Why Should I have a Shareholder’s Agreement?

Why Should I have a Shareholder’s Agreement?

Why Should I have a Shareholder’s Agreement?

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I would advise any director/shareholder in a limited company with more than one member to have a shareholders agreement. I have too often seen the disastrous results of failing to have one.

What is a shareholder’s agreement and what does it do?

books-690219_1280A shareholders’ agreement is an agreement entered into between all or some of the shareholders in a company which regulates their relationship. You can combine the use of a shareholders’ agreement with a specifically drafted set of Articles of Association

Shareholders’ Agreements are often used as a safeguard and to give protection to shareholders, because (amongst other things) they can provide for what happens if ‘things go wrong’ i.e. there is a falling out between the shareholders. Too many times people set up companies with friends and relatives and do not consider protecting their interests in the company until it is too late. The Articles of Association of the Company may not offer a shareholder full protection

People often rely on their Articles to deal with the position if one shareholder wants to leave or there is a falling out, or a shareholder just wishes to sell his or her shares. The standard Table A Articles will deal with the issue of new shares, in that they have to be offered to all shareholders equally and give everyone the chance to have an equal proportion of the shares, but it will not deal fully with what happens if a shareholder wants to sell the shares they already have.

You need a shareholders agreement to set out “pre emption” rights, so that, if a shareholder wants to sell their shares they have to offer them to the remaining shareholders first.

You can also say that if a shareholder leaves for any reason they have to offer their shares back to the others and failing that, the company (if the company has sufficient profit to pay for them of course).

I have been involved in shareholder disputes where there is no shareholder agreement in place and the argument is over the value of the shares. It is generally agreed that the shareholders will part ways but it is inevitably about how much the departing shareholder’s shares are worth.

If you have a well written shareholders agreement in place then it will set out the valuation process so there is no argument. You can set out how the valuation will be made. You can have some quite complex formulas but the most common method is to say your accountant will come to a valuation and the parties will agree that. If agreement cannot be made then you can go to an independent valuer.

I have been involved in cases where there is no shareholders agreement, a dispute arises, there is no process for the purchase and valuation of the shares a S.994 Unfair Prejudice claim is taken and both parties have incurred £50,000 + worth of costs each and still settled out of court by having an independent valuer asses the value of the shares.

You can also include provision in a shareholders agreement that, in the event of a shareholder leaving “under a cloud” for some misdemeanour (a Bad Leaver), his or her shares are valued at its nominal or “par” value, that is, the face value of the shares at issue, often £1.00 per share.

Should a shareholder leave by consent (Good Leaver) then his or her shares can be valued at fair market value at the time of their leaving the company.

There are usually provisions which require certain matters to be approved by all the directors/ shareholders before being acted upon, for instance, varying the salary of any directors, entering substantial business contracts or commencing legal proceedings.

You can also include a clause stating what the dividend policy of the company should be, and you can consider what percentage of the post tax profits should be paid to the shareholders each year, and provide for when the company doesn’t have to pay a dividend i.e. if the company would not then be able to pay its debts.

Occasionally a ‘tag along’ right is included (i.e. the outgoing shareholder can be required to procure that a third party purchaser offers to buy the remaining shareholders’ shares on no less favourable terms as he is getting for his shares). Conversely, the minority may be forced to accept such an offer (‘drag along’ right). A third party purchaser is likely to want to purchase the whole of the shares in the company. This is beneficial for majority shareholders, when ensuring they can leave the company without needing to worry about having to persuade all the other shareholders to sell.

About the author:

Bob has spent many years working in commercial law, managing the claims and legal teams.

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