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Why Is A Shareholders’ Agreement Important?

Posted 14 days ago

Why Is A Shareholders’ Agreement Important?
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When setting up a company, especially if family or friends are involved, it is easy to proceed under the assumption that nothing can go wrong in the future, and that no agreement outlining the roles and relationships within a business is needed. 

However, if you are going into business and to save future disputes, we greatly recommend putting a shareholders’ agreement in place to protect your business and your own investment in the company. 

In this guide, we aim to give you an idea of what a shareholders’ agreement should include and how it can protect you. 

What is a shareholders’ agreement?

The clue is in the name. A shareholders’ agreement is exactly that: an agreement between the shareholders of a company. Its specific purpose is to protect a shareholder’s investment in a company and to establish a relationship between the shareholder and founder in the governing of a company. 

While it comes as a surprise to many entrepreneurs, shareholders agreements can include anything a business owner wishes. However, for the purposes of this guide, we will focus on the prescribed elements. Ideally, an agreement should cover the following:

  • The sale of shares in a company
  • Outline how a company is going to be run
  • Establish shareholder’s rights and obligations
  • Provide protections for minority shareholders
  • Explain how important decisions will be made

These are the basic areas that an agreement will cover, but of course as an entrepreneur you can include as many clauses as you wish. 

What should a shareholders’ agreement include?

While it is certainly not possible to prepare for every eventuality, there are a number of issues that you can prepare for based on instinct or past experiences. Here’s a few issues that you may come across:

  • Preemption rights
  • Transferring shares
  • Approving changes in business direction
  • Competition rules (shareholders competing against the company they already have shares in)
  • Injection of debt

While the above are but a few of the common issues you may face as a business founder, as uncomfortable as it may be, it is worth making provisions for other events that occur at then end of a business’s life:

  • Sale of the ecompany
  • Shareholders buying each other out
  • A public placing of shares
    The assets that are sold if the company is wound up

Example clauses

As discussed, a shareholders agreement can technically include anything you like, but there are usually a common set of provisions you would expect in agreement. Below are just a few examples from Envestors:

  1. Whether the investors have a right to appoint one or more directors and observers, and if so the mechanics for appointment and removal
  2. Limitations on key decisions without the approval of a majority (and if so how great a majority) of investors typically major matters such as issue of shares, change in rights attached to shares, grant of options, creation of new subsidiary, transfer or closure of business or acquiring new business, change of Articles, or large purchases;
  3. Limitations on key decisions without the approval of the investor director (typically major operational matters including taking loans, employing or dismissing senior staff, entering into major contracts)
  4. The obligation of management to provide regular trading information and financial updates
  5. Provision for meetings of shareholders;
  6. The obligation of the founders to work full time, and not to dispose of their shares, for a stated period
  7. Limitations on the salaries and other benefits payable to founders without investor approval
  8. Non-compete obligations on the founders for a period after departure

Ultimately, a shareholders' agreement protects the rights of all shareholders and the value of their shareholding. Without an agreement, majority shareholders may force issues that are not in the minority shareholders’ or indeed the business’s interest. 

However, once again it all depends on how the agreement is put together. There can be several classes of shares, for example, that give you certain rights over the company. In theory, you can have one A Class share and own 1% of your business, but have total control if it is worded into the shareholders’ agreement. 

The key here is to try to understand where your business is going in the future. What controls you need over it as a shareholder or founder. Either one needs to consider the needs of each other to ensure the business is successful.

There are standard templates available for shareholders agreements. But, you can amend accordingly if you want a more bespoke agreement and seek advice. It is important to remember that you don’t have to be governed by a standard agreement, customise your agreement to suit your business needs. 

Authors: Oliver Murphy & Sacha Bright

Disclaimer

To the best of our knowledge, the information we have provided is correct at the time of publishing. Sacha Bright is not a solicitor or accountant and we recommend that you seek professional advice on any topic discussed.

Tagged: entrepreneur sme business



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