A shareholders’ agreement is a private contract between some or all of a company’s shareholders that sets out how the company is to be run and the rights and obligations of those shareholders. It also defines shareholders’ rights, obligations, and (where relevant) their involvement in decision-making alongside the board of directors. A shareholders’ agreement can help reduce the risk of disputes and provide agreed mechanisms for resolving them if they arise.

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 complete loggerheads. The company is suffering because they can’t agree on key decisions. The employees are leaving because they feel like the ship is sinking and goodwill is diminishing.  Alex wants to buy Sam out, but they cannot agree on the valuation 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.

A well-drafted shareholders’ agreement from the outset could have reduced the risk of this situation, particularly by including a clear share valuation and exit mechanism.

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 strategic direction of the company and how key decisions will be made.
• How shareholders may buy or sell shares.
• How the board of directors operates, including meeting procedures and the voting thresholds required for key decisions.
• How the company will be funded.
• How responsibilities are divided between shareholders and the board of directors.
• Restrictions on the transfer of shares.
• Anti-dilution and pre-emptive rights provisions.
• What happens if the relationship between shareholders breaks down – 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?

If a shareholder breaches the agreement, the other parties may have legal remedies depending on the terms of the contract and the nature of the breach. 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 may include provisions setting out consequences of a material breach, such as compulsory share transfer mechanisms, suspension of certain rights, or financial remedies, subject to enforceability under UK law.

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

A shareholders’ agreement should include provisions governing share transfers to third parties. These typically include pre-emption rights (giving existing shareholders first refusal) and may require consent from other shareholders before a sale can proceed.

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 company's shares are listed or if the company is sold. These provisions typically set out how shares will be valued and how one or more of the shareholders can leave the company. This may trigger a pre-agreed buyout mechanism or a formal dispute resolution process in the event of a disagreement between the parties.

Can a shareholders agreement template be used?

Generic shareholders’ agreement templates are often insufficient on their own 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 would have been better equipped to continue operating despite their personal dispute. The initial cost of putting a shareholders’ agreement in place is typically modest compared to the potential cost and disruption of a dispute – litigious or otherwise – including loss of good will, employees and the toll that the stress of a dispute takes.

To speak to one of our experts, get in touch at r.duncan@accountsandlegal.co.uk

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