The horrors of shareholder disputes cost eye-watering sums of money, destroy relationships, and destroy businesses. That is why, unless you are the only shareholder in a business, you should invest in a shareholder agreement.

In this blog post, Walker Foster commercial and corporate solicitor and director Keith Hardington shares insights into how shareholder agreements work, what kind of problems they can solve, and why they are so important to have…

What is a shareholder agreement?

A shareholder agreement is a documented contract (agreement) that records the intentions of the shareholders and governs their shareholder relationship and how they will act in relation to the company.

Many owner-managed and family businesses are private limited companies, and typically the company is ‘owned’ by two or more shareholders from the outset. These shareholder relationships change over time, presenting different challenges during the startup and growth phases, and when exiting the business. As people and circumstances change, ironically the success of a business can increase pressures on shareholder relationships and the business itself.

If you think about shareholder agreements in terms of what they do instead of what they are, their value becomes clearer. Here are some examples:

• Cross-options: these agreements allow the company to buy back shares in the event of the death or critical illness of one of the shareholders, using the proceeds of an insurance policy to fund the purchase. The remaining shareholder(s) remain in control of the company and the deceased’s estate receives the value of the shares – a win-win situation that avoids a great many costly issues.
• Employee shares: in recent times of increased salary costs, employers have been considering different ways of rewarding and incentivising key employees. This includes offering shares in the company; however, this should not be done without professional advice, and we will always recommend a shareholder agreement before doing this. We can advise separately on employee share schemes and growth shares, etc.
• Minority protection: minority shareholders hold 50% or less of the shares in a private company, and therefore lack sufficient control to protect their investment and to make or prevent key decisions in the business. Minority protection is therefore a very important value of shareholder agreements, ensuring that the perspectives of these shareholders are properly safeguarded.

What problems can shareholder agreements solve?

By putting a shareholder agreement in place, your company will be able to avoid a number of common issues that could otherwise arise:

• The shareholder agreement can clearly set out what cannot be done without shareholder consent (often defined by a percentage of total issued share capital or sometimes unanimity).
• A shareholder has no legal entitlement to be appointed a director of the company, and it is the directors who run the company. The shareholder agreement can provide a right to be appointed director.
• A shareholder who is not a director can set up business in competition with the company. The shareholder agreement can include restrictions on shareholders and former shareholders to prevent these conflicts of interest, to protect the business and the other shareholders.
• The shareholder agreement can include a dividend policy. This can be particularly helpful to avoid arguments about fairness. We have seen many examples of 50/50 share splits where both shareholders have been working in the company and one of them retires while the other is still working in the business full time, but the retiree is still entitled to receive the same dividends declared, giving rise to disputes. Shareholder agreements can help to avoid this.
• A 50/50 shareholding can give rise to deadlock, damaging a company, its business and therefore the shareholders. The shareholder agreement can include methods of breaking these deadlocks.
• A shareholder agreement is private to the shareholders and is not filed on the public register at Companies House. You can include provisions that you do not wish to be publicly visible.

Why you should consider a shareholder agreement as a priority

Most shareholders in disputes believed at the beginning of the relationship that they simply will not encounter conflicts and causes for disputes. Businesses often start with a lot of trust, collaboration and good relationships. That is the best time to plan and discuss your shareholder relationship, and record this in writing.

When the excitement of starting out in business becomes the reality of later business and personal challenges, planning and beginning with your shareholder agreement can save time, money, distraction and distress. They are a proportionate investment that can save you and the business.

Find out more

We recommend that you plan by investing in a professionally prepared shareholder agreement. Take a look at our commercial and business contract service page to learn more, or get in touch with us if you have any questions.