Purpose of a Shareholders’ Agreement and What to Include
In this article, our Head of Corporate & Commercial Solicitor, Yao Trinh, and Corporate & Commercial Solicitor, Amara Akhtar, cover the purpose and benefits of a shareholders’ agreement. They break down key provisions, including share transfers, director rights, dispute resolution, and shareholder protections, explaining how a well-drafted agreement can help prevent disputes and safeguard investments. Whether you're a startup or an established business, this guide will help you understand why a shareholders’ agreement is essential for long-term success.
What is a shareholders’ agreement?
A shareholders’ agreement is a contractual agreement between a company and some (or all) of its shareholders. The agreement covers the relationship between the parties including the ownership of the shares and the management of the company as well as govern the way in which the company is run.
Why should you have a shareholders’ agreement?
Firstly, a shareholders' agreement is a private contractual document. It is not made available to the public unlike the company’s articles of association. As such, it would allow some terms agreed between the parties to be kept private and out of the public eye.
For example, you can clearly set out how company matters should be processed such as when and how a shareholder may sell their shares. Following this example it can include details such as whether the shareholder may transfer their shares, to who, the share price, the steps they need to take in order to complete the transfer and additional consents or votes the other shareholders may have in relation to the transfer. Typically the existing shareholders of the company would have the first right of refusal over any shares that another shareholder would like to sell before the shares can be transferred to a new third party. This type of pre-emption right on transfers is not found in the Companies Act 2006 or the Model Articles.
The clarity provided in a shareholders’ agreement also reduces the risk of disputes arising and if they do so, may contains guidance on how to resolve them. Protections and securities can be given to shareholders using minority shareholder rights or non-compete clauses which can be encouraging to investors leading to the business growth.
It is not uncommon for there to be overlaps between the shareholders’ agreement and the company articles of association and some clauses will be mirrored in both document, providing shareholders twice the protection.
Below we break down some of the typical provisions found in a shareholders’ agreement and their purpose.
Sections within a shareholders’ agreement
These are topics that you will generally expect to see in a shareholders’ agreement but of course it would be tailored to the company’s / shareholders’ requirements:
The parties details – their address, number and type of share held, and percentage holding will be set out in a Schedule at the end of the agreement.
The purpose of the business – the purpose and nature of the business will be explained and it is an expectation that each shareholder will try promote the success and develop the business.
Director appointment and process – certain shareholders such as founders and key investors may have the right to appoint a director of the company, it can be themselves or another person on their behalf. The purpose of this is so they have a voice and oversight in the day to day running of the business. For investor directors this protects their investment and allows them to steer the company in a director they agree with.
Director decision making and voting – directors may be restricted from making certain business decisions without prior shareholder approval such as taking out a loan over a certain value, hiring professionals or entering into specific contracts or agreements binding the company. This will differ for each company to suit the needs of the shareholders and directors. Other rules can be implemented such as requiring certain directors to approve of certain matters before the company can act on that matter or require them to be in attendance for board meetings.
Shareholder approval – reserved matters – the shareholders can agree a list of matters that require shareholder consent at determined levels (e.g. 50%, 75%, 90%) or the consent of a certain class of shareholder if a company has multiple classes of shares. The purpose of this is to provide comfort that certain decisions cannot be made without approval from other shareholders.
Some of these matters may include:
Amending the articles of association;
Allotting, issuing, granting new shares;
Transferring shares;
Taking out a loan or similarly issuing a loan;
Granting security or rights over any of the company’s assets or shares;
Entering or terminating specific arrangements, contracts or transactions;
Declaring dividends;
Introducing share options schemes to employees or other individuals.
Founders would prefer to limit this list so they have more flexibility to run the company, whereas minority shareholders (who can influence the consent) may prefer a longer list to ensure the founder can’t do all things as they please. Essentially the list of reserved matters can be endless but will be tailored for the purpose of the Company and its shareholders.
