Shareholder Agreements

What is a Shareholder Agreement?

A shareholder agreement is often overlooked in the initial stages of a company formation. It is particularly critical when family or friends are involved, or where shareholders and directors are one of the same. People’s expectations can vary over time, a shareholder agreement can make many provisions to safeguard a company’s interests against potential future disputes.

The drafting of an agreement is recommended early on, as it identifies roles, levels of ownership and what happens if a shareholder decides to leave. It therefore has a tendency to iron out differences sooner rather than later.

Shareholder agreements are important to establish the level of control each shareholder has. Over 50% is considered a major shareholder. They are able to pass ‘ordinary resolutions’ in spite of the other shareholders, (e.g. remove one of the directors). A minority shareholder has less than 50% shares and has less rights. Without an agreement the majority shareholder controls the company.

A shareholder agreement can help to ensure the company as a whole, including both owners and directors all have the same objectives. It needs to be carefully drafted with provision, that any desired changes can be made, without seriously damaging the business. An example of which would be the removal of a director who is not performing.

It needs to ensure directors are motivated and acting in the best interest of the shareholders with the necessary procedures and mechanisms in place.

It determines the relationship between ownership (shareholders) and the management (directors) and how the company is run and controlled. Whilst the directors deal with the day to day running of the business, the shareholders have the power to make important decisions by casting their vote at board meetings.

An agreement can be drafted to give a minority shareholder more rights, over and above what is defined by the Articles of Association. Examples of these may be rights to voting, capital or dividends. Similarly an agreement may be produced in favour of a majority shareholder who may want to ensure that, if he wishes to sell his shareholding, minority shareholders have to sell as well.

Drag Along

In this instance if a majority shareholder wishes to sell, a provision is made to compel all other minority shareholders to have to do the same.

Tag Along

If a major shareholder is made an offer for his/her shares, they cannot sell unless the same offer is put to all other shareholders.

Problems occur between shareholders when one decides to leave or sell their shareholding. In a small company where equity is unlisted, (i.e. shares are not openly traded), there is no market for them. A potential purchaser will normally want to acquire the business ‘lock stock and barrel’. This means that minority shareholders may find themselves in a difficult situation.

Often shares are held in denominations of 50% 50% and sometimes there can be a state of deadlock. It is imperative that a company with this type of share structure has an agreement drafted to avoid a contentious situation. Provision for disputes can be incorporated with mediation or arbitration.

We draft shareholder agreements for a fixed fee of £375 + (VAT).

What information we will require:

Company Documentation

• A copy of the latest Articles of Association of the company.
• Type of business activity.
• Registered address.
• Company secretary.
• Company accountants.

Shareholders

• 1) Details of the shareholders
• 2) Details of the share capital, types of holding and amounts held by each.
• 3) How shares are to be sold. (e.g. if a major shareholder wishes to sell, whether this can be forced upon minority shareholders, Whether this could be to a third party, or whether the company can buy the shares back).
• 4) How the shares are to be valued in the future (e.g. by the company accountant or an independent valuer).
• 5) Life insurance in the event of a shareholder’s death.

Shares Required

• 1) Ordinary (Most common, normal class of shares with voting rights).
• 2) Non-voting.
• 3) Preferred ordinary (No dividend until all other classes have received one).
• 4) Redeemable (Gives the company the option to buy them back).
• 5) Preference (Annual fixed dividend, ahead of ordinary).
• 6) Cumulative preference (When dividend not awarded, underpayment satisfied with next distributable reserves).
• 7) Redeemable preference.

Directors

• 1) Details of directors
• 2) Directors service agreements (if they exist).
• 3) Restrictive covenants, (stops the starting of competitive businesses, protects the business).

The Board

• 1) How often the board meetings are.
• 2) Whether the chairman has the casting vote.
• 3) The control of spending by the directors (e.g. individual items purchased over £5k needs board approval).
• 4) Whether provisions are made for passing ordinary/special resolutions (e.g. The requirement of a unanimous majority of 75% for special decisions such as asset disposal or capital expenditure).
• 5) How the business is financed and how capital is secured and to what limits, (e.g. bank loan on assets and debtors).
• 6) At what level of profit do dividends get paid.
• 7) Additional share issues, rather than share dilution, consideration may be for the preserving of capital against using new share capital for funding.