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What are the benefits of a Shareholders’ agreement?

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With COVID-19 continuing to have a significant impact on all aspects of business, many of which have been unforeseen, a shareholders’ agreement has never been more important.

These agreements can provide for many eventualities, while the absence of a shareholders’ agreement opens up more potential for costly disputes and disagreements between shareholders.

Whether you’re a minority or majority shareholder in a company, it’s important to consider drawing up and implementing a shareholders’ agreement.

Dave Paterson, Partner in the Corporate Law team at Blacks Solicitors, discusses why businesses should implement a shareholders’ agreement and the benefits that will be returned.

‘Good Leavers’ vs. ‘Bad Leavers’

In Owner Managed businesses, a limited company’s shareholders and directors are often the same people. If a director or shareholder leaves the company, then the remaining shareholders may not want them to keep hold of their shares or have to pay market value to repurchase them.

Provisions in a shareholders’ agreement known as ‘Mandatory Transfer’ provisions will oblige leaving shareholders to transfer their shares back to the remaining shareholders should they leave. The price will be determined by whether they are considered to be a ‘Good Leaver’, or a ‘Bad Leaver’, which will be set out in criteria within the shareholders’ agreement.

A ‘Good Leaver’ will usually be defined as an individual who leaves the company on good terms, for example because they’re retiring, or are suffering from illness or disability. They’ll usually be entitled to a fair value for their shares. If a fair value can’t be agreed, there’ll be a process set out in the agreement for how that value should be determined.

A ‘Bad Leaver’ is an individual who, for example, leaves the company to join a competitor, or has been dismissed by the company for good cause.  Such Bad Leavers are likely to receive only the nominal value of their shares.

‘Drag Along’ or ‘Tag Along’

A shareholders’ agreement can protect both majority and minority shareholders’ interests if a majority want to sell their shares.

It’s important to note that those looking to purchase a private company will almost certainly only be interested in buying the shares if they can purchase 100 percent of the shares. Without a shareholders’ agreement, even if a majority shareholder wants to sell their shares, a minority shareholder is under no obligation to join in the sale. They could delay the process, try and hold the majority shareholders to ransom or even effectively veto the deal.

‘Drag Along’ provisions can stop this happening as they oblige minority shareholders to sell their shares along with majority shareholders if the majority have accepted an offer for their shares.

However, ‘Tag Along’ provisions are usually drafted alongside ‘Drag Along’ provisions and protect the interests and share value of minority shareholders by ensuring that where the majority shareholders have accepted an offer for their shares, the minority shareholders have the right to join in the sale on the same terms.

Profit sharing

A shareholders’ agreement can contain provisions which set out how shareholders share profits which are often linked to an individual’s role in the business.

An investor who takes a minority share in a company may want a guaranteed return on their investment, while those actually running and working in the company will be keen for their hard work to be recognised.

Such provisions can be very detailed and set out the exact role that each shareholder agrees to carry out.

Making decisions

Under the Companies Act 2006, company directors have very wide powers when it comes to running a company, and all that’s needed is a majority on the board of directors to authorise most day to day decisions. However, provisions in a shareholders’ agreement, usually referred to as ‘Reserved Matters’, can list the decisions of the company that a certain percentage of shareholders must agree to, (up to 100 percent).

‘Reserved Matters’ provisions can protect both minority and majority shareholders. For example, an individual who owns 10 percent of a company may not want the directors to issue shares to a new investor without their consent. They therefore should try and make sure the decision is listed as a ‘Reserved Matter’.

Conversely, majority shareholders may not want the directors to make, for example, a large spending decision without their consent, so may want a spending threshold to be included as a ‘Reserved Matter’.

‘Deadlock Provisions’

In addition, a shareholders’ agreement can also contain ‘Deadlock’ provisions which determine how decisions are made if a majority of shareholders can’t agree on one course of action.

Perhaps the most important thing to remember is that it’s much easier for everyone to agree to the terms of a shareholders’ agreement at the start of a new business venture, as those involved should hopefully feel like they are all on the same page…and optimistic!

Confirming a shareholders’ agreement at the outset can ensure that future disputes and costly litigation are much less likely, and should provide for fair procedures to determine decisions in the event of a dispute.

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What are the benefits of a Shareholders’ agreement?

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