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Why is a Shareholders’ Agreement essential for your start-up company?

Have you just incorporated your new start-up company with two or more shareholders? Maybe you have been advised to regulate the business relationships between shareholders of the company? Perhaps you are considering why you should invest your time and money into drafting a Shareholders’ Agreement at all? In this article we will cover all of this and more by answering the following questions: 

The importance of having a Shareholders’ Agreement is often underestimated. A common misconception is that nothing will go wrong in the future and if it does, then it can be easily resolved. However, from our experience, as a business grows, shareholders may fall out. This could lead to unforeseen conflicts and jeopardise your company. The absence of a Shareholders’ Agreement can potentially cause disputes and misunderstandings amongst the shareholders of the company. It is best to put a Shareholders’ Agreement in place when the company is formed so that there is common understanding of shareholders’ expectations of the business.

What is a Shareholders’ Agreement?

A Shareholders’ Agreement is an agreement between the shareholders of a company. Its main purpose is to protect the shareholders’ investment within the company, while maintaining and protecting relationships between the shareholders. The agreement contains specific provisions that set out the shareholders’ rights and obligations, regulates the sale and transfer of shares, describes how the company is going to be run and sets out how important decisions are to be made.

This document is highly confidential and is generally not required to be filed at Companies House, unlike the Articles of Association.

Why do you need a Shareholders’ Agreement?

Deciding to draft such an agreement while starting your new business can be the least of your priorities, as it means setting aside time and money to consult a lawyer, especially when there is no legal requirement to have a formal Shareholders’ Agreement. However, shareholders in a company can fall out with each other. Therefore, shareholders should consider having a clear and concise agreement in place prior to any trading, for the following reasons:

Disputes and Deadlock

Every shareholder starts off with having the company’s best interests in mind. However, in the course of running a business, disagreements between shareholders may arise and can often result in disputes. Disputes are costly and time consuming, putting the company’s success at stake, while also lowering the morale of not only other shareholders within the company but the workforce too. Having a well-drafted Shareholders’ Agreement in place can increases the chances of resolving a dispute as it sets out the obligations and rights of the shareholders, as well as provisions on how to resolve conflicts, such as a deadlock clause.

Deadlocks usually occur when shareholders have a major dispute related to the management of a business and where every shareholder holds equal shares within the company and there are no majority shareholders. Therefore, a Shareholders’ Agreement usually contains a ‘deadlock clause’, which sets out a procedure for shareholders to follow when there is a dispute. Common examples of this can be an Arbitration deadlock clause, Fairest deadlock clause and Russian roulette deadlock clause - these clauses provide protection to the company and all its shareholders.

Investor Protection

Investor protection is very important for any company. The Shareholders’ Agreement sets out how a shareholder can sell and buy their shares, through the use of formal provisions. These provisions also set out the price at which shares are sold between shareholders, e.g. shareholders can only sell their shares at a price that has been determined by an independent valuer or shares must first be offered to the existing shareholders before they are offered to non-shareholders and the conditions under which this can be done. If these provisions did not exist, then the shares could be available for anyone to purchase, including competitors. Not only would this affect the company, but it would also harm the shareholders. Thus, in order to protect the investment and all shareholders, the agreement should set out specific criteria that investors should meet before purchasing any shares.

What should the Shareholders’ Agreement include?

A good Shareholders’ Agreement should:

Be bespoke and tailored

The agreement should be tailored to your company’s and shareholders’ needs. It is important that you ensure that all unique requirements of the shareholders are contained in this agreement in order to avoid any future problems within the company. Each shareholder should be required to sign the agreement.

Contain protective clauses

Important clauses to include are:

- Matters requiring consent;

- Dividends;

- Board of Directors;

- Deadlock clause;

- Share transfers;

- Issue of new shares;

- Restrictive covenants;

- Quorum for board meetings, etc.

Mechanisms to resolve breaches

The agreement should incorporate the remedies available to the company and other shareholders if there is a breach of the Shareholders’ Agreement.

What do shareholders fail to include in a Shareholders’ Agreement?

The following are key provisions that some businesses fail to include in their Shareholders’ Agreement. These are important provisions that every business should consider when drafting their Shareholders’ Agreement:

· Company resolutions and the percentage of votes required;

· A deadlock provision;

· A workable termination clause;

· Death sale options;

· Share price valuation methods

How can Pure Business Law help?

We are specialist Shareholders’ Agreement Solicitors based in Bedford and operating nationally. We draft Shareholders’ Agreements and we deal with the resolution of Shareholder Agreement issues and disputes.

If you would like to discuss the preparation of a Shareholders Agreement for your business, any issues or disputes concerning your Shareholders’ Agreement or anything raised in this article please contact us and speak with one of our solicitors. Pure Business Law is regulated by the Solicitors Regulation Authority and is a licensed member of the Law Society of England & Wales.

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