Why you need the protection of a shareholders’ agreement

When the route of your business goes off-piste, and unexpected events begin to impact on the company, the fallout can be significant. Whether it’s disagreements between fellow directors, issues over share ownership or lengthy legal wrangles, this is time and money that would be better spent working on the success of your company – and with a properly planned shareholders’ agreement, you can prevent this negative impact.

Helen Robinson outlines the purpose of a shareholders’ agreement and how it protects you and your business from unnecessary harm.

Why you need the right legal documentation

The relationships between founders and directors don’t always run smoothly. You can argue for years about how your business works, what the company will do strategically or what it will be worth when sold. Having legal documentation in place to clarify these areas is a necessary part of managing your business.

The agreements between directors will generally fall into two types:

  • The articles of association – these are the public records that set out how the company will work and function – detailing the internal corporate processes, expectations and agreements.
  • The shareholders’ agreement – this is a private document that sets out your agreements around how dividends are paid, who gets what and – crucially – the specific rights that certain shareholders have.

Protecting your interests as the owner

Traditionally, the shareholders’ agreement was used to document the rights of minority shareholders. But in more recent times, the shareholders’ agreement is commonly used to provide protection for founders, right from the outset of the business.

The agreement will define how you hand over shares to family, children or other directors, and in most cases the owner will generally still have the power of veto. Ultimately, this company is your ‘baby’ and you’ll want to retain control over it – and this is a key factor for having a robust shareholders’ agreement in place right from the get-go.

The shareholders’ agreement also outlines how you deal with people who break the rules, and whether you have the power to kick them out of the company etc. The agreement is a contract and people can breach it, so you need a clear outline of whether shareholders can be taken to court, what the process will be and what happens to their share ownership following any misdemeanors.

The business must comply with the company’s articles of association – these are set in stone and are legally binding. But the shareholders’ agreement is a more personal kind of consensus around how the directors behave… and, as such, it’s easier for these agreements to be broken and problems to arise.

Do you opt for private or public information?

Ultimately, what you include in the shareholders’ agreement and in the articles of association comes down to what you want to be private and what you want in the public domain.

Public: the articles of association

The articles of association are freely available through Companies House to anyone who wants to access them. For this reason, you don’t generally put rules regarding personal wealth into the articles of association.

There will usually be a list at the back of important votes re sales of assets and what percentage of people must vote on this, who needs consent, and whether the founder/s have a vote.

Private: the shareholders’ agreement

This is the place to list the more personal agreements between you and your fellow shareholders, safe in the knowledge that this is a private document.

Although most owners will have heard of the shareholders’ agreement, in my experience many don’t ever get around to setting it up. My advice will always be set up the agreements early and to ensure you’ve got that protection in place as and when you need it.

Scenarios where it’s prudent to have your shareholders’ agreement in place, include:

  • Setting up an EMI option scheme – if you’re setting up an EMI options scheme as an incentive for senior staff, this is a good time to confirm the share rights in your shareholders’ agreement. This keeps things organised and clarifies exactly what rights your employees have.
  • Disagreements with fellow directors – it’s not unknown for founders to fall out badly as the business grows. With everything agreed in writing, your legal position is clear and there’s less risk of any major arguments having a negative impact on the business.
  • Dealing with divorce – passing shares to your spouse might be highly tax-efficient, but it can also cause complications if there’s a ‘conscious uncoupling’ or a messy divorce further down the line. Set up clauses around share buy-backs and spouses’ rights to minimise the impact.
  • Coping with an unexpected death – morbid as it may sound, it’s vital to plan for what may happen if a key shareholder passes away unexpectedly. Having clauses in place that specify how share must be sold back to the business, or other shareholders, is a vital level of protection – at a time when dealing with legal matters won’t be top of anyone’s list.
  • Handing the business on to the next generation – succession is an important consideration, but you need to be very careful about specifying the rights your children have as shareholders. Maintaining your veto and remaining in full control is prudent until such time as you’ve retired and have exited the business.

Helping you set up your shareholders’ agreement

At HW Business Law, we can quickly help you define what’s needed in your company’s shareholders’ agreement and provide the certainty you’re looking for. By filling out our simple questionnaire, and answering questions around different potential scenarios, we can understand your drives and priorities as a business and factor in the relevant clauses.

If you don’t have an agreement in place, you weaken your position as directors and create the potential for a major headache at a later date. But if you have completed a shareholders’ agreement you have the right mechanisms in place to overcome most scenarios – and can’t be held to ransom by a rogue director, angry spouse or overly ambitious family members.

Talk to one of our lawyers about creating a shareholders’ agreement.