When setting up a business, business owners do not usually think about what could go wrong within that business. At the beginning of any start-up, everyone involved will have great expectations about their business idea and will often be completely convinced that it will be a great success.
At this stage, many business owners forget or do not consider that it is important to apply prevention measures to solve any complicated situations that could arise in the future. Since as many as 8 out of 10 companies fail within the first year, according to statistics, it is highly important to implement the correct business processes with formal written agreements. A bespoke set of well-written terms and conditions is an absolute must for any start-up or business wishing to grow. It is also absolutely fundamental for any business where there is more than one shareholder/director/business owner that you have an agreement in place for this.
Think of it as a will for your business
If you are entering into business with a friend or a family member, you may assume that you can trust one another and that it’s unthinkable to imagine that anything could make you fall out. However, things do go wrong and you could end up with nothing and a failing business because parties just cannot agree.
Although the company’s articles of association and company law will help to some extent, a fully considered and well-written shareholders’ agreement will act as a safeguard and will give shareholders more protection against scenarios that are quite possibly unthinkable when you start out.
You may never need to rely on it. However, there will be many more cases where shareholders wish that they had taken the time to put a proper agreement in place and prevent the problems that arose in their business.
If you want to be positive about your future relationships with the other shareholders and want to protect both the business and your own investment in the company then a shareholders’ agreement is crucial.
Other reasons why you need a shareholders’ agreement
In addition to protecting your business from disputes among shareholders, a shareholders’ agreement can help you in many ways.
Restrictive covenants
Shareholders’ agreements usually have restrictive covenants designed to protect the company if and when one of the shareholders leaves the business. For example, restrictive covenants prevent an outgoing shareholder from joining a competitor and taking key clients with them.
Restrictive covenants in a shareholders’ agreement can also be very useful if an outgoing shareholder wants to take some employees with them upon their exit. The reason for this is that, compared to an employment contract, they are much easier to enforce and implement. As a result, they can help deter a former shareholder from resorting to employee piracy.
Building relationships with partners and shareholders
Not only is it a useful tool for dispute resolution but a shareholders’ agreement also promotes goodwill and better relationships among the shareholders. The process of discussing the contents of the agreement with your partners itself allows you to openly talk about matters that you might otherwise have been reluctant to.
Also, knowing that you all are ‘on the same page’ regarding important business matters gives everyone confidence and the assurance that, if and when a conflict arises, a fair and just resolution can be found.
Shareholders’ consent and making decisions
Disputes and disagreements often occur when shareholders have different views regarding the path the business should take. Having a shareholders’ agreement in place can help prevent such situations by restricting what shareholders can do without seeking consent. For example, provisions can be made to prevent shareholders from altering the name or nature of the business, hiring more employees or changing accountants and auditors without the knowledge and approval of other shareholders.
A shareholders’ agreement can also help dissuade directors and shareholders from taking actions that could damage the company in the future. For example, you can include terms in the agreement detailing what the consequences would be for the individual who breaches it.
Sales and transfer of shares
Without specific restrictions in place, company shares could be sold to individuals who might be not related to the business or even to a competitor. When ‘outsiders’ join the company, it may cause anxiety amongst the original shareholders and can even cause problems that could significantly affect the business. Fortunately, this is something that a shareholders’ agreement can address.
Provisions can be made to determine how shares can be sold, bought or transferred. For example, terms can be included to prevent an outgoing shareholder from selling shares to third parties without making the same offer to existing shareholders first. By placing clear restrictions on the sales, purchase and transfer of shares, disputes and rogue shareholders can be avoided.
Distribution of profits
A shareholders’ agreement helps determine how company profits are distributed among shareholders. Depending on what you and your partners/shareholders have agreed on, payments can be in the form of wages, bonuses, management fees and dividends.
The agreement can also determine how often company profits are distributed. Furthermore, it identifies who must approve the payment distribution and can even require directors to seek professional tax advice every year.
Managing the company’s day-to-day operations
One of the most important purposes of a shareholders’ agreement is to determine how the company is run and managed. It details shareholder duties and responsibilities and lays out the procedures for choosing directors and managers. The agreement may also include provisions on the mechanism for hiring key employees, seeking out new business ventures and making major purchases among many other important business matters.
Boosting investor confidence
Having a shareholders’ agreement in place is an indication of a strong and stable company. Because of this, it helps bolster investor confidence.
Investors are taking a huge risk when they invest in your company because there is no guarantee that they will recover the money they have spent on your business. This is why measures should be taken to assure them of your company’s stability so that they will continue investing.
A shareholders’ agreement can contain provisions designed to protect the interest of investors. For example, investors can require your business to meet certain goals within a specific time period. If those goals are not met within that period, they can force company management to take the necessary steps or, in some instances, even take control of the company themselves.
What your shareholders’ agreement should do
To ensure optimum protection for your business, your shareholders’ agreement must be drafted carefully. The agreement should:
- Set out the shareholders’ rights and obligations.
- Regulate the sale of shares in the company should a shareholder wish to leave.
- Describe how the company is going to be run: Who are the directors? Do some shareholders have more control than others?
- Provide an element of protection for minority shareholders and the company.
- Define how important decisions are to be made.
- Explain how dividends are paid.
- Explain any restrictions placed on the shareholders.
The agreement should contain specific, important and practical rules relating to the company and the relationship between the shareholders and/or directors. This can be beneficial for all shareholders whether they hold minority or majority shares.
Is it different from the articles of association?
A shareholders’ agreement is a private contract between the shareholders of a company. It details the rules by which the company is run and owned. The articles of association, on the other hand, outline the responsibilities of the board of directors and the types of business the company can undertake. It also defines how the shareholders govern the board of directors.
Another key difference between a shareholders’ agreement and the articles of association is that the former is not mandatory but the articles of association are. A limited company is required to have them when incorporating. However, although having a shareholders’ agreement is not legally required, it provides far more protection for your business than the articles of association.
When should you draft a shareholders’ agreement?
It is best to put a shareholders’ agreement in place when the company is first formed and the first shares are issued. Look at it as a positive exercise to ensure there is a ‘meeting of the minds’ of the shareholders’ expectations of the business. Be clear on the differences of opinion between the investors at this stage. If they are too different and a shareholders’ agreement cannot be agreed on, then this is a warning sign before the business has even started to grow.
However, it is never too late to put a shareholders’ agreement in place. Perhaps the business is well established and has a new investor coming on board. Loan agreements can be attached to shareholders’ agreements too should the investor be loaning money to that business. Potentially, the business has grown in such a way that each shareholder is taking on a different role and these need to be stipulated in an agreement.
Conclusion
A shareholders’ agreement protects your business in many ways. Not only does it help with dispute resolution but it also informs shareholders of their rights and expectations. This is why you should prioritise drafting one as you build your company.
At BEB, we can draft your shareholders’ agreement for an affordable price while ‘decoding’ all the legal jargon so that each shareholder understands exactly what each clause means.