Shareholders’ Agreements: What’s the Point?
06 September 2018
Starting a business is challenging, exciting and usually expensive so we’ll forgive you for pushing the legal issues down your list of priorities. Although you might not want to hear it, it really will benefit you in the long term to consider the legal issues that come hand in hand with running a business, rather than wishing you had something in place when things go wrong.
1. What is a shareholders’ agreement?
A shareholders’ agreement is a private contract between the shareholders of a private company limited by shares. It regulates the various aspects of ownership of the business, how the business is run and protects the owners on a day-to-day basis.
While there isn’t a legal requirement to have a shareholders’ agreement, we strongly recommend one if you’re going into business with someone else, whether it’s a friend, family member or investor. Many funding providers make it a condition of any facility that such an agreement is in place and we suspect that this practice will become widely-enforced in the future.
Why are shareholders’ agreements so important?
2. The fallout
In the first instance, having an agreement in place means you’ve regulated what will happen if something goes wrong. These situations are hard to foresee, especially if, for example, you’re going into business with a close friend. Unfortunately, as the Facebook fallout between Mark Zuckerburg and the Winklevoss brothers proved, if things do go wrong, they can go very wrong. Dealing with the ‘divorce’ at the outset makes everything smoother and more cost-effective, and minimising conflict upfront minimises the chances of a stalemate developing if relationships do break down.
Most businesses are not split 50/50; they have minority and majority shareholdings in various percentages. The agreement can be drafted in a way to protect minority shareholders from being outvoted or prejudiced, or alternatively, to allow majority shareholders to take action without the consent of all shareholders. By outlining the process, it will make decision-making more quick and efficient.
The general decision-making in a company is undertaken by the directors, rather than the shareholders (who may be the same people). A shareholders’ agreement can hold the directors accountable for certain actions and require them to seek shareholder consent on key decisions. It allows shareholders to take a step back from the day-to-day dealings of the company, while providing for situations in which they must be consulted and therefore enabling the owners of the business to retain control.
We all like to get paid for the blood, sweat and tears that go into building a business. Shareholdings in a company can be linked to financial contribution or investment in the company or perhaps performance, through mechanisms such as a share option scheme. There are a range of different ways that company profits can be distributed – the details of which may be contained in the shareholders’ agreement.
No-one wants their co-founder to stroll over to their biggest competitor, taking all their trade secrets with them.
It is extremely important to adequately protect the business and this can be done by placing restrictions on the shareholders during their involvement with the business and for a period of time after their departure. Restrictions can be imposed to protect intellectual property rights, trade secrets, suppliers, customers and employees from being taken from the company, along with restrictions on setting up a competitive business.
In summary, a shareholders’ agreement can be used as a safeguard to protect the shareholders because (amongst other things) it provides for what happens if things go wrong. The agreement can cover many eventualities, including the financing or re-financing of a company, the management of the company, the dividend policy and deadlock situations. The absence of a shareholders’ agreement opens up the potential for disputes and disagreements which may, ultimately impact the success of the business.