Shareholders’ agreement – do I need one and who will it benefit?

29 March 2018

This is a very common question asked by some businesses I interact with. My answer is always – you are asking the wrong question.

Consider these:

  • How do you resolve disputes amongst the shareholders? Especially when there’s only two shareholders each owning half the company and you have a deadlock.
  • What happens if one of your fellow shareholders wants to sell some or all of his/her shares? And worse case start-up a new business in competition?
  • What happens if you want to exit the business or retire? How will you leave the business? Who will buy your shares? How will they be valued?
  • What happens if you or one of your shareholders gets run over by a bus tomorrow? Who inherits the shares? Also, what tax implications would this have?

If, like a lot of business owners, the answers to the above questions are ‘I don’t know’ then I would encourage you consider the scenarios in detail now before it’s too late. More often than not business owners do not put in place a shareholders’ agreement or consider the above scenarios until issues arise. As a business grows views will diverge, circumstances change and resentment can build between shareholders leading to potential disagreements that could harm the business in the long run.

So let’s get back to basics – what exactly is a shareholders’ agreement? A shareholders’ agreement is a contract between all shareholders of the company to govern the relationship and put in place rules and responsibilities that each party should abide by.

The benefits of a shareholders’ agreement include:

Dispute Resolution

Despite all parties having the best intentions, sometimes company shareholders and/or directors run into a dispute. These can be time consuming and a huge distraction from running the business. This can be particularly difficult where there are only two shareholders owning equal stakes.

A shareholders’ agreement can include a mechanism for the parties to resolve such disputes without drastic measures such as dissolving the company. These can include an independent vote by an external third party such as a non-exec director or a professional advisor or the chairman can have the casting vote.

Decision Making

It is also common for there to be multiple shareholders in an SME business holding different share percentages. This can result in the majority shareholders forcing issues and making decisions for the business that are not necessarily in the best interest of all shareholders.

This is quite often why shareholders’ agreements identify which specific circumstances require unanimous approval from all shareholders for example entering into a loan agreement or appointment of directors.

Share Transfer Restrictions

Generally, SME businesses have a handful of shareholders, therefore any change (addition or removal of shareholders) would have a huge impact on the business. Without any specific provisions, shareholders can freely transfer their shares to anyone! An agreement would include restrictions such as approval from all shareholders before shares can be sold and usually the other shareholders have the first opportunity to buy before an external third party.

Non-Compete

Intangible assets such as databases and client relationships are the most valuable and also easily transferrable to a new business. Including a non-compete clause will provide some protection for the shareholders and also an opportunity of some sort of compensation should this situation ever arise.

Death

In the event that a shareholder dies, if no agreement is in place, then the remaining shareholders are forced to deal with a shareholder’s estate or beneficiary who has no interest in the business. To provide certainty and comfort, provisions can be included so the company and/or shareholders can have the option to purchase the deceased shareholder’s shares.

Drag & Tag

Where there are minority and majority shareholders, ‘drag and tag’ clauses are recommended. This means if the majority wishes to sell their shares to a third-party buyer, that buyer would be forced to make an offer to buy the minority shareholders’ shares at the same time. The minority shareholders can effectively ‘tag along’ with the sale if they do not wish to continue under the new management and control.

On the other hand, if the majority shareholders wish to sell their shares to a third party but the third party is only willing to purchase 100% of the shares in the company then the selling shareholders can ‘drag along’ the minority shareholders to also sell their shares.

Following on from this there are not really any disadvantages to putting a shareholders’ agreement in place. In almost all circumstances shareholders will be in a better position than no agreement at all.

An ounce of prevention is worth a pound of cure. Investing time and resources in discussing and agreeing various scenarios from the outset when the shareholder relationship is stable will provide great benefit for the future and success of your business.

If you would like to discuss any of the points raised, please contact myself or your usual UHY adviser.