Justin Ellis, a Solicitor with iLaw, who specialises in shareholder and investment agreements, explains how a well drafted shareholder agreement can avoid acrimony or misunderstanding further down the line:
When starting in business entrepreneurs are often full of hope and excitement about their new enterprise, directors and partners are often working from an established and friendly relationship and it may seem like nothing can go wrong.
All companies will have basic articles of association which are written rules about running the company agreed by the shareholders or guarantors, directors and the company secretary. It is often assumed that this is sufficient to maintain the effective administration of the business.
Articles of association contain the basics, such as the classes of shares and the rights to vote, dividend entitlements and return of capital on a winding up of the company.
However, they will omit other important aspects of a company’s ownership and management, such as transfer of business premises to and from the company, supply agreements to or from the company, management agreements or technology agreements, including intellectual property rights.
Such matters would often be prescribed for in a shareholder’s agreement.
Many assume that such agreements are a luxury, rather than a necessity, and it is indeed true that the law does not oblige the creation of a shareholder’s agreement. Unfortunately, by the time shareholders discover the true value of such an agreement, it is often too late as they are already in a complex and acrimonious dispute.
Considering the benefits that they can offer; this article will look at the seven steps to creating the perfect shareholder agreement.
Address difficult questions early
Shareholder agreements are typically created during the founding of a business it is worth taking some time to consider the different scenarios and conflicts that could arise during the company’s life, for example:
- If we cannot obtain funding, will the shareholders be called upon to provide more capital?
- You there is a deadlock between shareholders over an issue, how should it be resolved?
- If a shareholder/director falls ill or dies, what happens to their shares?
By asking these and other questions you can prepare an agreement which ensures shareholders and stakeholders are on the same page in advance of the issue arising.
This will allow the business can act quickly and with minimal disruption. It is better to agree during a good relationship rather than being forced to agree during a dispute.
All of the items traditionally included in a shareholder agreement could be included within the articles of association, but there are commercial and legal reasons why shareholders prefer to use two separate documents.
Articles of association are be filed publicly at Companies House and so you must consider what information is available to competitors.
Articles of association will typically include details of the issue and transfer of company shares, the number of directors and their duties and company procedures, such as who must be present at meetings.
You may prefer to keep other matters private such as exit strategy, remuneration policy and dividend policies. This is where the privacy of a shareholder agreement can be extremely beneficial when administering the affairs of the business.
Establish Share Vestment
It is important to consider how shares are vested within the company i.e. how will the shares be issued, retained or sold by the shareholders.
At the founding of a company, it is usual for key members of the team, to be offered shares as an incentive to drive value within the business that they can mutually benefit from.
As such a shareholder agreement should outline:
- When departing employees are permitted to retain their shares; or
- When the basis upon which shares can be sold and the rights of the other shareholders or the company to buy and retain these shares.
Although it can be a contentious issue, the agreement should also outline the price calculation mechanism at which shares are to be sold. For instance, the price may be affected by the behaviour of the employee/shareholder.
Those who retire or leave due to ill health will usually be offered the market value, but those who are dismissed or are asked to resign due to misconduct may be offered a lower or indeed nominal value. An agreement should spell this out clearly so that decisive action can be taken and minimise the likelihood of recourse.
Protect ongoing concerns
Shareholder agreements regulate the relationship between the company and its shareholders.
They can also regulate the relationship between the majority and minority shareholders and the board and other shareholders.
All businesses are started in good faith and usually on good terms, things can and sometimes do turn sour – even between the best of friends and family.
A shareholders’ agreement codifies your business relationship and should prevent the exploitation of existing or former personal relationships if trust deteriorates further down the line.
Consider your exit
You have just founded your new business, but have you thought about what happens when it is time to sell? It may seem bizarre to consider how you will exit the business, but it is an important first step.
Exit forces shareholders to consider their vision for the future of the business and allows disagreements to be resolved.
Articles of association and shareholder agreements should be consistent with one another and not contain contradictory provisions.
It is easy to make a mistake when drafting the two documents separately, especially if they are done some time apart, but inconsistencies can lead to confusion and disputes, as well as leaving the business vulnerable to legal challenge at a later date.
Drafting a shareholders’ agreement not only provides clarity on the vision for the business and its future but also gives shareholders the chance to address difficult issues beforehand.
This should ensure that all parties share the same aspirations/plans before taking the big step of going into business together and provides a route for recourse, later on, should things fall apart.