In what circumstances does a company benefit from a shareholders agreement?
If your company is set up and running smoothly but lacks a shareholders agreement to govern the understanding between the shareholders, what will you do if someone dies or wants to retire or leave ? Without a shareholders agreement in place, there are no default procedures to govern how such circumstances are to be dealt with. You could therefore find yourself locked in a costly shareholders dispute which will damage the business.
A Shareholders Agreement is not a standard, off-the-shelf document. It’s a bespoke agreement that must be drafted carefully by an experienced lawyer who is working with you to gain insight into how your business is run. This will ensure it suits your needs and also makes provision for your exit strategy.
One key requirement is for the shareholders agreement to deal with a situation where one shareholder wants to sell their shares. The remaining shareholders will want to ensure that they have a right to buy the shares of the shareholder who is selling, at a fair price and that they have first refusal. If they do not have this right they could find themselves running the business with a random, unknown third party, which in a small business could be a major problem. This right can be incorporated into a shareholders agreement and is known as a pre-emption right. It can include an agreed formula for valuing the shares and a time-frame for buying those shares. The pre-emption right can be applied if a shareholder dies or becomes incapacitated, to ensure their next of kin doesn’t get their right to vote on business matters they may never have been involved in, and of course the right to a dividend.
A shareholders agreement should also be put in place to ensure there is clarity and certainty as to what can or cannot be done and to ensure that decisions are taken by consensus after full discussion. It can include limits on individual shareholders’ and directors’ authority to make sure no one person can, for example, incur debt or lend money over a certain amount without first getting unanimous consent. It can additionally set out matters requiring majority consent.
The shareholders agreement should be drafted in conjunction with the Articles of the company. Some provisions may be included in either document (or both of them). However, more effective legal remedies are likely to be available for breach of the Articles. For example, the remedy for breach of pre-emption provisions on transfer where these are included in a shareholders agreement may be limited to damages (which could be difficult to quantify). Yet if the same transfer breaches pre-emption provisions contained in the company’s Articles, the transfer may be void or the Articles may provide, for example, that all rights attaching to the shares are forfeited.