What Is a Shareholders Agreement?

Last Updated: Mar 10, 2021

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Company FormationLimited Companies

A shareholders’ agreement means a legal private document that is drawn up between the members or shareholders of a company that is limited by shares. This sort of agreement is optional and states precisely the shareholders right, their obligations to the company and the relationship between them. Though the Companies Act 2006 and the articles of association covers this issues to a certain point, a shareholder’s agreement specifies the specific duties and right of a shareholder which to a larger extent isn’t covered in the articles of association.

Do I require a shareholders’ agreement?

Yes and no. It isn’t legally required for companies limited by shares to have such an agreement or file a document like that with the Companies House. Nevertheless, it is something that must be carefully considered if the shareholders of a company are more than one. It is needed more especially when the shares of the shareholders in the company are not equal.

An agreement like this will help protect all the shareholder right, not minding if they hold the majority, minority or equal stake in the business– however it is especially valuable for minority shareholders who need protection from the voting powers of those majority that might be possibly unfavourable to them.

At what point should we put in place a shareholders agreement?

Normally, you ought to put in place a shareholders’ agreement immediately after your company gets incorporated and the first set of shares gets issued. This is the most ideal approach to ensure the interests and rights of the initial members and any individuals who join the business after its incorporation, irrespective of the value of their stake in the company is protected. Do not make the mistake of assuming all things will continue to be okay simply because you are setting up the business with family, people you presently have a wonderful relationship with our friends.

Anything can turn out badly in business, therefore it is better to begin on a good track and put in place a shareholders agreement, and peradventure a disagreement comes up. And, they most likely will! You must really protect other members and yourself by putting in place clear guidelines and rules when the going is rosy. Going into a shareholders’ agreement will help you solve issues rapidly and easily in a helpful and favourable way. Also, it could keep a wonderful relationship from going bad.

What should make up a shareholders’ agreement?

A shareholders’ agreement works hand in hand with an organisation’s articles as a practical system to govern and regulate the inner administration of the business. Some of the well-known and vital issues a shareholders agreement can and should cover include:

• The organisation’s main goal and the things it can do
• The removal and appointments of its directors
• The directors’ obligations and powers
• The salaries, terms of payment and bonuses of the directors
• Its distribution of profit as dividends policy
• Rules, procedures and restrictions for share issue and transfer
• Shareholders obligations and rights, including provisions for ‘tag along’ and ‘drag along’
• The investment of the shareholders, liability and extra financing commitments
• The process for handling a shareholders termination or departure
• What happens when a shareholder dies
• Procedures for Internal and external resolution of disputes
• Holding board meetings and general meetings
• Procedures for making key decisions, like which decisions require more endorsement and which decisions must be approved by every member.
• Non-competition and also provisions and covenants for confidentiality
• Entering huge financial agreements or business contracts

Changing a shareholders agreement is a lot easier than that of the articles of association. It can be modified whenever and there is no compelling reason to reveal the report to anybody other than the companies’ members.

Advantages of a shareholders’ agreement for minority shareholders

Minority shareholders will gain much from a shareholders agreement. Except given protection by an agreement like this, the powers of the minority shareholders to vote (i.e. those who own less than 50% of the issued share capital of an organisation) can be vetoed by the voting strength of the majority. This simply means their votes are basically useless when decisions require the vote of the majority as opposed to a unanimous vote. This can result in the majority having the capacity to make significant changes and key decisions without the approval of other shareholders.

A shareholders’ agreement can thus protect minority shareholders right by empowering them to:

• Participate in vital administrative decisions
• Veto certain activities
• Receive reasonable treatment
• Be an executive of the organization and establish his or her right not to be sacked as a director
• Enjoy ‘drag along’ rights if the organisation is sold – i.e. the majority can sell out their shares except same offer is likewise made to the minority. They can’t just be ignored if most of the share of the business is sold to an outsider.
• Protect their shareholdings investment value
• Not be compelled to sell their shares

Moreover, an agreement can only be changed when all the shareholders approve it, while the articles can be changed by a 75% majority. This action can be unfavourable to the minority if they do not concur with the changes made to the articles.

Advantages of a shareholders’ agreement to majority shareholders

The majority of shareholders have a tendency to gain more when there is no agreement in place. They hold most of the shares and voting power, therefore the majority rule, so they can do just about anything they like. Nevertheless, they have little power to really compel the minority to offer their shares or keep them from selling to the wrong individual. This is the point an agreement can be truly useful to major shareholders.

• Drag along rights

Drag along rights can be incorporated into a shareholders’ agreement to compel the minority to sell their shares if a reasonable offer has been made to the majority. Basically, the majority can simply ‘drag-along’ the minority to prevent being caged and not able to sell due to the minority reluctance.

• Restriction on offer exchanges

A guideline on the share transfer restriction can be incorporated to avert a troublesome or stupid minority shareholder from selling shares to a wrong outsider or adversary; nevertheless, this is advantageous to all shareholders, as against only the majority. The most ideal approach to deal with the sale/transfer of shares is to think of a reasonable and efficient set of guidelines concerning when they can sell the share and to whom.

Article by

Jody Smith

A content and media expert, I have worked for 7 years alongside start-ups and small businesses to effectively promote their brands through blogs, social media and content marketing strategies.