A shareholders’ agreement is a legally binding contract between the shareholders of a company; it regulates the relationship between the shareholders in order to protect the interests of the individual shareholders as and against each other. A shareholder agreement is an essential document for any company to have especially if there is more than one shareholder. It provides protection for the shareholders and establishes a fair relationship between them. Generally a shareholder agreement sets out the rights and obligations of the shareholders, regulates the sale of shares in the company, details how the company is going to be run and how decisions are to be made.
Here are some uses of shareholders’ agreements:
- To give to a shareholder rights which would otherwise be unenforceable if inserted in the company’s Articles e.g. personal rights such as a right to be appointed as a professional adviser to the company.
- To regulate the relationships between shareholders which have nothing to do with the administration of the company, e.g. if one or more shareholders are investing in the company.
- To protect minority shareholders’ rights e.g. by giving them a power of veto which they would not otherwise enjoy under Company Law.
- To preserve confidentiality. Articles of Association are open to public inspection, thus it may be more appropriate in some circumstances to deal with matters in a shareholders’ agreement for reasons of confidentiality.
- To provide a way to transfer shares in the business and help run the business smoothly in the face of future events such as death, disability or retirement of a shareholder. Shareholders’ agreements generally establish a purchaser for the shares of the deceased or existing shareholder, a formula for determining the purchase price of the shares, and a method for funding the purchase.
In the absence of a shareholders’ Agreement any disputes between shareholders will have to be settled by what is contained within the Articles of Association, however the Articles generally do not offer shareholders full protection.
The Articles of Association of a company are the rules governing its internal management and administration. The Articles are governed by Company Law and are binding on all the members of the company. A shareholders’ agreement is an agreement between the members of a private limited company which is governed by the normal law of contract. Some matters covered in a shareholders’ agreement may equally be incorporated in the Articles of Association for example pre-emption rights. However, bearing in mind that the Articles of Association are open to public inspection, it may be more appropriate in some circumstances to deal with matters in a shareholders’ agreement for reasons of confidentiality. Furthermore, shareholders’ agreements are often used to give protection to shareholders because they provide for what happens if ‘things go wrong’, if there is a falling out between the shareholders. Also, a shareholders’ agreement contains detailed provisions to cover specific issues and it gives a contractual remedy if its terms are broken.
There are also some drawbacks with shareholder’s agreements. There may be complications when a member who is signatory to a shareholders’ agreement transfers shares since the new member must agree to be bound by the shareholders’ agreement and the old member released from it. Also Shareholders’ agreements can become unwieldy if the number of shareholders increases substantially.
Clauses commonly included in shareholders’ agreements are:
Provisions covering initial funding and further financing of the company. Warranties and indemnities from existing shareholders to a new shareholder/investor. The appointment of auditors and bankers. Provisions governing the application of funds invested. Provisions governing any personal guarantees given by a shareholder to third parties dealing with the company. Dividend policies. Rights of first refusal in the event of a shareholder wishing to transfer his or her shares (pre-emption rights). Compulsory transfer or option arrangements. Covenants not to compete with the company nor to solicit its customers, suppliers, officers or employees. Undertakings of confidentiality. Provisions for protection of minority shareholders (e.g. rights of veto). Mechanisms for dealing with deadlock.
Please note that this list is not an exhaustive. Shareholders’ agreements can take a variety of forms and can serve a variety of purposes, they can range from the extremely simple to the extremely complicated.
We have a large number of documents including shareholders’ agreements.
Our shareholders agreements are fully comprehensive and contain detailed and practical clauses, including clauses dealing with:
- transfer of shares in the company,
- pre-emption rights on a transfer of shares,
- deadlock which determines how disagreements on key issues are to be resolved,
- drag-along enabling a majority shareholder to force a minority shareholder to join in the sale of a company,
- tag-along protecting the interests of minority shareholders where the majority shareholder is selling out, thus allowing the minority shareholders to jump on the back of the buy-out,
- confidentiality, non-compete, non-solicitation and non-poaching to safeguard the interests of the company.
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All business relationships start out with good intentions, however, they all have the capacity to go horribly wrong. Disputes can arise between shareholders for many reasons and shareholder agreements are supposed to take account of such eventualities.
We strongly recommend that all companies with more than one shareholder enter into a shareholders’ agreement since it provides a piece of mind and lets everyone know where they stand so to avoid costly disputes in the event of a falling out between shareholders. Also, venture capitalists usually require a shareholders’ agreement as a condition of funding.