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What is a Shareholders’ Agreement? All You Need to Know

24 September 2021

A shareholders’ agreement is an agreement between the shareholders of a limited company, the contents of which are determined by the shareholders themselves.

The agreement typically contains rules on how the company is run and sets guidelines to follow upon the occurrence of certain events.

Whereas a company’s articles of association are public and can be viewed by anyone, a shareholders’ agreement is a private document and so may contain provisions which the shareholders wish to remain confidential.

What should be in a shareholders’ agreement?

What to include in your shareholders' agreement can depend on a number of factors, including the size and nature of the business, the number of shareholders and the size of their respective investments and shareholding.

A shareholders’ agreement is not a mandatory legal document so it can be as straightforward or as complex as is needed.

Typically, shareholders’ agreements cover the following matters:

Board constitution and meetings

It is common for shareholders agreements to outline the make-up of the board, how often the board should meet, and whether any shareholders should have rights to appoint, remove and replace directors.

Reserved matters

This is a list of matters that the Company must not carry out (for example, in relation to financing, material contracts, related party transactions, etc) without the prior consent of a particular group or voting percentage of the shareholders.

Selling and transferring shares

Provisions may be included that restrict the ability of shareholders to transfer their shares, or require shareholders to offer their shares to existing shareholders before being able to sell them to third parties.

Compulsory transfers

Shareholders may be required to sell their shares on the occurrence of particular events, for example if the shareholder ceases to be an employee, suffers an insolvency event, or repeatedly breaches the agreement.

Restrictive covenants

Restrictive covenants prohibit shareholders from carrying out certain activities in order to protect the business. Typically, they restrict involvement with competing businesses and solicitation of clients, suppliers and employees.

Drag along

“Drag along” provisions operate where an offer is received to buy all of the shares in the company and a defined majority of the shareholders wish to accept that offer.  The rights allow the majority to require the other shareholders to also accept the offer in order for the transaction to progress.

Tag along

“Tag along” provisions can enable minority shareholders to “tag on” to a majority shareholder in a share sale situation, where the majority attempt to sell only their shares rather than seeking to find a buyer for all the shareholders.

Accounting and other information

Certain shareholders may wish to receive financial and other reporting information that they would not otherwise be legally entitled to, such as monthly or quarterly management accounts.

Financing the company

Shareholders may wish to agree at the outset how they envisage the company will be financed, including through equity, shareholder loans, and/or external financing.

Why have a shareholders’ agreement?

Whilst a company’s articles of association will contain a lot of the rules concerning the operation of the business at a constitutional level, a shareholders’ agreement allows the shareholders greater freedom and privacy to create rules by which the company must operate.

By way of example, some common benefits of having a shareholders’ agreement include:

Avoiding shareholder disputes

Many of the disputes that commonly arise between shareholders may be avoided or more easily resolved by the terms documented within shareholders’ agreements.

Control over share transfers

Share transfer provisions, such as transfer restrictions and pre-emption rights, can be a useful tool to regulate who may or may not acquire and hold shares in the company.

Specific shareholder rights

Individual shareholders may not necessarily have the legal right to appoint directors or receive operational information in relation to the company, which rights can be granted by shareholders’ agreements.

Greater control for shareholders

Whilst the day-to-day running of the company is generally left to the board of directors, certain “reserved matters” can require shareholder approval before being carried out rather than being left to the discretion of the board.

Protection for majority shareholders

The “drag along” rights discussed above can enable majority shareholders to achieve an exit by removing the possible obstacle of minority shareholders not agreeing to sell their shares to a buyer wanting to acquire the company.

Protection for minority shareholders

A shareholders’ agreement can generally only be amended by unanimous consent of the shareholders (unlike articles of association, which can be amended by 75% shareholder approval). The “tag along” rights referred to earlier also allow minority shareholders to participate in a sale by majority shareholders.

Demonstrates business stability and sophistication

Having a shareholders’ agreement in can demonstrate a sense of stability of your business to banks, creditors and potential investors that may be looking to invest in your company, with the indication that the relationship amongst the shareholders is well regulated.

Restrictions on leavers

If a shareholder exits the company, the restrictive covenants can operate to protect the legitimate business interests of the company with a level of protection that would not otherwise exist.

These are just a few examples of why a shareholders’ agreement is an important tool for a company to have and to protect individual shareholders.

Whilst shareholders can create a shareholders’ agreement at any time, the advantage of preparing a shareholders’ agreement as soon as possible is that it is easier to agree terms and set out a clear procedure on how the company should be run and how disputes should be addressed at the outset of a relationship.

This article is provided by Burlingtons for general information only. It is not intended to be and cannot be relied upon as legal advice or otherwise. If you would like to discuss any of the matters covered in this article, please contact Maria Nadarajah or write to us using the contact form below.

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