Guide to shareholders agreements

Shareholders Agreements

For many people buying shares in a Private Limited Company, they want to make sure that their rights will be protected in some way. Whilst the Companies Articles of Association (‘Articles’) and the Companies Act 2006 go some way towards this, the most effective way of controlling and safeguarding shareholders rights is through a shareholder agreement.

A shareholders’ agreement can be used for various purposes, including certain voting rights at meetings, protecting minority shareholders from exploitation and setting out simple distribution of power.

Whilst some of the shareholders’ agreement will merely be setting out what is already stated in the Companies Articles, the added benefit to a shareholders’ agreement is that it is private in nature and is not open to public examination like the Articles are.

The most common clauses found in a shareholders’ agreements include:

Positive Obligations:-

This is where the parties bind themselves to positively exercise their rights as shareholders to make sure that they put into effect their agreed aims, objectives and intentions of how the business should be run, developed and even funded.

• Rights of Veto:-

This is where the parties set out which important decisions need the agreement of a specific percentage of shareholders, or even unanimity. This is commonly done to provide minority shareholders the ability to veto certain major decisions such as the issuing of further share capital or changing the Companies Articles.

Any decisions can be included in such a clause, whether or not it would usually be decided by the shareholders or even by the directors.

• Issue and Transfer of Shares:-

Most shareholder agreements will want to specify the procedure to be taken on the issuing and transfer of shares.

The problems arising here are that the agreement must balance the need to protect the shareholders shares from being diluted with the need for the company to be able to raise more funds by issuing more of its shares.

Even when dealing with a transfer of shares it is necessary to balance the issues of giving the current shareholders a market to sell their shares in, against the concerns of the remaining shareholders as to the suitability of the new proposed shareholders. Even the possibility of a current shareholder purchasing the shares and building up too large a holding must be taken into account.

• Rights to Appoint Directors:-

Some shareholder agreements will want to protect the rights of an outside investor by providing that they can appoint a director to the Company board in order that they can protect their investments.

Usually this is in the form of a non-executive director who does not have an active day to day role in the Company’s business, but who will oversee what decisions are being made and will report back to the investor, especially if the Company is not performing as expected.

Others may want to take a more hands on approach and appoint a more active board member. This can depend on their level of investment.

• Dispute Resolution:-

Although it is hoped that there will be no disagreements, almost all shareholders’ agreements contain procedures to be followed should it not be possible to resolve the disagreement between the parties themselves.

This is usually in the form of a third party mediator, or may even be a buy-out mechanism whereby one party will buy out the shares of the other at a set price, since the Company would not be able to continue with its course of business with an impasse between the parties. The terms of a buy-out are complicated and need to be carefully drafted since it must be made clear who will sell to whom and how the price will be determined.

In order to stop parties selling at an unrealistic price, shareholders’ agreements usually provide that if the buyer does not accept the price the seller put forward, the seller must now become the buyer at the price he originally stated. This would encourage him to set a reasonable price at the outset for fear of him having to purchase the shares at too high a price should the other party not agree.

If the disagreement is extremely serious the provision may even call for the parties to agree to wind up the Company.

Whatever the provision to be put into a shareholders’ agreement great care must be taken in its drafting to ensure that the rights and interests of the shareholders are protected as they had wanted.

It is therefore important when drafting or signing such agreements that you seek legal advice on its contents before agreeing to anything.

Many thanks to Darlingtons Solicitors for contributing this article.