don’t like, know or trust, however loyalty and friendships are not always a solid foundation for long-term business success.
If you are a limited company shareholder, you can get a shareholder agreement in place to plan ahead and think about issues that may arise in the future. A shareholders agreement is essentially a contract between the owner of a business. That could be an agreement between a husband and wife, lifelong best friends, or between the individual with an idea plus their investors.
Look at shareholders’ agreements like a pre-nup, but for business which lays down certain provisions to look at in the event of issues arising whilst protecting each shareholder and their finances (amongst many other things). Just like when a marriage breaks down, a falling out amongst shareholders is rarely just a tiff, it can become very bitter, personal and one hell of a toxic divorce.
The specific implications of not having a shareholder agreement can vary depending on how the business is set up, and of course there is no legal requirement to have one but if there is an intention to having different dividend policies, not happy with just anyone buying into your business, want your business to grow and want to protect years of hard work then you need a shareholder agreement.
Below are some potential consequences of not having a well drafted bespoke to your business shareholder agreement and having to rely on the model articles should an issue arise.
- Decision-making: Without a shareholder agreement, decision-making processes may be less clear, especially where the voting shares in a company are held equally with 50% each by just two people. Important matters such as hiring new staff, approving major transactions, or making fundamental changes to the company’s structure can all prove problematic when there isn’t an agreement amongst the parties. A simple dispute resolution clause can be refer to a third party expert or potential buy-out provisions. In the absence of this in an agreement, disputes will generally go on for longer, will need to be resolved through litigation, which can be costly and time-consuming.
- Shareholders rights: Standard articles come with only one class of share which carries equal rights. Different share classes enable shareholders to be paid different dividends and vary voting rights. This is popular if different shareholders contribute different amounts of workload to the business. The articles do have to set out the different classes of shares. The finer details on the different classes of shares can be stipulated in the shareholders’ agreement.
As stated above, no one wants a messy divorce. In the absence of a shareholder agreement, shareholders will have no clear guidelines or protections for exiting the business.
- What happens if majority shareholders want to sell the company? – Without changes to the articles or adding drag along rights in a shareholder agreement, a minority shareholder could block a company sale. This is resolved by including tag and drag along clauses within the agreement. A typical drag along clause will allow the company to be sold if the majority shareholders want to sell the business. Then the tag along provisions protects the minority shareholders. The purchaser must offer to buy the minority shareholder’s shares on the same terms if they do not want to keep their shares in a company under new management and control.
- Who can shareholders sell their shares to? Most private limited companies will want to ensure that a shareholder cannot sell their shares to a third party without first offering them to the other shareholders. There may also be a hierarchy for existing shareholders of who gets first refusal before the other shareholders. This would all be laid out clearly in a shareholder agreement and would prevent shares being sold to someone not known to you. Further, the share valuation process can be predetermined by the shareholders whilst considering good leaver and bad leaver clauses to ensure there is a clear process to complete any share sale.
- When shareholders do part ways with a company. In the absence of a shareholder agreement, any shareholder is free to take your clients, customers, suppliers, know how and continue trading under a new company. Shareholder agreements commonly include provisions on confidentiality and non-competition to protect the company’s proprietary information and prevent shareholders from engaging in activities that may compete with the company.
Not having a shareholder agreement can create uncertainties and potentially lead to conflicts among shareholders which in turn could wind up the business. It is crucial for all private limited companies to have a well-drafted shareholder agreement in place to provide clarity, protect the interests of shareholders, and establish mechanisms for resolving disputes and managing the company effectively.
We are very experienced at drafting this type of agreement and work closely with you to tailor the agreement to the specific needs of the company and its shareholders. Call us if you wish to discuss this in more detail on 01604 217365.