Legal Legal Advice

What is a shareholder’s agreement?

4 Sep 2021

A shareholder’s agreement is a private binding contract which outlines what the shareholders of the company can and cannot do. It also defines each of the shareholders rights and obligations and their roles in running the company. A shareholder’s agreement can therefore be used to prevent and resolve any disputes.

Why is a shareholder agreement important?

To help answer this question, we’ve provided an example of why you need a shareholder agreement:

Alex and Sam have known each other for 20 years. They started a website design agency together which now has a turnover of £15 million per annum. They have equal shares in the company. Everything was going well until a personal issue caused a falling out at the beginning of lockdown.

They are now in dispute and at a complete loggerheads, the company is suffering as they can’t agree on anything. The employees are leaving because they feel like the ship is sinking and goodwill is diminishing. Alex wants to buy Sam out, but Sam is refusing because they can’t agree the value of the company or the price of the shares.

What is the problem? They didn’t think it was worth entering into a shareholder’s agreement when they started the business because they were such good friends and wanted to save costs.

If a shareholder agreement was entered from the beginning, this problem could have been avoided.

What does a shareholders agreement cover?
  • The ownership, structure and management of the business – including a shareholder’s right to appoint directors, confidentiality, restraints of trade and dividend distribution.
  • The proposed direction the company will go in and how the shareholders plan to run it.
  • How shareholders may buy or sell shares.
  • How the board of directors operate, including how and when it meets and the level of majority to pass a particular resolution.
  • How the company will be funded.
  • How responsibilities will be divided between the shareholders and directors.
  • Restrictions on the transfer of shares.
  • Anti-dilution and pre-emptive rights provisions.
  • What will happen if the relationship between the parties ends – including a resolution process that provides an agreed framework that can be implemented if issues arise.
  • Provisions for unwinding and deadlock.
  • What happens if one of the shareholders dies.
What happens if a shareholder breaches the agreement?

A shareholder can take action against another shareholder if they breach one of the obligations under the agreement. You should take the time to list all the circumstances that will be considered a material breach.

Examples of breaching a shareholder agreement include:

  • a shareholder committing fraud; and
  • failing to provide agreed capital or failure to comply with the provisions of the agreement.

The agreement can also include a provision that if the material breach is not resolved the shareholder in breach must transfer their shares, have their voting rights suspended or pay compensation to other shareholders.

What happens if a shareholder wants to sell their shares to a third party?

A shareholder’s agreement should set out provisions relating to the sale of the shares to third parties, these may include that the seller must obtain written consent from the other shareholders or anti-dilution and pre-emptive rights provisions.

What happens if the shareholders no longer want to be in business together or an exit event happens?

The shareholders agreement should include provision for what happens when an exit event occurs, for example, if the companies’ shares are listed or if the company is sold. These provisions will determine how the price of the shares will then be calculated and how one or more of the shareholders can leave the company. It could trigger a pre-determined buy out mechanism or a mechanism for dispute resolution in the event of a disagreement between the parties.

Can a shareholders agreement template be used?

Shareholder’s agreement templates should not be used, and a properly drafted agreement should be customised for your particular business and for the age and standing of the parties. Clauses can be drafted to cover nearly any situation you envisage or scenario that concerns you.

If Alex and Sam had covered all the above points in a shareholder’s agreement, the company could have continued operating despite their personal issues. The initial cost of setting up a shareholder’s agreement is small compared to the costs of a dispute – litigious or otherwise – including loss of good will, employees and the toll that the stress of a dispute takes.

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In our Guide to Shares and Shareholders, we dive into some of the issues mentioned in this article in more detail.

Shareholder Agreement