Shareholders’ AgreementsGoing into business with someone is one of the most exciting things that you can do. The world is your oyster – you have a great idea, have spotted the gap in the market, your partner is the perfect complement to you and the sky is the limit. Things are going to go absolutely brilliantly and you and your business partner have been friends for ages – what could possibly go wrong?

Unfortunately, life and business are not so simple. The trials and tribulations of business life cause frictions, even in the most secure of business relationships. Worries about sales, cash-flow and just paying the bills can have a corrosive effect on a work relationship. Once this sours, it can mean that every problem or irritant becomes magnified out of proportion, which can eventually destroy both the relationship and the business.

However, no one thinks it will happen to them. Just as ever marriage starts out with chirping birds and not a thought of divorce, so every business relationship starts with an expectation that the path will be smooth and that the relationship can survive anything.

A shareholders’ agreement can actually help with that. By setting out the parties’ expectations upfront and dealing with things like what will happen if they wish to split apart, a shareholders’ agreement can take some of the heat out of a disagreement and prevent the relationship suffering a permanent breach. This means that the parties can still work together to make the business a success, despite any personal disagreements.

What are shareholders’ agreements?

A shareholders’ agreement is exactly what it says on the tin. It is an agreement between shareholders as to how that relationship is going to work. It can be a simple or as complicated as it needs to be.

Shareholders’ agreements are used where the business structure being used is a company limited by shares. Similar agreements can also be put in place for partnerships and limited liability partnership, which have the same goal, but these are structured in slightly different ways to deal with the difference in the business structure.

What does a shareholders’ agreement contain?

A shareholders’ agreement is broadly divided into two sections. The first deals with how the business is going to be managed. The second section deals with what happens if one party wants (or is required) to exit the business.

Management

This sections sets broad limits for how the company is going to be managed. It will cover things like:

  • How many directors the company will have and whether all the shareholders are entitled to be or appoint a director.
  • How often the directors will hold a formal board meeting.
  • What decisions of the company (if any) must be agreed by all or a majority of the shareholders.

Decision making of the company is a key part of this section. Generally, the shareholders have very little influence on how the business is run on a day to day basis. This is preserve of the directors and directors make their decisions by majority decisions. Imagine a situation where either not all of the shareholders are also directors of the company or where there are three shareholders who are also directors. In both cases, major decisions of the company could be taken even if one shareholder does not agree with them. This could include large capital expenditure, buying or selling property, granting charges over the company’s assets, taking on employees (and deciding their salary) or even ceasing trading.

Using a shareholders’ agreement, the shareholders can set limits to what can be done with the company in which they have all invested without all (or a certain proportion) of them giving their consent.

What this does is set expectations as to what decisions will be the subject to discussion and debate before they are undertaken. This will set up an obligation to communicate, which will often mean that no just the subjects which are set out in the shareholders’ agreement are discussed, but all matters relating to the business.

The management section is also one of the key reasons why shareholders’ agreements should be reviewed on a regular basis. As a company grows, some of the limits and items which are detailed in the shareholders’ agreement may become too restrictive and may need to be reset or replaced to ensure that the directors are using their time in the most productive manner (rather than having to review, discuss and agree on every little decision being made).

Issuing of shares

One issue which falls within the management section of a shareholders’ agreement is what happens when a company wants to issue more shares, normally in order to raise additional funds. The issue of further shares dilute the existing shares, so can significantly change the balance of power within a company depending on who they are issued to.

Shareholders will normally be quite keen to ensure that in the case of any such proposed issue, the shares are offered to them first, to ensure that the proportion of shares that they hold in the company is maintained. If they do not want to (or cannot) participate in the share issues, they will normally want to ensure that they can at least have a say in who those shares are going to be issued to.

Exit

When most people think of a shareholders’ agreement, this is the section that they tend to focus on. Shareholders’ agreements are generally thought of as documents to look at when things go wrong, which is true to a certain extent. This section is generally of most importance when things have gone wrong and one party wants to leave or the others want to get rid of him.

Types of Exit

Exits are generally divided into two types; voluntary and involuntary. A voluntary exit is where one party decides, for whatever reason, that he wants to leave the business. This could be for retirement, family reasons or because he just wants to leave. In this case, the exiting shareholder makes the decision and triggers off the process. In an involuntary exit, the exiting shareholder does not make the decision. It is either made for him (in the case of an expulsion) or is triggered by an event such a death, critical illness or bankruptcy.

Voluntary Exit

The usual structure for a voluntary exit is that the exiting shareholder gives a notice to the company that he wants to leave. The company then informs the other shareholders that the exiting shareholder wants to depart and that his shares are therefore up for sale, together with the price that the exiting shareholder wants. The other shareholders then decide whether they want to purchase their allotted proportion of the exiting shareholder’s shares and, if so, if they want to pay the price he is asking. If they think that he is asking too much, the other shareholders can request that an independent valuation is undertaken, normally by the company’s accountants or auditors. If they elect to go for an independent valuation, the other shareholders have to agree to pay that price, whether it is more, less or the same as the price originally requested by the exiting shareholder.

If some of the other shareholders do not want to take up all of their proportion, the shareholders who do wish to participate can take up the left over shares. If not all the shares are taken up in this way, the exiting shareholder either has to keep hold of them or can sell them to a third party. Normally the directors retain the ability to have the final say over whether they are prepared to register the new shareholder.

Involuntary Exit

With an involuntary exit, the same basic process is used, except that the exiting shareholder (or his representatives) does not give notice; it is automatically triggered by the relevant event. Also, the exiting