Shareholder Agreements

Why do I need a Shareholder Agreement?

Under English law, the default “rules” governing a company’s constitution (often referred to as the company’s “Articles of Association”) do not contain detailed provisions relating to how shares in the company are bought and sold. In the vast majority of cases, companies are incorporated with these default rules and no thought is given to the shareholders’ or directors’ specific requirements – the owners are more likely to be focussed on building up the business rather than considering how it will be run in the future, or what their exit strategies should be.

Why does this cause a problem?

The most significant problem is the difficulty that a shareholder may encounter when they decide that they would like to realise their investment and sell their shares in the company.

The market for the sale of shares in private companies to third parties that have not previously been involved with the company is very limited. In practice, a buyer will not be willing to purchase unless all (or at least 75%) of the shares are sold to them at the same time, so they can exercise a controlling stake in the company. With many shareholders owning 50% or less of the shares in a company, the only realistic option they are left with is being “bought out” by their fellow shareholders.

But what if their fellow shareholders are not willing to purchase the shares, or are only willing to do so at a low price to reflect their lack of marketability?

What can be done?

These problems can be overcome by properly thought out exit strategies which can be implemented into a shareholder agreement that is signed by all of the shareholders and which lays down the ground rules governing all sales and purchases of shares in future.

These rules may include “rights of pre-emption”, which require that shares are first offered to the existing shareholders before any sale to an unconnected third party, or an obligation for the remaining shareholders to purchase the outgoing shareholders’ shares in certain pre-agreed situations.

A shareholder agreement can also deal with sensitive issues such as the value to be attributed to the shares, either via a pre-agreed formula or by referring to an independent expert. This formula could include a modest discount to reflect that the buyers have been put to an inconvenience in raising funds to purchase, or a more severe discount could be implemented to act as a disincentive preventing a shareholder from parting with the company for an agreed period of time.

Are there any other issues that a shareholder agreement can help with?

Shareholder agreements can also deal with issues such as the conduct of the directors, and how to deal with key management decisions for the business. For example, provision can be made for a shareholder to be forced into selling their shares should they not comply with a pre-agreed set of rules, or for the value of their shares to be lowered in such circumstances.

Further, shareholder agreements can list certain decisions that can only be made with the consent of all of the shareholders, or in the alternative, those decisions that can be vetoed by one or more of the shareholders.

Without these provisions, shareholders could otherwise be left with having to abide by key decisions about the company that they simply do not agree with, such as the decision to declare a dividend or to enter into a particularly risky contract with a supplier or customer.

My company does not have a shareholder agreement. What should I do next?

At Nicholsons, our experienced commercial solicitors have the knowledge and expertise to be able to design a shareholder agreement that suits you and your company. Why not get in touch with us to arrange an appointment so that we can discuss your specific needs in more detail?