What is a shareholders' agreement and when do you need one?
If you're setting up or in the early stages of a startup, 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.
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 is a Shareholders’ Agreement worth having?
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.
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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).
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.
What kind of terms does/should a Shareholders’ Agreement include?
Which terms should be included in a Shareholders’ Agreement will vary from deal to deal and business to business. They may 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.
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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’ 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.).
By now you’ve probably realised that a Shareholders’ Agreement can have a significant impact on your investment rights. This is why it’s important to take proper legal advice before signing one, so that you can be confident your position is protected and that you’re aware of all the potential risks. Whilst a falling out is something many business owners (understandably) do not foresee in advance, failure to plan for it with a well-drafted shareholders' agreement could have a catastrophic impact on your business.
Morgan has extensive experience advising businesses on company and commercial law. His practice includes advising on acquisitions and disposals, capital raising, commercial contracts, partnership matters, outsourcing, shareholder & joint ventures agreements and general company law matters.
Lucy is a member of the Commercial Team with a particular expertise in the technology and manufacturing sectors. From a technology perspective, Lucy spent a number of years at Sage UK. From a manufacturing perspective, Lucy has a wealth of experience gained from supporting blue-chip clients in the rail sector.
Adam is a director with 14 years' experience. As a business owner himself, Adam is able to advise a range of clients, from entrepreneurs to large private companies, on any aspect of corporate or commercial law.