14 Jun 10 Reasons Your Business Needs a Shareholders’ Agreement
When starting a company with more than one shareholder, it is advisable to make a Shareholders’ Agreement. This is a good way to further regulate the way shareholders conduct business between them. Like all relationships, business relationships start out with the best intentions. Usually all the directors and shareholders are on the same page and share the same longterm goals.
Things happen, circumstances change and any one of the shareholders could change their view. So, you need a set of rules that indicate how to sort out any differences and ensure everyone comes out on top. However, having a shareholders’ agreement it is not a legal requirement. Why should you invest your time and money in drafting an agreement? There are at least 10 reasons:
1. Link shareholdings to directorship and employment
It is common for directors or key employees of the business to hold shares. If they were to resign or leave for whatever reason, you would more than likely want them to sell their shares. Otherwise, they could remain entitled to receive dividends after they leave the business.
A shareholders’ agreement can provide a mechanism whereby a person’s shareholding is linked to their employment. So, if they were to leave, they must offer their shares up for sale. Otherwise, there is no requirement for them to sell their shares if they cease to be employed by the business. You can include different valuation methods in the agreement, depending on the reasons for seizing the relationship with the company.
2. To regulate the management of the company
Usually, the company is run by the directors, but sometimes, there are decisions that require shareholders approval. A shareholders’ agreement can ensure that the directors work for the best interest of the company and its shareholders, and don’t overstep the mark.
3. Shareholders can, and do, fall out
At the beginning, it is often difficult to foresee a scenario in which the business partners would fall out. However, unfortunately disagreements can occur. Trying to agree the provisions that should apply if you fall out when you have already fallen out is almost impossible. The solicitors are usually the winners in situations like this.
It is easier to formalise which approach to take should the relationship turn sour, in a shareholders’ agreement, at the outset. Otherwise, it can become both personal, and costly.
4. Minority shareholders need protection
A shareholders’ agreement can provide protection for minority shareholders, ensuring they are included in major decisions such as issuing further shares. Otherwise, someone could own 10% one minute, and be diluted to 1% in the next, if new shares are issued.
5. Majority shareholders ALSO need protection!
“Drag along” provisions would usually operate where an offer is received to buy all of the shares in a company and the majority shareholders wish to accept that offer. This ensures that other minority shareholders are forced to sell (on the same terms), and not prevent the sale.
6. Competition restrictions
If a shareholder wishes to exit the company, the remaining shareholders may want to apply restrictions. These restrictions are usually aimed at the exiting shareholders’ ability to set up or work in a competing business. They can be stricter than then ones in an employment contract, and can be extremely valuable in protecting the interests of the company.
7. Customised dividend policy
A shareholders’ agreement can set out a customised dividend policy which allows different dividends to be payable to different types of shares. For example, you could have invested shares, as well as director shares, so directors could have different dividend rates to non-director shareholders
8. Dispute resolution
It may be that a dispute between shareholders is not terminal. However, if disputes do occur, you still need to have a method in place, to resolve those differences.
9. Control the transfer of shares
You wouldn’t want your company shares falling into the wrong hands. A shareholders agreement can control who can buy shares, by giving the existing shareholders “first preference”. This is also known as”right of first refusal” over shares. This can be very useful as it prevents getting into business with competitors, or someone you would rather not partner with. After all, you have gone into business with your business partner for a reason.
10. Business stability
Having a shareholders’ agreement is proof that you have planned ahead. If you have one, your company will look more appealing to banks, future investors and creditors.
These are just a few of the reasons it’s important to have a shareholders’ agreement in your armoury. You should review any agreement periodically to check that it still operates in the way the company and shareholders wish. Don’t forget to update and re-execute the agreement as shareholders come and go. As a Shareholders’ Agreement is a private document, there is
generally no requirement to file it at Companies House. This means you can keep the content confidential, and share it between the company shareholders only.
Source: Ashtons Legal
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Alan Davidson is a Chartered Accountant, director and founder of Pentins Business Advisers, entrepreneur and author of the Amazon best-seller “Achieve Your Business Vision”. With over 25 years of helping businesses succeed, Alan knows how to build a business with real value, while avoiding costly mistakes.