Share classes and rights – in this section the different share classes (e.g. Ordinary Shares, A Shares, Preference Shares etc) can be set out with their respective ownership rights, voting rights, dividend rights and rights on winding up. This may include rights that are not stated in the company’s articles of association. Certain shareholders may have additional voting rights whereas others may have none. Similarly, some may receive a proportion of the dividends before they are distributed to the remaining shareholders. An example of when this can come into play is when there are investors, shareholder loans or employee options.
Process of selling and transferring shares – earlier we discussed an example of setting processes for when a shareholder wishes to transfer their shares including a transfer notice and pre-emption rights on the transfers. Processes can also be set for when a buyer has shown an interest in buying the whole Company meaning all of the shares in issue. Other situations that can be covered are where shareholders’ shares are automatically transferred following a breach of their duties / covenants or upon their exit or death.
Drag along or tag along rights – these can come into play when a buyer is looking to purchase the entire Company. A drag along right enables shareholders making up a percentage of the shareholder and looking to sell their shares to a potential buyer ‘drag’/force the remaining minority shareholders into the share sale with the proposed buyer. Whereas a tag along right enables the minority shareholders may opt to ‘tag along’ to the deal should a majority of the shareholders wish to sell their shares to a proposed buyer, and the proposed buyer is required to buy their shares too on the same terms. These provisions protect both the majority and minority shareholders. The levels required for each can be set based on the shareholders needs.
Obligations on the company and/or shareholders
Dividend policy – restrictions may be added as to when directors are allowed to declare dividends, whether shareholder approval is required, or how the dividends are split with shareholders.
Shareholder loans – shareholders may lend money to the company for initial capital or on an ongoing basis to assist between investment rounds. Rules may be set for paying back these shareholder loans and whether these take priority over dividends.
Issue of further shares – pre-emption rights (right of first refusal) is a statutory right in the Companies Act 2006 however shareholders may waive these rights or on the flip-side agree more stringent consents required before the directors may issue further shares. This may come into play when the founders are looking to bring new investors on board or grant share options as employee incentives.
Restrictions on the shareholders – similar to restrictive covenants on employees, shareholders can also be subject to restrictive covenants. They are commonly placed on founders restricting them from setting up a similar or competing business, soliciting employees, suppliers, customers and contacts for a number of months during the existence of the Company. Restrictions can also be placed on other shareholders from doing the same.
Confidentiality – similar to a non-disclosure agreement, this provision will sit in the shareholders’ agreement restricting them from sharing any confidential information outside of the Company for a set period of time.
Employee share options (if applicable) – provisions may be included so that any employee (or other) share options to be granted are subject to shareholder approval. This approval can also be limited to a number of shares or a period of time for the grant of the options. The existing share option plans and template agreements can also be approved here to avoid passing a separate resolution.
Dispute resolution – any agreed mechanisms for dispute resolution can be noted whether this may be instructing an agreed intermediary or voting on relevant issues.
Additional bespoke clauses tailored to the company’s or shareholders’ requirements.
The downsides of a shareholders’ agreement
While having a shareholders’ agreement has many advantages, if a shareholders’ agreement is not well-drafted then you may run into problems and at that point you want to vary or amend the agreement. However, a shareholders’ agreement may be drafted so that you require every shareholder to agree to the amendment or variation. This can cause issues where not everyone is in agreement or you are looking to waive a section which will disadvantage some of the shareholders. It may simply be difficult to get in touch with a shareholder therefore the amendment/variation/waiver cannot take place.
Shareholders (especially founders) are also potentially at risk of having the shareholders’ agreement be too restrictive meaning they are unable to run their business effectively. This can be in the form of having too many reserved matters or areas requiring shareholder consent. It can slow down the Company’s progress and add time or legal costs to have matters approved.
Notwithstanding the possible downsides, it is often the case that the advantages of having a shareholders’ agreement would always outweigh the disadvantages, if drafted well. This is particularly the case for SMEs where shareholders have a significant interest or involvement in the business nd they want to protect the position, but it is for each company to carefully consider whether a shareholders’ agreement is right for them.
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Written by:
Head of Corporate & Commercial Solicitor
Corporate & Commercial Solicitor
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