Ask any experienced corporate lawyer what document they wish their clients had in place before they needed it, and the answer is almost always the same: a shareholders’ agreement. Ask any business owner who has been through a shareholder dispute what they wish they’d done differently, and the answer is the same again.
A shareholders’ agreement is the document that governs the relationship between the owners of a business. It sets out who can make which decisions, what happens when shareholders disagree, how shares can be transferred, and what happens if one shareholder wants to leave or if the business is sold. It is, in effect, a rulebook for the ownership relationship and like most rulebooks, it is most valuable when things go wrong.
Why most businesses don’t have one, or have an inadequate one
Shareholders’ agreements are frequently absent or inadequate in fast-growing businesses for a predictable set of reasons. The business was founded in a spirit of shared enthusiasm, when the idea of needing a formal document to govern the relationship felt unnecessary or even offensive. The business grew quickly and the agreement was always on the to-do list but never quite reached the top of it. Or the business has one, but it was drafted when the company had three shareholders and £2m of revenue, and it has never been updated as the business has grown to £50m with a more complex ownership structure.
At the point where a shareholders’ agreement becomes necessary, when one shareholder wants to leave, when a co-founder’s performance becomes an issue, when there is a disagreement about strategy or a proposed sale, the window for negotiating one has often closed. Shareholders who are in dispute are rarely willing to agree on the terms of the document that would resolve the dispute.
What a shareholders’ agreement should cover
Decision-making and reserved matters
Which decisions can the board take without shareholder approval, and which require a shareholder vote? Reserved matters typically include material acquisitions, disposals, changes to the business’s constitution, and certain financial decisions above defined thresholds. The threshold between board authority and shareholder approval should reflect the actual ownership and governance structure of the business.
Deadlock
What happens when shareholders cannot agree on a material decision? A deadlock mechanism, whether a casting vote, a buy-sell provision, or a right to refer the matter to mediation prevents a business from being paralysed by shareholder disagreement. Without one, the only route out of a serious deadlock is often litigation.
Transfer restrictions and pre-emption rights
Can a shareholder transfer their shares freely, or do existing shareholders have a right of first refusal? Pre-emption rights protect existing shareholders from having an unknown party acquire a stake in the business without their consent. Good leaver and bad leaver provisions govern the price at which shares must be transferred when a shareholder leaves — distinguishing between someone who leaves in difficult circumstances and someone who retires after long and distinguished service.
Drag-along and tag-along rights
If a majority of shareholders agree to sell the business, drag-along rights allow them to require minority shareholders to sell on the same terms. Tag-along rights give minority shareholders the right to participate in a sale on the same terms as the majority — preventing a majority shareholder from selling their stake and leaving minorities holding shares in a business under new ownership.
Dividend policy
What is the policy on the payment of dividends? Disagreements about whether to distribute profits or reinvest them are a common source of shareholder tension. A documented dividend policy — even a simple statement of the principles that will guide dividend decisions — reduces the scope for disagreement.
Non-compete obligations
Should shareholders be subject to non-compete obligations during their involvement in the business and for a period after departure? For businesses where shareholders are also active in the business, this is an important protection.
When to do it
The best time to put a shareholders’ agreement in place is when you start — when the relationship is good, the intentions are aligned, and there is no reason to resist. The second best time is now. If you have a shareholders’ agreement that hasn’t been reviewed in the last three years, or if the ownership or governance of the business has changed since it was put in place, it needs to be updated.
The conversation you don’t want to have
The difficulty with shareholders’ agreements is that having the conversation feels like planning for failure. It isn’t. It is planning for the reality that relationships change, circumstances change, and businesses that don’t have clear rules for managing those changes are the ones that end up in expensive, distracting, and damaging disputes.
The conversation is much easier before anyone has a reason to be difficult.
