Starting a new business can be an incredibly exciting time for any shareholder and in the rush to get things up and running, it is easy it avoid contemplating some of the less positive ‘what ifs?’.
Consequently, by paying a limited degree of attention upfront to what might occur should the relationship turn sour, shareholders risk losing out on an opportunity to secure the long-term future and stability of the business.
Indeed, there remains a perception that having a shareholders’ agreement can be an indication of mistrust at the outset, yet this simply may not be the case. By ironing out potential future issues from the start, a shareholders’ agreement can hopefully pave the way for a smooth and prosperous road ahead.
The shareholders’ agreement – what is it?
Shareholders’ agreements regulate the relationship between shareholders within a company and set out the various aspects of their dealings within a private document.
As a smart business tool, such agreements offer a flexible way of recording matters and setting certain parameters which can cover a diverse range of issues, including the following:
- business succession;
- long term strategy;
- financing; and
- management in an efficient manner.
Even if you, as shareholders, get along now, there may be later changes to the business which affect your relationship. Similarly, as an investor you should consider how you intend to exit the business well in advance of actually investing into it.
A properly drafted shareholders’ agreement will provide an exit mechanism that will be invaluable when the right time comes for you to part ways with the business and exit.
What should a Shareholders’ agreements contain?
Through an open dialogue, shareholders should discuss the provisions that they may wish to include within the shareholders’ agreement.
A shareholders’ agreement will typically contain provisions relating to an organised exit of a shareholder at a prescribed fair price.
If a dissatisfied party wishes to leave, negotiating such a mechanism in advance will save costs and reduce the chances of any dispute arising once relationships become strained.
A deadlock provision is another particularly useful provision for start-ups and small businesses, where for instance you might hold a 50 per cent shareholding in the business.
By incorporating a deadlock breaking mechanism or an exit at fair price for one of the parties, this ensures that you can obtain a clean break, which might come into play, should there be continuing disagreement between you and the other shareholder(s).
In the knowledge that disputes arise, it is important for shareholders and directors to consider the best approach to take in steering the parties through a breakup without destroying the business in the process.
Where the business is managed on a day to day basis by its board of directors, a list of reserved matters could be further included under the shareholders agreement.
Such a list will cover those key decisions that are required to be approved in advance by a special majority of shareholders (this could be a unanimity requirement depending on the number of shareholders in existence, but typically some percentage greater than 50 per cent).
Reserved matters might also include decisions relating to, any significant capital expenditure, acquisitions or disposals, the granting of security and any alterations to share capital or the company’s Articles.
What does this mean for both minority and majority shareholders?
As a shareholder acquiring a minority shareholding in the business, you may wish to widen the ambit of reserved matters, while carefully considering some of the other common sticking points that could emerge. This provides an excellent way to protect you as a smaller shareholder by conferring powers to:
- appoint or remove directors;
- agree a favourable dividend policy; or
- have access to information which otherwise you wouldn’t necessarily have.
For majority shareholders, a shareholders agreement can provide you with suitable protections from an intransigent minority; a problem which many majority shareholders face within a small business.
In addition to having to resolve other differences, such agreements can also deal with fundamental ownership issues, such as interest from a potential buyer.
In anticipation of any future offer to buy your business, the inclusion of drag along provisions could be advantageous; ensuring that you as the majority shareholder can force the minority to sell their interest in the company, provided that certain conditions are met.
Tackling this somewhat emotive issue, before it becomes ‘live’ can be of significant value – saving the shareholders of a small business both heartache and financial resources in the long run.
What can be included in the company’s Articles and why it is better suited?
Entering into a shareholders’ agreement might result in some crossover with issues that are dealt with in your Articles of Association.
As a safeguard against conflicts between these two documents, it is common to include a prevailing terms clause within the shareholders agreement to provide that the shareholders agreement prevails over the provisions of the Articles.
Typically, shareholders will agree to amend the Articles as necessary to eliminate conflicts and ensure that the Articles match the obligations imposed under the shareholders agreement.
Notwithstanding the above, there may be provisions that are better suited to, and thus warrant their inclusion within a company’s Articles of Association, rather than a shareholders agreement.
For instance, the respective rights attached to separate classes of shares are usually included in the Articles. This might be to provide for a situation where consent of a class or class of shareholders is required in order to make a particular decision binding on the company.
Further provisions which are arguably more suited to the Articles include:
- Notice and proceedings at shareholder and director meetings (including quorum and voting);
- Certain economic rights which, for tax reasons, are better included within the inherent rights of shares; rather as personal rights conferred on shareholders; and
- Procedures for the issue and transfer of shares (including pre-emption rights and restrictions on transfer)
A well-crafted shareholders agreement can contain the most effective means of resolving disputes quickly.
Through preventing the business from being derailed by conflicts, a shareholders agreement can go a considerable way towards managing the expectations of shareholders, demonstrating its overall versatility, particularly for SMEs or start-up businesses.
Aaron Fermahan is on the corporate team at Wright Hassall LLP.
Further reading on shareholders’ agreements