Protect your interests with a Shareholders Agreement

When setting up a company with family or friends it is easy to assume that nothing can go wrong in the future.

You might assume that as you trust each other you do not need to put something like a shareholders’ agreement in place.

You might think that asking for a shareholders’ agreement will make it sound like you do not trust or respect your new business partners.

But of course, there are no certainties in life or in business!

And that’s why for most companies, especially startups, a shareholder’s agreement is its most important document.

Put simply, your shareholder’s agreement is essentially a contract between some or all of the shareholders in your company and the company itself.

Its purpose is to protect your investment in the company, to establish a fair relationship between the shareholders and govern how your company is run.

Ideally, such agreements are best prepared in the ‘honeymoon period’ at the start of your business, like a ‘business pre-nup’.

In fact, this can be a very positive exercise to ensure there is common understanding of shareholder’s expectations of the business.

Consensus can be more easily reached on how your business should run, while all the stakeholders are motivated and collegiate, and disagreements or disputes over the day-to-day running of the business have yet to arise.

Why do you need a Shareholders’ Agreement?

The need for such an agreement becomes very clear when:

• Business relationships between shareholders sour or end
• Disputes arise over how your business is run, money spent or dividends paid (or not paid)
• Business partners wish to exit the business and cannot agree a sale price or what is ‘fair’ or ‘market’ value
• The business needs more funding or a founding shareholder(s) wants to bring on an additional business partner or investor to inject capital, but is concerned not to lose control of the company or ‘be voted off their won company’.

A properly drafted shareholders’ agreement can minimize conflict and maximise opportunity for growth; it can ensure that you can sell the business if you want to do so (or conversely, stop the business from being sold out from under you).

Key clauses for your Shareholder Agreement

There are many scenarios that can cause anxiety for Directors, Boards and Shareholders.

That’s why we recommend that your shareholders agreement aims to provide structure and guidance on share-related issues and how they will be dealt with.

Here’s a list of some of the things you should consider:

• How shareholders enter and exit the business
• Valuation of shares and how and when this is determined
• Funding of the business and the issuance of shares for fundraising purposes
• Composition of the Board of Directors and Board Meeting procedures
• Determining how key decisions will be made
• How to deal with the death or retirement of a shareholder
• Restraints of trade to govern shareholders participating in competing businesses

You may find our Shareholders’ Agreement checklist useful when reviewing what you should consider when drafting your Shareholders’ Agreement.

What if my business doesn’t have a Shareholders’ Agreement?

Without a Shareholders Agreement, your company will be governed by its Constitution and the Companies Acts.

The Companies Acts have a set of default ‘replaceable rules’, and your Constitution is unlikely to be tailored to suit your individual needs.

Having a Shareholders Agreement allows the shareholders to control and determine how matters are dealt with within the company.

You can find our shareholders agreement template here

5 Tips to consider

Tip 1 – Get it done at the beginning

The single biggest mistake we see is small business owners failing to prepare a shareholder’s agreement at the outset of the venture.

There can be many reasons for this, including the following:

• It may not occur to you that you need a shareholder’s agreement at all;
• You or your business partners want to avoid difficult conversations about control, management and expectations; and
• The legal costs may be seen as prohibitive

The problem here is that by the time you realise the need for a shareholder’s agreement, such as in a dispute, it is often too late or very expensive to reach an agreement.

It is far easier to get reasonable agreement in advance – before any dispute arises.

Tip 2 – Understand your business partners may not always be who you think

This is not just about relationships deteriorating, although that does definitely happen and is reason in itself to have a shareholder agreement.

The fact is you may not even end up dealing with the same individual.

If you don’t have any procedures in place, a shareholder may sell their stake to any third party.

If a shareholder dies, you may end up dealing with their spouse or executor.

If a shareholder becomes bankrupt, you may be dealing with their bankruptcy trustee.

A shareholder’s agreement can provide some protection against such occurrences.

Tip 3 – Verify the expectations of each party

Have clear expectations about what each participant will contribute to the business and how those contributions will be repaid (if at all).

If a participant is contributing cash, consider whether this is a loan to be repaid (and on what terms) or if this is initial share capital.

If another party is contributing their labour to manage the business operations, consider how they should be remunerated for their time and how.

A co-founders agreement may be of real benefit here.

This is generally entered into before a formal company is establish and deals with many of these issues.

You’ll find our co-founders agreement here

Tip 4 – Have a clear protocol for deadlocks

50/50 owned and controlled companies can be lethal to a business.

If there is a complete breakdown of trust between the parties, there may be no way to manage the company.

Director’s resolutions cannot be passed, documents cannot be signed and a majority shareholder does not exist.

When there is a complete impasse to decision making (particularly in 50/50 business arrangements) the only option may be to apply to court for an order to wind up the business.

Tip 5 – Have an exit plan

It is unlikely that all shareholders will want to exit the business at the same time.

There are often many personal factors involved in exiting the business.

If you decide to exit, consider how your interest will be valued and who will buy your shares.

If another shareholder decides to exit, consider whether you have a pre-emptive right to buy those shares and what price and payment terms are feasible.