Do I need a Shareholders’ Agreement?

Monday, April 15th, 2019

Corporate Department

 

The short answer is no. Under UK law, there is extensive legislation that regulates not only the company itself but the relationship between a company, its directors and shareholders. However, if you are going into business (or already are in business) with 1 or more other parties, we would recommend having a shareholders’ agreement in place. We set out below some reasons why.

Share Transfers

There is nothing in UK law preventing a shareholder from transferring their shares to a third party. As a shareholder, you may see this as a positive, however, if your business partner suddenly informs you they have sold their half of the business to someone you do not want to work with, that positive quickly becomes a negative.

The most common way of dealing with this issue is to add provisions in a shareholders’ agreement requiring a selling shareholder to first offer their shares to the remaining shareholders.

Management

Shareholders have surprisingly little say in the day to day running of a limited company, which is, in the main, the responsibility of the board of directors. If there is separation between management and ownership, a shareholders’ agreement can prohibit the directors from making certain key decisions without shareholder approval.

Dividends

It is arguable whether shareholders have the power to declare dividends. If you do not hold a majority at board or shareholder level and you are concerned you will not receive the dividend on your investment that you expected, we would recommend including provisions in a shareholders’ agreement under which a certain percentage of the company’s profits must be distributed to the shareholders each year.

Death, Bankruptcy or Incapacity

On the death of a shareholder, the position at law is that their shares will pass with their estate, whether it be through their will or intestacy. However, it is rarely the case that the surviving shareholders and/or the deceased shareholder’s beneficiaries want to carry on in business together. To prevent this unwanted outcome, a shareholders’ agreement normally provides that a deceased shareholder’s shares will automatically be sold to the surviving shareholders at a pre-agreed value (often the fair value, as determined by an independent expert).

Similar provisions can be added for the circumstance that a shareholder becomes permanently incapacitated or bankrupt, to avoid a family member (acting by power of attorney) or a trustee in bankruptcy from effectively becoming a partner in your business.

These provisions in a shareholders’ agreement are often linked with cross-option insurance policies which pay out to the remaining shareholders on the occurrence of death or incapacity.

Dispute

If a company has an equal number of directors or shareholders with equal shareholding, and those directors/shareholders fall into dispute, it may result in the company being deadlocked. Although the company will continue to trade, the decisions required to run the business successfully cannot be passed as there is no majority for them.

There are a number of different provisions that can be added to a shareholders’ agreement to break the deadlock, such as giving one of the directors/shareholders a casting vote or weighted voting rights, referring the matter to an independent third party or, if the relationship between shareholders is beyond resolution, a mechanism can be incorporated that allows one party to buy out the other for a fair price.

Minority Protection

If you have a minority shareholding or are outnumbered at board level, it is paramount that you protect your interest through a shareholders’ agreement. This is dealt with by adding a list of reserved matters that the majority shareholders/board cannot pass without your say so. Common examples of matters a minority will want veto power over include the ability of the company to issue new shares and the power to put the company into liquidation.

Majority Protection

The situation may arise where a majority shareholder wishes to sell the business but, as is common, the proposed buyer only wants to proceed if they can purchase 100% of the business. If you have a minority shareholder refusing to sell their share of the business, it could frustrate the deal.  Without a shareholders’ agreement, a minority shareholder could suddenly have a lot of power over the majority.

With a shareholders’ agreement, provisions can be included that give majority shareholders the power (in the event of a potential sale of the whole business to a third party) to force the minority shareholders to sell their shares to the same third party at the same price per share.

If you want help with a shareholders’ agreement please call a member of our corporate team on 0207 228 0017.