DTM Legal’s Fredrica Reid outlines the importance of Shareholders’ Agreements, and the risks of not having them.
Whether you’re starting a joint venture, investing in a business without day-to-day involvement, or running an owner-managed company with fellow shareholders, it’s essential that everyone involved understands their rights, responsibilities, and how decisions will be made.
A Shareholders’ Agreement is a key legal document that provides this clarity. Without one, disputes and uncertainty can arise – often with serious consequences.
The Risks of Not Having a Shareholders’ Agreement
Failing to put a Shareholders’ Agreement in place can lead to several problems, including:
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Decision-making deadlock – If shareholders cannot agree on a course of action and there is no majority to pass a resolution, the company can become paralysed.
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Limited rights for minority shareholders – Without formal protections, those holding smaller stakes may have little say in how the business is run.
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Too much power in the hands of directors – The board could make significant decisions without consulting shareholders, even on matters shareholders may view as critical.
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Lack of confidentiality – The company’s Articles of Association are a public document, so they may not be suitable for dealing with sensitive or internal issues.
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No clear exit strategy – Relationships and circumstances can change. Without a defined mechanism for resolving disputes or transferring shares, tensions can escalate.
How a Shareholders’ Agreement Helps
A Shareholders’ Agreement can prevent or resolve these issues by:
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Outlining dispute resolution processes – Including mechanisms for resolving deadlock, such as “Texas Shootout” or “Russian Roulette” clauses where shareholders offer to buy or sell shares at a set price.
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Protecting minority shareholders – By specifying matters that require unanimous or majority shareholder consent, and allowing smaller shareholders to appoint directors or block certain decisions.
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Defining shareholder and director powers – Clarifying the respective responsibilities and decision-making rights of directors and shareholders.
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Maintaining confidentiality – Unlike the Articles, a Shareholders’ Agreement is a private contract between the parties.
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Binding the company to certain obligations – The agreement can include commitments by the company itself, as well as rules for share transfers and how and when the agreement may terminate.
What Else Can a Shareholders’ Agreement Include?
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Management structure – How directors are appointed and how the company is to be managed.
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Funding arrangements – How the business is financed and how additional funding will be raised in the future.
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Share transfer rules – Including valuation methods, rights of first refusal, and restrictions on sales to competitors.
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Issuing new shares – Whether existing shareholders have pre-emption rights to maintain their shareholding percentage.
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Dividend policy – Setting expectations on how and when profits will be distributed.
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Restrictive covenants – Preventing shareholders from competing with the business during and after their involvement.
Top Tip: Restrictive covenants in a Shareholders’ Agreement can often be more enforceable than those in an employment contract – especially as outgoing shareholders are usually paid for their shares.
Why Getting It Right Matters
A well-drafted Shareholders’ Agreement strikes the right balance – protecting shareholders’ interests while allowing the board to manage the business effectively. It can be tailored to cover as many or as few matters as the parties wish.
Too often, businesses are set up between friends, family, or trusted contacts without considering what happens if things don’t go to plan. Disputes or misunderstandings may arise years down the line, by which point it’s often too late to resolve them easily or cheaply.
Putting a Shareholders’ Agreement in place at the outset – or as soon as possible – can prevent conflict, safeguard everyone’s investment, and provide peace of mind as the business grows.
Need Advice?
If you’re setting up a company or want to put a Shareholders’ Agreement in place, speak to our Corporate and Commercial team at DTM Legal. We can help tailor an agreement to suit your business goals and shareholder relationships.
You can contact Fredrica Reid, Corporate and Commercial Solicitor by emailing fredrica.reid@dtmlegal.com or call 01244 354 814.
