Why every business needs a shareholder agreement

All business partnerships start out with good intentions. At the outset, business partners rarely see the need to ensure the business is protected in the event that things go wrong later down the line. Instead, many place significant trust in their relationship with their business partner to resolve any disagreements that might arise in the future. People also often find it difficult to discuss contentious worst-case scenarios.

However, shareholder disputes do arise, and quite often they cannot be resolved amicably. When disputes occur, they can be extremely disruptive to the business. Anticipating these issues before they arise can save significant time, cost, and stress. It is therefore essential to have documentation in place outlining the procedural steps shareholders must follow to protect the business.

A shareholder agreement plays a crucial role in safeguarding both the company and its shareholders, as they:

1. Provide a clear mechanism for resolving disputes. Attempting to agree provisions after a dispute has already arisen is usually extremely difficult. It is far more efficient to establish a process at the beginning of the business relationship. While the agreement may not need to be referred to every time a disagreement occurs, it can act as a “default” position where shareholders hold differing views. For example, deadlock provisions can be included to force a decision when shareholders cannot agree, helping prevent operational stagnation. Although it is recommended that a shareholder agreement is created at the start of a business relationship, it can also be introduced later if one does not already exist.
2. Offer protection for minority shareholders. A shareholder agreement can offer important safeguards for minority shareholders. Certain decisions can be structured to require unanimous approval rather than a simple majority, such as the issuing of new shares, selling the company or even changes to the company’s constitution. Agreements may also include “tag-along” provisions, which serve as legal safeguard for minority shareholders by allowing them to participate in sales initiated by majority shareholders. This ensures they receive the same price and terms for the sale of their shares, preventing them from being left with a new business partner they may not wish to work with.
3. Provide protection for majority shareholders. Conversely, shareholder agreements can also protect majority shareholders through “drag-along” provisions. This allows a majority shareholder to force minority shareholders to sell their shares, which facilitate full company buy outs.
4. Planning for the unexpected. A shareholder agreement can also protect the business in the event of a shareholder’s death. Shares may pass to family members, friends, or third parties who may not have the experience to run the business effectively or may not see eye to eye with existing shareholders. In these circumstances, an agreement can include a buyout option. This acts as a way of controlling who can and cannot own shares within the company, providing existing shareholders with decisive control. Shareholders can also arrange insurance to pay for the buyout, preventing such events from impacting the business’s cash flow.
5. Require shares to be offered to existing shareholders. Shareholder agreements can also provide pre-emption rights which compel shareholders looking to sell their shares to offer those shares for sale to existing shareholders before they are able to sell to a third party.
6. Maintain confidentiality. Unlike articles of association, there is no requirement to file a shareholders’ agreement at Companies House. This allows a company to include sensitive business and financial information within the agreement with the reassurance that all the information will remain confidential.
7. Impose restrictions. A shareholders’ agreement can also prevent shareholders wishing to leave the business from poaching key employees and setting up a competing business.

If you are currently a shareholder and do not have an agreement in place, it may be worth discussing your position with the corporate team at Backhouse Jones. Taking advice early can help identify potential issues before they arise.

It is important to consider the future of your company – don’t leave matters to chance. Get in touch by emailing corporatedept@backhouses.co.uk.

This article was written by Emily Carpendale.