Why do I need a shareholders’ agreement and what should it include?

This is a submission from Richard Cramer of Front Row Legal, a specialist in Sports, Media and Business Law based in Leeds.


As there is no legal requirement to have a shareholders agreement and your company’s articles of association (in conjunction with UK company law) should provide you with at least some legal protection, it is no surprise one of the questions we continually have to field is “why should I spend additional time, trouble and money to put a shareholders’ agreement in place?”


The answer is simple. Only a shareholder’s agreement will give you with the ultimate safeguard should things go wrong in the future.


As no one ever starts a business planning to fall out with the friends or family they formed the business with, nothing will be further from your mind during the excitement of launching your new venture. But unfortunately, disputes are an all too common occurrence in our working lives. If your business is going to weather those disputes, you need to have a framework in place to ensure any disputes are resolved quickly before they cause any long-term damage to your customers, reputation or revenue.


Moreover (and in more practical terms), experience has repeatedly taught us that in comparison to the lengthy, stressful and expensive litigation required to resolve a shareholders dispute, taking this extra step at the beginning of your business’ life more than pays for itself should things not quite go to plan.


If you do see the benefit of adding that extra level of security to shield your business from potentially damaging disagreements in the future, what should you be looking for your shareholders agreement to achieve?


Aside from confirming the practicalities (e.g. outlining when your directors’/shareholders’ meetings will be) and demonstrating to your bankers and investors how stable and therefore trustworthy your business is, we’d suggest the main objectives of any shareholders agreement should include:


To provide you with an easier way to resolve future disputes

Once a dispute begins it’s almost impossible to get the parties involved to agree what belongs to who and in what ratio. It is much easier to have the division of assets formalised at the outset so the parties have no means to deviate from what has been agreed and legally documented.


You can also control exactly how disputes are handled by including specific provisions, for example when you would look towards alternative dispute resolution options like mediation or arbitration.


To clearly set out your shareholders’ responsibilities

While a company is generally run by its directors, some decisions will require shareholder approval. The directors’ unwillingness to ask for that approval (especially if some shareholders aren’t directly involved with the business on a day-to-day basis) is a common cause of a shareholders’ dispute.


To help you control your employees’ shareholdings

If shares are held by key employees you may want them to sell back their shares if they were to leave for any reason. A shareholders agreement can limit share ownership to the holder’s employment.


Alternatively, if an employee with shares did want to leave you may want to add restrictions preventing them from setting up in direct competition to your shareholders’ agreement to strengthen similar terms set out by their employment contract.


To protect your shareholders’ interests

Major shareholders may want to have the right to “drag along” other shareholders to make sure they accept any offer they feel would benefit the company. Equally your minority shareholders may want to protect their rights, for example to make sure they’re consulted should the company wish to release additional shareholdings.


Your shareholders’ agreement should also set out which class of shareholder is paid which level of dividend. This is an important consideration as remuneration is another common reason for a shareholder dispute.


Maintain control of the transfer or sale of your shares and assets

If you are to maintain control of your company you need to be able to control how your shares and/or assets are transferred or sold in the future and, by extension, who can and can’t buy shares in your company.


In many cases you may want to ensure your shares remain within a defined group of people, particularly if you want to avoid becoming the unwanted target of investors or a larger acquisitive group.


If that is the case, you may wish to consider adding some form of pre-emption right to your shareholders’ agreement. In simple terms a pre-emption right provides certain parties with first refusal to buy shares should they become available and before they can be offered to a third party.


While most businesses will of course want to maintain control over the transfer or sale of their shares and assets, a pre-emption right is particularly important to the construction and property development sectors. Companies may be formed for a single development and the parties involved will often want to make sure the houses, flats or other property that company builds are only made available to each parties’ preferred buyers. The inclusion of a pre-emptive right will help them do that.


If you would like to discuss how to put a shareholders’ agreement in place to minimise the potentially damaging effects any form of shareholder dispute could have on your business, please call Robina Hussein on 0113 426 00 01 or email Robina at Robina@frontrowlegal.com.