Shareholders Agreements: A Simple Guide
What is a shareholders agreement, when do you need one and how do you make one? We explain all in our simple guide to shareholders agreements.
By MyLegalAdviser - Last Updated January 2018
If you're setting up or in the early stages of a running a business, you've probably heard a bit about shareholders' agreements. You may even have been told you need one.
If you're not sure why that is, or if you're just looking for a bit more information about what a shareholders' agreement does, we've put together a guide below to help explain what a shareholders' agreement is and when you might need one.
IN THIS GUIDE:
- What is a shareholders agreement?
- Why do you need a shareholders agreement?
- What are the key terms a shareholders agreement should include?
- How do you make a shareholders agreement?
What is a shareholders agreement?
A Shareholders’ Agreement is a private agreement between the shareholders of a limited company.
Whereas a company’s articles of association (essentially the document which details what the company can and can't do) are public and can be viewed by anyone, a shareholders’ agreement is private and so may contain provisions which the shareholders don't want everyone to know about.
And because a shareholders’ agreement is not a formally required legal document, it can be as straightforward or as complex as is needed.
Why do you need a shareholders agreement?
Although not legally required, a Shareholders’ Agreement is often a good idea where there is more than one shareholder of a company.
The main benefit of a properly drafted Shareholders’ Agreement is that it limits the scope for a fight over the business in the event of a falling out between the shareholders. This is because the Shareholders’ Agreement generally prescribes what happens in the event of an argument and so limits the potential for a disagreement to tear the company apart.
Shareholders’ Agreements are also particularly beneficial for minority investors, as they can help protect their rights despite the size of their shareholding (e.g. by including reporting requirements, rights to attend and vote at meetings, rights to appoint directors and tag along with business sales). This why most investors will require a shareholders agreement is in place at or before the time they invest.
A Shareholders’ Agreement is also often seen by banks and potential investors as a welcome mark of stability when the company is looking to raise, or increase, funding.
TWO HEADS ARE BETTER THAN ONE: A shareholders agreement is a great way to ensure founders can work together as a team.
What are the key terms a shareholders agreement should include?
Which terms should be included in a Shareholders’ Agreement will vary from deal to deal and business to business.
It will also depend on your role in the investment: e.g. vesting provisions for founders may be welcomed by investors but perhaps not by the founders themselves.
Having said that, here are some of the provisions which are commonly included in a Shareholders’ Agreement:
- What the company's business is and how it intends to do it.
- Any vesting arrangements on the shares (e.g. founder shares often vest over 4 years, giving investors’ and employees confidence that the founders will stick around).
- Who invests/provides what (e.g. finances, property, IP, etc.).
- Share rights - e.g. when shares can be sold or transferred and at what price.
- What happens in the event of a deadlock on a decision.
- How directors are chosen and how they can be removed.
- Restrictive covenants to stop shareholders from poaching staff or ideas and setting up a rival business.
- Drag and tag provisions (allowing for a sale of the business to an investor who wants to acquire the entire share capital).
- Protection for minority shareholders (e.g. reporting requirements, tag provisions, rights to attend meetings, rights to appoint directors, etc.).
How do you make a shareholders agreement?
Shareholders agreements are often complex and their provisions can affect your ownership rights down the line.
We don't want to be dramatic, but getting it wrong can be catastrophic. Warring founders tearing the company apart. Being unable to sell the company because an employee shareholder won't sell. Investors cashing out before the founders leaving them high and dry.
Without a shareholders agreement, or with a badly drafted agreement, these are all things that go wrong. Just make sure it isn't something that happens to you!