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Why a shareholders agreement is vital

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Why a shareholders agreement is vital

The early stages of setting up a company can be an exciting yet challenging time. There are so many tasks to be carried out and, as such, dealing with legal matters can sometimes slip to the bottom of the pile to be dealt with at a later date.

However, it is extremely important during these early stages where everything is positive and everybody is focused and getting along so well, to set out the ground rules as to how the owners will deal with various circumstances in order to keep matters straightforward further down the line. It is imperative that all parties have a clear understanding of the relationship so that if any unforeseen circumstances crop up, everyone will know where they stand and how to move forward when the situation is not immediately clear.

Why do you need a shareholders agreement?


Many firms operate as limited companies or limited liability partnerships. Whilst the entity may be correctly set up, the documentation required to protect individual shareholders' interests may not be. When a business is owned by more than one person, an agreement between the shareholders is vital. With the best will in the world, you cannot guarantee that two or more of you will not have a dispute during the lifetime of the firm, even if you are the best of friends and cannot ever envisage this happening. How would you tackle this quickly and easily without a formal agreement in place?

Even the basics require some thought. How are your shares going to be allocated? You may think you are in agreement over this but miscommunications can and do happen.

If a shareholder decides to leave the business and sell his or her shares in the company, would this be allowed? And what would be the process required for this to happen?

Then there is the question of the unfortunate event of a shareholder’s unforeseen serious illness or even death. Any circumstances in which they will be unable to participate in the running of the company will require a pre-agreed set of procedures in order to maintain business continuity. Similarly, the interests of their family or beneficiaries must be correctly protected and whilst your business partner or partners may have made provision in their wills, these are personal and can be changed at any time, affording little or no protection to the other shareholders or, indeed, the firm.

Whilst none of these are issues we really want to think about, they are easily dealt with in an agreement, giving all shareholders the peace of mind that, should any one of a range of situations occur, the rules are all set out in writing and everybody can refer to them as and when required.

What should a shareholders agreement include?

A shareholders agreement sets out the rights and responsibilities of the shareholders. Being thorough is important. It is usually suggested that the following areas should be included in the agreement:

- Control of the company and the voting rights regarding making decisions. Will you all have equal voting rights? How will the voting system work?

- Allocation of risk - will all owners share an equal risk or will it be fairer to allocate risk according to the value of their share in the business?

- Allocation of profit / dividends - how will these be determined and allocated and how will profits be fed back to the business?

- Sale of shares. If one or more shareholders wish to sell their shares, how should this be handled and what protection should be in place for the firm itself and for the remaining shareholders? This is particularly important in protecting the interests of minority shareholders against the actions of majority shareholders.

- The business plan and capitalisation - having this written down helps to avoid miscommunication and encourages focus.

- Further capital / dilution of equity. If the business enters into additional funding rounds requiring new equity partners, what impact will this have on existing shareholders?

- What happens in the case of insolvency? This can be a complicated area and needs some careful consideration.

- Restrictive covenants. What conflicts of interest could arise and how should they be handled? What are the implications for shareholders, for example, where one or more shareholders wishes to leave the business and set up a competing entity? How can the firm and the remaining shareholders be protected?

- Dispute resolution. Disputes can - and do - happen at any stage of the business cycle. Having a clear set of procedures through which you can explore and resolve any disputes will be key to minimising the disruption that can so easily ensue.

- Confidentiality. This is an important area and it is essential to clarify what this means and to set out any relevant rules and procedures to ensure all shareholders abide by those rules.

- How can shareholders exit the company and transfer shares? This is another vital component of the agreement. Change can happen frequently in business and the company needs to be in a position to move forward, grow and adapt to the changing circumstances of the shareholders.

- Provisions for management. What will be the management structure on a day to day basis?

- Intellectual property rights - how will the rights to the firm's IP be protected?

Although it seems rather a lot to consider at first, imagine the satisfying position of being able to refer to a clear legal document as soon as any potential query or conflict arises without the need for heated debate and variable interpretation.

The importance and value of getting the shareholder agreement completed in a timely and thorough manner cannot be overstated. This way, all shareholders can focus on getting on with the job at hand and enjoying their role as a shareholder in an exciting new venture.