Do I need a shareholders agreement?

Have you been told that you need a shareholders agreement for your business but don’t know where to start? Hiring a lawyer to draft one will cost you a significant amount, which is not always an attractive proposition for many businesses, especially those in start-up or scale-up mode.

Whilst there’s no legal requirement to have a formalised shareholders’ agreement it’s advisable to have one if your company has more than one shareholder. It will ensure everyone’s responsibility is clear, reducing the potential for conflict and helping the company to run smoothly.

Jonathan Dawe, co-founder of Paper Rock and practising English lawyer explains:

Why do I need one and what would go in it?

You’ll need a shareholders’ agreement if you own shares in a company or if you’re in business with one or more other shareholders. You may have agreed with your business partner what each of you will bring to the business and this needs to be clearly documented, including what happens if either of you fails to perform. Also, you should consider what happens if one of you wants to leave or if you want to sell the company.

There is no single standard shareholders’ agreement. One form of shareholders’ agreement may be suitable for one situation but will be unsuitable for others.  English company law will provide a default framework for some of the things that a shareholders’ agreement will cover, but this is unlikely to encompass all circumstances.

The following questions will help you identify common variables for your shareholders’ agreement:

• Are the shareholdings equal (50%/50% shareholdings) or is there are majority shareholder (over 50% shareholding) and one minority shareholder (less than 50% shareholding)?
• Are there more than two shareholders and does any of them hold more than a 50% shareholding?
• Is this a single project company (for example, the acquisition and ownership of a particular asset) or a trading/services company?
• What are the owners’ ultimate expectations for the business? Is the aim to build it up and then sell the company, or will the company have no underlying future value once a particular project has been completed?

What does a shareholders’ agreement usually cover?

Typical areas covered in a shareholders’ agreement include:

Shareholders and shareholdings. Clarifying the names and percentage of shares owned by each party.

Share rights. This articulates any conditions on the shares. Do all shares have equal rights, or will some shares have special rights like dividends or sales proceeds?

Shareholder roles. This refers to the role each shareholder will undertake.  This could include providing premises, equipment and services, intellectual property or acting as an employee or consultant.

Directors. Directors are legally responsible for the management of the company’s business activities. Not all shareholders will be directors.

Additional shares and shareholders. A shareholders’ agreement should describe the process for bringing in new shareholders or issuing more shares in the company.

Funding. Who will provide the initial finance for the business? How will the funding be provided —share capital or loan?  How will it be repaid and what happens if the business needs more money?

Decision-making. Outline how day to day decisions of the business will be made and who can make them. Be sure to list important and critical decisions that require consent of all (or a specified majority) of shareholders.

Deadlock. What happens if the shareholders cannot agree or are in dispute?  Your agreement should provide a legally binding mechanism for what should happen in this scenario.

Termination. A shareholders’ agreement should clearly state how the contract may be brought to an end.

Restrictive covenants. Conditions can be placed in the agreement that restrict shareholders’ from competing with the business or soliciting clients, suppliers, and key employees if they leave.

Transfers of shares. A shareholders’ agreement governs the transfer of shares in the company, whether transfers should be permitted or restricted in some way.  Common provisions around the transfers of shares include:

• Pre-emption rights — designed to restrict the opportunities to shares being sold to a prescribed group of people external to the company. This ensures that existing members can purchase them at a fair price.
• Good and bad leaver clauses — provisions that outline how the shares of shareholders leaving the business will be handled. Good leavers are those that leave due to reasonable circumstances. Bad leavers refer to exits because of misconduct or actions that break a prior agreement.
• Drag-along rights — where a majority of shareholders force a minority to join in the sale of the company to a third party.
• Tag-along rights — where minority shareholders are empowered to ‘tag along’ with a majority shareholders sale to a third party.

Governing law and disputes. Which law will govern the shareholders agreement and where will disputes be handed?  This is particularly important for contracts with an international dimension

Jonathan Dawe is the co-founder of Paper Rock and is a practising English lawyer. Paper Rock is a legal template service that provides a flexible, reliable, and cost-effective solution to securing business agreements. Find out more at PaperRockDocs.com.