Do not underestimate the importance of a Shareholders' Agreement! - | Hudson McKenzie

Do not underestimate the importance of a Shareholders’ Agreement!

December 10, 2015 | Corporate, M&A and Securities, News

When a shareholder decides to invest in a limited company and subscribe for shares, it is common to desire to protect the investment. The simple solution is to enter into a shareholders’ agreement: a contract between members of the company, laying foundations governing their relationship by listing their duties and responsibilities.

The most common scenario is for small to medium sized enterprises to be run by a private company, limited by shares.

Formation of a new company can be done quickly and efficiently. Although the Articles of Association are the backbone of the company, they do not always satisfactorily account for all of the issues which may arise during the company’s life.

Shareholders’ agreements, unlike the Articles of Association, are not fully entrenched and offer a greater degree of flexibility; they are not registered with Companies House and are therefore not in the public domain – a huge advantage.

Areas which are frequently addressed in shareholders’ agreements:

  1. Selling your shares

When selling shares, there is no automatic right which requires other shareholders or the company to buy your shares at a fair value. The other shareholders may simply do nothing, and at worst, could reduce the value of your shareholding.

If drafted well, a clause should provide a right to require other shareholders (or the company) to buy back, failing which the company would have to be sold in order to realise the shares. The effect of this is to apply pressure on shareholders to make reasonable offers for the shares being sold.

  1. Regulation of Directors

It is the directors who are responsible for the day to day running of the company. The unease here is that where a minority shareholding is concerned, decisions regulating the activities of the company can be taken which may have an adverse effect on the shareholders. As such, it is typical for a shareholders’ agreement to stipulate that consent from a requisite shareholder minority must be obtained when making important decisions, for example issuing new shares or removing a director.

  1. Restrictive covenants

Most shareholders would rather that their fellow shareholders did not for example, disclose confidential information to third parties or set up in competition, however, without a shareholders’ agreement in place there is little to prevent this from happening. While some shareholders may fall under the restrictive covenants of a service contract (i.e. those who are employed by the company), those who are not employed aren’t, and it is important to ensure similar restrictions are in place for their counterparts who are not employed.

  1. Dividend policy

Particularly in the teething years of a company, it is common for shareholders’ rights to receive dividends to be restricted. The driving factor being that the company can retain sufficient profits to support future maintenance and growth.

  1. Dispute resolution

Litigation is not only costly but time-consuming, very often the value of the claim being far surpassed by the cost of bringing the action in the Companies Court. Wherever possible, it is advisable to have a clause which provides for alternative dispute resolution in the event that the parties reach an impasse.

Of course, the above is not an exhaustive list of areas which can be catered for in a shareholders’ agreement, but it is a solid platform to build on.

If you would like assistance with drafting a shareholders agreement or have a shareholders’ dispute, please get in touch with our Commercial Lawyers in London  on +44 (0)20 3318 5794 or via email at londoninfo@hudsonmckenzie.com.