Shareholders’ Agreement and Articles – A Basic Guide

The Articles of Association and the Shareholders’ Agreement work together to set out how a company will be run and how its internal activities are governed.

A Shareholders’ Agreement is a private contract between the shareholders of a company. It sets out how the shareholders will behave in relation to the company. A Shareholders’ Agreement only binds those shareholders who are signatories to the original agreement or enter into a Deed of Adherence (a document by which a person/company becomes a party to an existing Shareholders' Agreement where a Shareholders’ Agreement is already in place).

The Articles of Association bind all shareholders who hold shares in the company so it can be advantageous to have certain provisions contained in these rather than the Shareholders’ Agreement.  The Articles of Association act as a contract between each of the company’s shareholders, and between the shareholders and the company itself. The Articles of Association are kept at Companies House and are publicly available documents.

We recommend that business partners enter into a Shareholders’ Agreement and have tailored Articles as they act as an insurance policy if any of the shareholders fall out. Sadly, we see too often the result of people not having tailored documentation.

Within the Shareholders’ Agreement and Articles you can include various provisions, including those which govern what: (i) happens if a disagreement between shareholders occurs or a shareholder was to die; and (ii) the company and/ or shareholders can do with or without the approval of another shareholder.

Whilst doing so cannot prevent disagreements between shareholders, it does give the shareholders parameters as to how they can act whilst in business with each other. Establishing these parameters helps manage the relationships between shareholders. It can also provide a mechanism for the shareholders to separate in the event that the business working relationship cannot be repaired.

Whilst no shareholders anticipate falling out, it is useful to have an agreement in place to prevent or at least reduce, the consequences that can follow shareholder disagreements (i.e. costly legal fees and damaged relationships).

We have set out in the table below some of the common provisions which are included in Shareholders’ Agreements and Articles.

Each business and each relationship is different, as a result we recommend that this list be seen as a conversation starter rather than exhaustive.

What we always recommend is that you do pay attention to these issues when you go into business with someone. Whilst there is a cost to document your agreements now, the cost of not doing so is a lot higher!

 

 Item

Comment

1. 

Business of the Company

A provision is usually included to explain what the business of the company is and that the shareholders will use their reasonable endeavours to promote the success of the company.

2. 

Directors

Usually an agreement will stipulate if the shareholders must be directors or if they can appoint a director to be their representative.

You can also include provisions for a casting vote.

A mechanism can be included as to how new directors are appointed and if unanimity is required. 

3.

Information

A Shareholders’ Agreement will usually give shareholders the right of access to business information including key financial information. The level of information will differ depending on the number of shareholders and their involvement with the company.

 4. Restricted Matters 

A list is typically included of what are considered to be major decisions and will require the consent of either: (i) all shareholders, (ii) a majority of shareholders; or (iii) a certain shareholder.

When deciding what matters require consent, you need to strike a balance between protecting the key stakeholders/ shareholders whilst still allowing the business to function properly. If every decision has to get approval it could make the day to day to day running of the business particularly cumbersome.

5.

Transfer/Issue of Shares

Generally, these provisions will include details as to how any new shares are to be allotted. It is common for them to be offered first to existing shareholders in the proportion they hold shares.

Transfer of shares can be more complicated. For tax planning reasons, some agreements allow shareholders to transfer shares to their spouses, children or family trusts without prior approval.

Other transfers then need to be considered. For example, will shares have to be offered to other shareholders, proportionate to the shares they hold, before the shares can be offered to a particular shareholder or third parties?

Will shareholders be deemed to have served a transfer notice if certain events occur (i.e. material breach of Shareholders’ Agreement, ceasing to be an employee, or committing an act of fraud or dishonesty)?

6.

Leaver Provisions

Leaver provisions govern what happens if one of the shareholders, who is an employee or director, wants to leave the business. When a person leaves, they will automatically serve a notice on the other shareholders to sell their shares.

Leavers are generally either good or bad leavers. A Good Leaver is often someone who leaves as a result of: (i) death; (ii) ill health, disability or incapacity; or (iii) any other reason agreed by the Directors or the Shareholders. A Bad Leaver is generally anyone who is not a Good Leaver.

Whether a person is a Good or Bad Leaver will dictate how much they will receive for their shares.

Generally, a Bad Leaver will just receive the nominal value for their shares. Whereas a Good Leaver will receive the current market value which is often known as the Fair Value. This is determined by an auditor or accountant and can be discounted for minority status.

If the sum of money to be paid is high, it can be prudent to have a mechanism which allows for the shareholders to pay the sums owed over a period of time in order for them to raise the funds.

7.

Death 

On the death of a shareholder, the shares held by that person would normally go to the estate and be dealt with under the will. This can make running a company difficult.

It is common for a Shareholders’ Agreements to provide that on death of a shareholder, they are automatically deemed to have served a notice to sell their shares. This can create difficulties for the surviving shareholders as there may not be funds available to purchase the shares.

One option to mitigate this risk is to put in place a cross option which provides for the shares to be purchased by the remaining shareholders using the funds paid out under an insurance policy.

This results in the deceased shareholder’s estate holding a sum of money for the shares and the remaining shareholders owning the shares. This arrangement does not work in all circumstances, but it is worth considering.

8.

Drag Along and Tag Along Rights 

These rights are particularly helpful when you have some minor shares and are worried that they might hold up the sale of the Company.

A drag along right allows the majority of shareholders to force a minority shareholder to sell shares to a third-party for the same price per share as the other shareholders.

Tag along rights give the minority shareholders protection from being left behind with a new third party majority shareholder by allowing them to force the third party to purchase their shares as well as the other shareholders at the same price per share.

9.

Confidentiality  This is often the least controversial issue. It will contain a requirement that the shareholder keeps all matters regarding the company confidential, save for a few exceptions.

10.

Intellectual Property  If your business produces lots of intellectual property, it is sensible to include provisions which results in any intellectual property produced by a shareholder to become the property of the company.

11.

Restrictive Covenants It is worth considering whether any shareholder should be subject to restrictions over and above what is contained in their contracts as directors and employees.

It is very difficult to guarantee that any restrictions will be enforceable. As a result, restrictions should be limited in scope and be focused on the particular business of the company.

Non-compete clauses which prevent a person from working are generally harder to enforce than non-solicitation or deal with employees, clients or suppliers.

12.

Dividends  Wording can be included which will set expectations as to the level of dividends to be paid and whether or not any sums should be reinvested in the company.

13.

Termination of Directorships  Clauses are often included which mean that a shareholder has to resign as a director if they cease to be a shareholder or cease to hold a certain amount of shares.

14.

 Deadlock Wording can be included which sets out what happens when the parties cannot reach an agreement.

 

If you have any questions or would like advice about shareholders’ agreements and articles, please contact Jack Gardener, by calling 01256 854665 or by emailing [email protected]

Alternatively, click here to go to our contact page.

 

Disclaimer

This article is current at the date of publication set out above and is for reference purposes only. It does not constitute legal advice and should not be relied on as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action.