You’re a busy entrepreneur. We get that. The majority of our clients rarely have a moment to themselves. You’re also at the top of your game, with a great team around you. And having co-founders, friends or family share in your business is a great start. But it’s a mistake to let either loyalty to those who’ve got you this far or complacency about what it takes to truly succeed in business spoil your future chances. Protect your company and everyone’s interests with a shareholders’ agreement.
Why is a shareholders’ agreement important?
A shareholders’ agreement is a contract between the owners of a business. In the case of a private company limited by shares, these are shareholders. It regulates their relationship and contains certain protections designed to guard against the most common issues and disputes that can arise between business owners. Such as what to do if you can’t agree on a decision and the company is stuck.
When you first set your business up – unless you’re flying solo – you’ll likely have given shares to your co-founders, your partner, your friends and family members who may have helped you along the way. It’s the way many companies start. So, you may have a number of people with their fingers in your pie.
In addition, at the beginning of your company’s life, you or your advisor will have registered Articles of Association at Companies House and unless you’ve opted for a bespoke set, these will be on standard terms. If you’ve scanned the Articles, you will have noticed that they contain a number of provisions that protect the rights of shareholders. For example, if one person wants to sell, they may have to offer their shares to the other shareholders first (‘pre-emption rights’).
You may, therefore, have assumed that either the law or the Articles will have your back if you and your shareholders fall out. In many scenarios you’d be wrong. The Articles only go so far when it comes to solving the kinds of issues that can crop up in even the best-run company.
Why your company’s Articles aren’t enough to protect your interests
The Articles of Association aren’t designed to be a catch-all to protect you or your other shareholders when things go wrong. They are designed to cover kinds of scenarios that can impact shareholders unfairly. They’re a vanilla document that works for the majority of uncomplicated companies.
If you’re happy with the status quo, that’s fine. And if you control 75% of the voting powers, you can change the Articles if needs be to protect your interests, But if not, and you’ve got ambitions to grow and expand, you may need a little extra protection.
What can go wrong with no shareholders’ agreement in place?
Scenario one: Your end-game of selling the business is blocked by a minority shareholder.
If your ultimate aim is to sell, then you need to be absolutely sure that your shareholder colleagues can’t block your ambitions. After all, they may be quite happy with the way things are and would like to continue receiving dividends and the like. The fact is, without a shareholders’ agreement, a minority shareholder could block a sale.
The way around this is to agree ‘drag along’ or ‘tag along’ provisions in an agreement so that, if the majority of shareholders want to sell, the minority will do so too. That way, a buyer gets to acquire all of the company’s shares.
Tag along provisions protect your minority shareholders by enabling them to sell on similar terms. Drag along provisions force your shareholders to sell if you’ve agreed a great deal but they want to hold out for more money or want things to stay as they are.
Scenario two: Your shareholders know your business inside out and swiftly leave to set up a competing company.
Unless you have a shareholders’ agreement that would stop them, any of your shareholder colleagues could exploit their insider knowledge of your business to set up in competition with you. It’s common sense to have everyone agree that they’ll do the decent thing, and a shareholders’ agreement can help you achieve that. A shareholders’ agreement can:
- Stop your shareholders setting up in competition with you
- Stop them poaching your customers or staff
- Make sure they don’t interfere with your supply chain
Scenario three: A dispute arises that de-rails the business.
Sure, you’re all getting along fine, and that’s great. But if there’s an issue with the business and you can’t all agree, the last thing you’ll want is a costly dispute that might distract you from your business. A shareholders’ agreement can pre-empt these kinds of circumstances and set out a clear path for resolving disagreements that will smooth the way to an amicable resolution.
Scenario four: You’ve given shares to your employees, but they now want to leave, and you have no provisions in place to stop them from taking their shares (and their company knowledge) with them.
Employee share schemes are a great way to incentivise and reward your best performers. But if you part company, you’ll need to ask them nicely to return their shares. You can tweak your shareholders’ agreement depending on if they’re ‘good’ or ‘bad’ leavers, so that this is fair to both sides, and also include provisions to make sure that they don’t take clients with them.
Scenario five: A shareholder is contributing less to the company but there are no standards set and they continue to receive the same dividends and voting rights as those who contribute more.
The standard Articles only envisage one class of shareholder who has an equal right to dividends, voting rights and a share of the company on a liquidation. With a shareholders’ agreement, you can re-jig these rights if there are some shareholders who are contributing more than others.
Scenario six: One of your shareholders sells their shares to a stranger and you risk losing control of your vision for the business.
Unless you have a shareholders’ agreement, any of your shareholders can sell to someone else, even someone you don’t know. While your Articles may give you rights of pre-emption, you may need to tweak these so that you’ve got maximum control over who gets to share in your company.
Scenario seven: You have ambitions to grow and expand but investors are wary that you don’t have the right agreements in place to protect their interests.
If you’re serious about your business, even if you’re at an early stage, you’ll know that you may need to borrow or seek extra funding to expand. Investors like VCs and lenders like banks will want to see that you’re working as a team with your shareholders. Putting a shareholders’ agreement in place demonstrates that you take a professional approach to running your business and have considered all the ways in which you can smooth the path to new investment.
The risks of not having a shareholders’ agreement in place can certainly throw up questions about how you want to take your business forward, and what your ambitions are. Generally speaking, if you have two or more shareholders, then you should have a comprehensive shareholders’ agreement in place. It will reduce the risk of shareholder disputes having a significant impact on your business, give you the control you want so that you can take your strategy in the direction that you envision, and help you to govern the rights and obligations of your shareholders clearly and fairly.
For more information on what provisions should be included in your shareholders’ agreement, read our guide: What Should A Shareholders’ Agreement Contain?