Matt Worsnop (Associate Solicitor at BHW Solicitors in Leicester) sets out below some common questions and answers in respect of shareholders agreements. For more information or advice, please contact Matt on 0116 281 6235 or by email at matt@bhwsolicitors.com.
What is a Shareholders Agreement?
A shareholders agreement is an agreement between the shareholders of a company, setting out detailed rules in respect of various matters, including:
- the management of the business;
- the financing and re-financing of the business;
- the constitution of the company’s board;
- the sale and transfer of shares;
- the payment of dividends;
- the conduct of shareholders; and
- the protection of the shareholders’ investment in the company.
Why do we need a Shareholders Agreement?
Without a shareholders agreement, the shareholders in your company will have to rely solely on the provisions in the Companies Act 2006, the company’s Articles of Association and general common law, which may not provide the outcomes that the shareholders want.
Why can’t we just amend our Articles of Association instead of having a Shareholders Agreement?
You can! Many (though not all) of the provisions commonly found in a shareholders agreement can instead be incorporated into your company’s Articles of Association.
However, you should bear in mind that the Articles of Association are a public document, available for download from Companies House to anyone who wishes to see them. If you wish to keep the agreement between your shareholders confidential, then you will need to put in place a separate agreement.
Our shareholders work closely together and get on very well. Surely we don’t need an agreement?
The most difficult (and costly) disputes tend to arise between shareholders where there is no overall control and no shareholders agreement (often because the shareholders were originally all friends or long-standing colleagues and didn’t consider a written agreement necessary).
Putting in place a shareholders agreement now (when you are all getting on so well) is far easier than trying to negotiate one in the future at a time when relations between the shareholders might have become strained.
We want to ensure that the company’s shares stay with the existing shareholders. Can a shareholders agreement help with this?
Your shareholders agreement can contain an outright restriction on any of you selling your shares. Alternatively (and perhaps more commonly) it can provide for a right of first refusal for the other shareholders.
You can also include provisions requiring a shareholder to transfer his shares in certain circumstances. Common circumstances include a shareholder’s death, bankruptcy, material breach of the terms of the agreement or (where relevant) ceasing to be a director/shareholder of the company.
How do we ensure we can agree a value for a shareholder’s shares if he wants to sell them?
If the shareholders cannot agree on the value of a leaving shareholder’s shares (or if a shareholder is required to sell his shares through death, bankruptcy etc) you’ll need a way of determining their fair value.
There are generally two different ways of valuing shares. The first method is simply to appoint an independent valuer (usually a firm of accountants) who will value the shares according to market conditions, the performance of the business and the guidelines set down in the agreement.
The second method is to include a precise formula in the agreement, usually calculated as a multiple of average adjusted profits over the last few years, and scaled proportionately to the number of shares being sold. This provides certainty for the shareholders but if the company has suffered an unexpected downturn since the last accounts were prepared, the value produced might be unrealistically high.
How do we ensure we can afford to buy a shareholder’s shares if he dies?
Your agreement might state that the other shareholders have the right to buy a shareholder’s shares if he dies. But what if the other shareholders cannot afford the fair value of the shares?
You can protect yourselves by putting in place special life assurance policies that name the other shareholders as potential beneficiaries. Your shareholders agreement can then specify that the shareholders must use this money to purchase the deceased shareholder’s shares from his family/executors. The end result is that the family receives the money while the shareholders get back the shares.
What happens if someone wants to buy our company but not all shareholders want to sell?
Without a shareholders agreement, your options are quite limited. If 90% of the shareholders support the offer then you may be able to rely on the Companies Act to force the remainder to sell, but this depends upon the offer being structured in a way that meets the Companies Act requirements.
Your shareholders agreement can specify that, provided a certain percentage (or perhaps certain named individuals) accept the offer, then the remaining shareholders must agree to sell their shares.
What happens if the shareholders and/or directors are deadlocked on a fundamental decision (i.e. because exactly half are in favour and half are against)?
This is a common cause of disputes in companies where there is no shareholders agreement, particularly where the shareholders have different views on the future direction the company should take.
You can agree that the chair of any meeting has a casting vote but this is quite arbitrary and unfair.
Instead, your shareholders agreement can allow any shareholder to refer a disputed matter to a third party expert to resolve the matter in the best interests of the company.
Of course, no shareholder wants an outsider telling him how to run his company and the shareholders will be keen to avoid the costs of the independent expert. However, having these provisions in your shareholders agreement is very useful because they may make you more likely to reach a negotiated agreement between yourselves, to avoid any shareholder appointing a third party umpire.
Can we agree in advance what dividend payments we should make?
You don’t need to include any reference to dividend payments in your shareholders agreement, in which case the directors will (in general) recommend the level of dividend to be paid.
However, to avoid disputes in the future, you might want to agree that either a specific amount of profits will be retained each year for working capital (with the rest paid out as dividend) or that a specific amount or percentage of profits will be paid as dividend each year.
What if I’m outvoted by the other shareholders on something that could fundamentally affect my investment in the company?
Without a shareholders agreement you don’t generally have any protection, provided the decision in question isn’t being taken simply to prejudice you.
However, you can include in your shareholders agreement a list of key actions and decisions which can only be taken if all of the shareholders (or perhaps a certain proportion of shareholders) agree. These can cover all manner of decisions and often include matters such as dilution of share capital, selling off key parts of the business, entering into high value capital expenditure transactions or commencing risky litigation.
In my company, I’m the only shareholder but I’m selling/gifting a small amount of shares to a loyal employee? I don’t need a shareholders agreement do I?
If you are remaining firmly in control of your company (through both the board and shareholder control) then you certainly won’t need all of the detailed provisions referred to above.
However you should still put in place a shareholders agreement to ensure that your employee cannot transfer his shares without offering them to you and that he can’t do anything with his minority shareholding that could hinder your future plans (e.g. block a sale of the entire company). You’ll also normally want to ensure you can get back the shares if the employee leaves the business or is guilty of misconduct.
You’ll also need to get tax advice on the implications of gifting shares to employees and you may want to consider alternative incentivisation options such as an HMRC-approved Enterprise Management Incentive (EMI) scheme.