A Shareholders’ Agreement is a legal contract that sets out the rights of a company’s shareholders and offers protection to each and all of these individuals. Once a company has more than one shareholder it is important to have an agreement like this in place because standard company law may not quite fit a company’s particular circumstances.
The key individuals in a company often rely on the Articles of Association, one of two constitutional documents, to protect their rights but in truth these do not cover shareholders’ rights completely or in every situation. In the absence of a shareholders’ agreement some potential issues that can arise are:
- Removal of a director by half the shareholders passing an ordinary resolution;
- Directors’ versus members’ rights in key areas such as pay, benefits and dividends;
- Significant decisions being made by a majority of directors, overruling individual directors who may be majority shareholders;
- Conflict over the direction of the business;
- Disagreements about the shareholders’ exit strategy;
- Amendment of the Articles of Association stripping away shareholders’ protections by a 75 percent majority of shareholders;
- Deadlock resulting in a failure to resolve disputes that goes on to affect the smooth running of the company.
To avoid these and other issues, a Shareholders’ Agreement is usually put in place to protect all parties. The three most common agreements are:
Designed for companies with both minority and majority shareholders and where new shareholders are joining or the company wishes to change the terms of the existing relationship. These agreements protect the interest of shareholders with less than 50 percent of the company’s issued share capital. Generally, minority shareholders are in a weak position under company law as a simple majority will overrule them in most cases. This is not always appropriate. For example, in cases where an outside investor, such as an angel investor, is involved with the company, this party will often want more rights than standard company law allows. Having a Shareholders’ Agreement – Protection Minority Shareholders in place sets out the rights and duties of the shareholders and covers aspects such as the appointment of directors and how directors’ decisions are made. It also provides for shareholders to be directors, as this is not automatic under company law, and can cover other important aspects such as share transfers, confidentiality clauses, non-compete, non-solicitation and non-poaching clauses.
This legally binding contract protects those with more than 50 percent of the issued share capital in the company and is designed to cater for situations where new shareholders are joining the company or the relationship between shareholders is changing. The agreement covers the key aspects of shareholder rights including share transfers, a drag-along clause (ensuring minority shareholders cannot obstruct a sale of the company), confidentiality, non-compete, non-solicitation and non-poaching clauses.
This type of agreement is extremely useful in cases where two or more shareholders have an equal stake in the company, such as two shareholders each holding 50 percent of the company or three directors holding one-third each, common occurrences when firms are starting out. The Shareholders Agreement – Equal Shareholdings sets out the rights and obligations of all shareholders with respect to share transfers, how to deal with deadlock situations, along with confidentiality, non-compete, non-solicitation and non-poaching clauses.