Starting a business with another person is often built on optimism and trust.
At the beginning, everyone may agree about the direction of the company. Decisions are straightforward, responsibilities are understood and formal rules can feel unnecessary.
As the business grows, circumstances can change.
A shareholder may want to leave. Someone may wish to sell their shares. The founders may disagree about strategy. A new investor might join. One shareholder might stop contributing to the business while retaining a significant ownership stake.
A well-drafted shareholders’ agreement can provide a framework for dealing with these situations before they become serious disputes.
What is a shareholders’ agreement?
A shareholders’ agreement is a private contractual agreement between some or all of a company’s shareholders.
It can establish how shareholders will interact, how important decisions will be made and what happens when particular events occur.
This sits alongside the company’s articles of association and the wider requirements of company law.
The importance of understanding shareholder rights should not be underestimated. Government guidance explains that shareholders can exercise control over companies and participate in important decisions, while different classes of shares can carry different rights.
A shareholders’ agreement can add a tailored contractual framework around those relationships.
Establishing how important decisions are made
Not every business decision should necessarily require every shareholder’s approval.
Day-to-day decisions may be left to directors and management, while particularly significant matters can require shareholder approval.
A shareholders’ agreement might identify reserved matters such as issuing new shares, taking on substantial borrowing, selling major assets, changing the nature of the business or entering significant contracts.
Agreeing the decision-making framework in advance can help reduce uncertainty as the company grows.
What happens if a shareholder wants to leave?
One of the most important issues to consider is what happens to a shareholder’s shares when they leave the business.
Without appropriate arrangements, the remaining shareholders may find themselves in an unexpected position.
A shareholders’ agreement can establish procedures for proposed share sales and transfers, including whether existing shareholders should have an opportunity to purchase shares before they are offered to an outside party.
The agreement can also address particular circumstances such as death, incapacity or an employee-shareholder leaving employment.
Protecting minority shareholders
Ownership percentages can have a significant impact on influence within a company.
A shareholder with a relatively small holding may have limited ability to influence decisions where voting follows a simple majority.
A shareholders’ agreement can therefore include protections requiring a higher level of approval for particularly important decisions.
This can help ensure that fundamental changes to the company cannot be made without an agreed level of shareholder support.
At the same time, the agreement needs to avoid making ordinary business decisions unnecessarily difficult.
The appropriate balance will depend on the company’s ownership and management structure.
Planning for deadlock
What happens when shareholders simply cannot agree?
This can be particularly problematic in a company owned equally by two shareholders.
If both parties have equal voting power and fundamentally disagree about an important decision, the business can become stuck.
A shareholders’ agreement can include a mechanism for addressing deadlock. Depending on the circumstances, this might involve escalation, negotiation, mediation or a procedure through which one party ultimately buys the other’s shares.
It is much easier to agree a mechanism while relationships are positive than after a serious dispute has developed.
Protecting confidential information and business interests
Shareholders can have access to valuable information about customers, pricing, strategy, intellectual property and commercial opportunities.
An agreement can contain confidentiality provisions and appropriate restrictions designed to protect legitimate business interests.
These provisions should be carefully drafted for the particular company rather than simply copied from a standard template.
What happens when an investor joins?
External investment can transform a business, but it can also change its internal dynamics.
New investors may request specific rights relating to information, board representation, future share issues or significant corporate decisions.
Existing shareholders should understand how those rights interact with their own interests and the company’s existing constitutional documents.
Government guidance also highlights that ownership and control can create reporting obligations under the people with significant control regime. For example, holding more than 25% of shares or voting rights is one of the statutory conditions relevant to PSC status.
Investment should therefore be considered from both a commercial and legal perspective.
Do not wait for a dispute
A common mistake is treating a shareholders’ agreement as something to consider only once a business has become large.
In reality, some of the most difficult shareholder disputes occur in owner-managed businesses where personal relationships and commercial interests are closely connected.
Once a dispute has begun, negotiating rules for resolving it becomes significantly harder.
Putting appropriate arrangements in place early allows shareholders to discuss difficult scenarios objectively, before anyone knows who might benefit from a particular provision.
How Penerley Solicitors can help
Penerley Solicitors provides legal services to businesses and advises on corporate, governance and commercial matters. Its wider transactional practice includes business sales, mergers and commercial contracts.
Whether you are establishing a new company, bringing in an investor, restructuring ownership or reviewing arrangements between existing shareholders, carefully drafted documentation can help provide clarity and protect the business as it develops.
If your business needs a shareholders’ agreement or you would like an existing agreement reviewed, contact Penerley Solicitors to discuss your requirements.
