Shareholders' agreement

So, your shiny new company is up and running and you and your fellow shareholders who now own the business have sailed through the process of incorporating a company and are ready to start out on your exciting new venture. But wait. Have you thought about what might happen if things don’t go according to plan? You might think that your company’s articles of association will set out the day-to-day running of your company, but beware, this is very often not the case and you could find yourselves in a potentially very expensive procedure to unpick the mess.

The classic example is a company with two directors, who are also equal shareholders (or indeed, with any even number where the parties are split evenly). This is known as the 50/50 joint venture deadlocked company. The chances are that you have adopted the Model Articles under the Companies Act 2006 as the constitution of your new company, which state that if the members of a company are faced with a decision to be made in a shareholders’ meeting but cannot agree on it, then the chairperson of the meeting has a casting vote. But who appoints the chairperson and how can the interests of any smaller shareholders be protected?

Not having a shareholders’ agreement in place in the early stages of a company’s life is a disaster waiting to happen. We like to think of them as a bit like an insurance policy or a pre-nuptial agreement. Although it is quick, cheap and simple to set up your company, it might seem an avoidable expense to put a shareholders’ agreement in place, especially when funds are limited in the early life of the company. But this would be a false economy.

So what is a shareholders’ agreement? Very simply, it is an agreement setting out the relationship between the shareholders, including their rights and obligations. It is much easier to agree what should go into it before things get really busy and there is no time to deal with it after things have gone wrong. It is a contract between the people who own the business and it is a private agreement, unlike the company’s articles, which are available to the public.

What does a shareholders’ agreement say? No two shareholders’ agreements are identical, in the same way that no two companies are either, but common topics include:

  • what shareholders can and cannot do. Important things, like changing the business of the company, spending large amounts of money or even changing the name of the company can be restricted by requiring all the shareholders or a specified majority of them to agree to any action before it happens
  • deciding whether to increase or reduce the number of directors
  • setting out the procedure for when a shareholder decides he or she want to sell shares and who can buy them at what price
  • what happens if further shares are to be issued, maybe when a new investor wants shares, and how the interests of smaller shareholders whose holding might well be diluted if that happens can be protected
  • what happens if the agreement comes to an end.

Most of this sounds like common sense, but it is truly surprising how many companies do not have shareholders’ agreements in place and then find themselves in a situation where the only possibilities are either to slug it out in the courts or, cheaper but not in accordance with their intentions right at the beginning, to walk away and wind the company up.

Don’t wait until it’s too late. What may seem expensive at the outset could save you a fortune in the long run.

If you have any shareholder related questions please contact Nicola Prior on 020 8761 2302.

Disclaimer: Nothing in this article is intended as legal advice. If you have a particular legal requirement you should take specialist legal advice from a solicitor based on the facts regarding your individual situation.