Most companies are created in quite a basic form at companies house with a simple allocation of shares, and standard articles of association. The articles of association normally provide some guidance on how the company is to be run, but aren't normally sufficient if the company has shareholders with different roles and responsibilities, or different types of equity. So that's when a shareholders' agreement can be really useful.
It's best to put a shareholders' agreement in place when a company is formed and the shares are first issued, but it is perfectly possible to do this later, particularly if there are a few rounds of funding or the investors change over time.
Many entrepreneurs set up their businesses with friends or family members, and whilst it might not feel necessary to document arrangements too formally, the process of creating a shareholder's agreement can help identify a broad range of situations which would need to be handled carefully in the future.
What exactly does a shareholders' agreement do?
The agreements itself is designed to set out the shareholder's rights and obligations, and describe how the company is going to be run. It will also be quite specific about how the company's share could be sold, and create a process for making important decisions about the business. Equally, if some shareholders work within the company and get their remuneration by dividend, then the shareholder agreement can help make sure these parties get paid an amount equivalent to their salary, before the company profits are distributed in the normal way.
Is a shareholders' agreement useful for minority shareholders?
Shareholders with small stakes, known as minority shareholders often have very little control over how the company is run, with the decisions normally being made by a majority decision which could well be by single person if they own more than half of the equity.
So changing the rules so that all shareholders, or a larger majority, have to agree on the issues of new shares or the appointment or removal of directors, can help protect the interests of minority investors.
Further protection for minority shareholders is also useful in the event that some or all of the equity is sold. If a majority shareholder elects to sell some or all of his equity, a minority shareholder can be given the right to "tag along" and benefit from the same terms. Equally, if a majority shareholder wants to sell the whole business, the minority shareholder can be obliged to sell at the same time, by what's known as a "drag along" provision.
Equally, it might well be the case that minority shareholders will need to accept some restrictions to whom they can sell, so that they can't sell a small proportion of the shares to an arch competitor with voting and information rights along going with it.
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If you are an entrepreneur setting up your business, if you have just raised some additional equity, or you need advice on a shareholder related matter then why not drop us a line to talk it through?