If there is one thing that you should get as soon as you shake hands with your co-founders, is a well-drafted shareholders’ agreement.
Let’s say you are a visionary entrepreneur with a great business idea, a unique product in development and a talented team. Perhaps you have already registered your company and adopted the standard model articles of association. Most likely, the last thing that you are thinking about at this stage is the “paperwork” and spending on anything that does not directly improve your product. Sounds familiar?
Well, we urge you to reconsider. Think of a shareholders’ agreement as your insurance policy that offers protection against unforeseen circumstances and disputes that may emerge in the future – be it with your co-founders, investors or directors. Sure, you are all “mates” now, but conflicts happen and this is where having a solid legal framework is essential.
WHAT IS A SHAREHOLDERS’ AGREEMENT?
A shareholders’ agreement is a legally binding contract among the shareholders that sets out their rights and obligations, maps out how the company should be managed, establishes share ownership and share transfer rules – all in order to provide clear solutions to contentious scenarios that may arise in the future.
In contrast to the articles of association of a company, a shareholders’ agreement is a private confidential document that does not need to be filed at Companies House and is often a more appropriate document to address sensitive commercial matters such as assignments of intellectual property rights, the directors’ compensation or other matters that may need to be kept confidential.
As there is no business that is the same, there is no one standard shareholders’ agreement, which is why we are always cautious about any off-the-shelf templates that are available online. So where should you start? Naturally, we suggest that you speak with an experienced legal professional who could help you prepare the shareholders’ agreement that is specific to the needs of your company and co-founders and, if needed, negotiate the terms with your investors and/or their legal team.
While you are getting ready to instruct your trusted legal advisers, we suggest that you do your homework too and get a clear idea – to the extent possible – how to address the following fundamental questions.
HOW WILL YOUR COMPANY BE MANAGED?
The directors of your company – and not the shareholders – are in charge of managing your company’s business. They make strategic and operational decisions and are responsible for ensuring that the company meets its legal obligations. The Companies Act (2006) requires all private companies to have at least one director (a public company must have two) and leaves the decision as to the composition of the board of directors to the shareholders.
This is where the shareholders’ agreement comes into play and gives the shareholders an opportunity to specify how many board members should manage the company, how many votes are required to make a decision, how directors get appointed to or removed from office.
SHOULD SHAREHOLDERS HAVE A SAY AND WHEN?
Shareholders’ agreements are often drafted with a view to exceeding the minimum statutory requirements established in the model articles of association that you are likely to have adopted while registering your private company.
For example, where the model articles of association require a vote by a simple majority of 50% plus one share, your shareholders’ agreement may increase that threshold for all or some important decisions such as mergers, acquisitions or adjustments to the composition of the board directors, among other things.
We often suggest a “three-bucket” approach here. Think about all possible business decisions that the shareholders or the board will be making in the future and try to allocate them into three buckets:
- The first bucket would contain decisions that require the consent of 75% of voting shares (supermajority consent),
- The second bucket would contain the decisions that would require the consent of more than 50% of shares (majority consent),
- and the third bucket would contain all other decisions that would be made by the board of directors.
WHAT HAPPENS IF A SHAREHOLDER DECIDES TO LEAVE?
As life goes on, the composition of the shareholders may change. You or your co-founders may decide to move on and sell their shares to someone else. Or you may be faced with a situation of a “bad leaver” and must decide how to proceed. These are the situations that the share transfer provisions in your shareholders’ agreement are designed to address by distinguishing between permitted, voluntary and compulsory share transfers.
- Permitted transfers are transfers to another existing shareholder, an entity controlled by an existing shareholder or to an existing shareholder’s family. The shareholders’ agreement would define which relatives are included or excluded in each case and contain clear language as to whether the consent of (or simply a notice to) the remaining shareholders would be required.
- Voluntary transfers refer to the disposition of shares by way of a sale, assignment or encumbrance. Normally, the consent of at least the majority of the remaining shareholders would be required for any voluntary transfer.
- Compulsory transfers (or automatic transfers) are triggered when a shareholder dies, is convicted of a crime, is dissolved or liquidated. Your shareholders’ agreement may provide that the compulsory transfer provisions “kick in” when a shareholder becomes a “bad leaver”.
WHAT HAPPENS WHEN YOU RAISE CAPITAL?
Most companies reach a point when additional funding is needed for further growth and to access more working capital. So, when raising capital means issuing additional shares to, for example, an independent investor, it is important to specify in the shareholders’ agreement what anti-dilution protections – if any – the original shareholders have.
It should also be clearly stated that any new shareholder must become a party to the shareholders’ agreement prior to receiving his shares (typically by executing a document called a deed of adherence).
HOW COULD WE HELP?
Getting your shareholders’ agreement right is of fundamental importance to your business. We are here to help, share our market knowledge and guide you through key concepts discussed above, as well as other provisions important for your shareholders’ agreement such as exit, information rights, competition and non-disclosure, among others. Book a call with our friendly and experienced legal team to discuss the preparation of your shareholders’ agreement or your other legal needs.
Our legal commentary is not intended to be a comprehensive review of all developments in the law and practice. Please seek legal advice before applying it to specific issues or transactions.
