Shareholder Agreements – What’s the Point?
A Shareholder Agreement is a bit like a pre nuptial marriage agreement – they are not always easy to put together especially as they sometimes deal with slightly awkward issues - but if your relationship with a co-shareholder breaks down, you will be very pleased that you have one. Of course, if you enjoy a long, happy and prosperous business relationship you may never miss not having one. A client said to me recently that, before a deal goes through, the parties are only ‘dating’ – smiling and saying all the right things to each other - but once the contract is signed and the ‘knot is tied’, the honeymoon period will end and the relationship is bound to develop (for better or worse). I suppose that has a bit of a cynical ring to it, but I am a lawyer after all so you shouldn’t expect anything better!
It's best to start from the beginning, of course, with a reminder as to the nature of any shareholding in a company. As most will understand, company ownership is expressed through the ownership of a company’s share capital, which can be comprised of a single share or of many shares. Where a company has more than one share, those can be made up of a single type (or share class) or of several different types (ordinary shares, preference shares, etc.). In all cases, shares are simply a bundle of rights, to which the shareholder is entitled – such as the right to share in the profits and to vote on certain company issues - coupled with the obligation to pay for the shares.
Many of these rights are recorded in a company’s ‘Articles of Association’ (or ‘Articles’) which is a document that every company in England and Wales must have. So what is the point in having a shareholders agreement?
To begin with it is only relevant if there are two or more separate shareholders – there’s not much point having an agreement with yourself! The nature of a Shareholder Agreement is that of a private contract between individuals, compared to the Articles which is a bit like the Company’s basic ‘rule book’ or ‘constitution’ and must be filed at Companies House for anyone to see. It is therefore more acceptable to many to record private or commercially sensitive arrangements in a Shareholder Agreement. Its also important to remember that the Articles can be changed by ‘special resolution’ of the shareholders (i.e. by those holding at least 75% of the voting shares) and, therefore, any key rights enjoyed by minority shareholders are vulnerable to be lost unless protected.
Many companies will by default have a standard set of Articles, as provided for under law, commonly referred to as ‘Table A’. These are often a very good foundation to base even bespoke Articles on, but at the same time they will tend to lack certain key provisions which many shareholders will usually regard as desirable.
The most desirable of all is the ability to control who can own the shares in a company. In most owner managed businesses, co-owners will not usually want fellow owners being free to transfer their shares at will (especially to competitors). Very often, share ownership is seen to go ‘hand in hand’ with the holder performing a job in the business and, where a person chooses or is forced to leave, the remaining shareholders will normally expect to be able to purchase the shares of the departing member. Neither company law nor Table A articles restrict any shareholder from selling their shares to anyone they choose or retaining their shares should they leave the company’s employment. Shareholder Agreements and bespoke Articles will typically include detailed restrictions on a shareholder being able to sell their shares and rules forcing shareholders to sell their shares in certain specified circumstances (for example, if they leave the company’s employment or on death).
Decision making is a key issue for shareholders. The default position is generally that the majority will control the company, but this is not always acceptable to minority shareholders who may expect a level of control in relation to very key decisions a company may make from time to time.
Shareholder Agreements will sometimes tackle the potentially sensitive issue of extracting profits from the company, particularly by dividends. After all, people are usually in business to make profits and extracting those, and deciding how they should be divided between shareholders, is not always a straightforward matter. The approach taken can be very much subject to tax advice and care is often required when creating different share classes which carry different rights to dividends.
At the end of a long and successful business career, many owners dream of selling their business and sailing off into the sunset, but there are dangers where the co-owners exact aspirations and timetables are not the same. Anyone purchasing a company will typically only buy 100% of the shares and, so, majority controlling shareholders can easily find themselves trapped by minority shareholders who may not agree with a sale process and are either unable or unwilling to fund a management buy out. Both Articles and Shareholder Agreements can include provisions to help avoid this situation and put the majority in control of any sale process.
Shareholder Agreements are not all made equal. It is true that many professionally prepared documents will contain similar themes and provisions, but they will only ever work properly if the shareholders who sign them have thought through the issues properly and prepared an agreement which suits their requirements and desired outcomes. We do see from time to time, very simple Shareholder Agreements, which probably seem fine to the untrained eye; but unfortunately, simplicity can often be synonymous with ‘inadequate’. Like most things in life, if you are going to go to the trouble of getting an agreement, do it properly or you will probably find that you are just wasting your time and money.
Its important to remember that Shareholder Agreements will deal only with shareholder related matters. Terms of employment for owner managers (duties, hours of work, holidays, sick pay, salary, benefits, etc.) should often be considered in conjunction with preparing Shareholder Agreements. Perhaps the most common issue which co-owners will fall out about is the perception of some that certain others do not work as hard as them yet take an unfair proportion of the profits. Disputes of this nature can be difficult to resolve, especially if the relevant parties never agreed what they expected of each other in terms of duties, hours of work, holiday, sick pay, etc. Without that benchmark in the form of an employment contract or, at the very least, a written ‘statement of employment particulars’, it can be difficult to advise on whether owner managers have fulfilled their legal obligations or not. So many shareholder disputes will arise from performance disputes and the approach to resolving them will usually demand close attention to employment law, any shareholder agreement in place as well as general company law. In reality, the solution to most disputes is for parties to go their own way and a Shareholder Agreement can include rules for helping to determine how that happens.
So, what is the point in having a Shareholder Agreement, or bespoke Articles of Association (or both)? The answer is, broadly, that they are a good thing to have to help fill in the gaps which a ‘standard set up’ usually contains, but, inevitably, the barrier for many is the time and cost of putting these in place. I occasionally hear clients telling me that they need to ‘trust’ the ‘other party’ and the ‘t’ word is sometimes used as a justification for not tackling the difficult issues. If you are going to invest money into a business or pour your heart and soul into developing it, putting in place an agreement to help protect your personal financial interests is not such a bad idea!
Michael Crook, Solicitor