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19/03/2021

What is the purpose of a Shareholders’ Agreement?

Tim Edwards Corporate director

When setting up a new company, it is common for shareholders, as owners of the company, to enter into a Shareholders’ Agreement. It is highly recommended and common for shareholders to enter into on the registration of a new company but may be entered into at any time in the life of a company.

Through entering into a Shareholders’ Agreement, the shareholders can regulate the exercise of their rights in relation to the company and commit to how they will behave and run the company. If you have a Shareholders’ Agreement, it is therefore important to keep it in order to protect each shareholders’ interests.

There  are a number of key clauses that should be included that will facilitate decision making both for board members and shareholders.

Company decisions can be taken by the board (as appointed directors) to manage the company on a day to day basis, however, to main control and in some cases as a legislative requirement, shareholders can reserve certain important decisions and restrict director decision making on the management of the company to the shareholders.

A Shareholders’ Agreement should set out the restrictions that the shareholders are likely to want to control, as far as possible e.g. changes to the articles of association, alteration of share rights, increase or reduce the amount of share capital.

A Shareholders’ Agreement can help protect a minority shareholder and their interest where they would not otherwise have that protection. Important changes to the company can be decided by all the consent of the shareholders (100%) and not just by the standard position i.e. by majority voting rights. 

Therefore, for certain reserved matters, there should be an undertaking in the Shareholders’ Agreement that the company will require the consent of all parties and not simply the majority of shareholders.

Voluntary Transfer of shares – pre-emption rights and permitted transfers

What happens if a shareholder wants to transfer their shares?

A common position is that pre-emption rights apply (right of first refusal) e.g.  if anyone wishes to transfer their shares, they must first offer them to the existing shareholders (pro-rated in accordance with their % shareholding) on the same terms.

If the existing shareholders refuse the offer, the shares may then be offered to the company (which may choose to buy back the shares if it has sufficient distributable reserves and cash to do so).

If neither the existing shareholders nor the company wish to acquire the shares, the Shareholders’ Agreement can outline whether the shares be transferred to a third party. The Shareholders’ Agreement should prohibit transfers to specific third parties or to any third party that competes with the business of the continuing shareholder.

The Shareholders’ Agreement may also specify various transfers to third parties which are free from restrictions such as pre-emption rights. These are commonly known as permitted transfers. Examples of permitted transfers may include transfers to family members and family trusts.

Issue of shares – anti dilution

The Shareholders’ Agreement should include provisions dealing with the directors’ authority to allot and issue further shares. Additional equity subscriptions can dilute the voting power and rights of existing shareholders. It is important that the Shareholders’ Agreement contains anti-dilution mechanisms before the issue of any new shares to protect the shareholders against a dilution of their shares and voting rights.

Buy out events  

It is important that the Shareholders’ Agreement deals with what happens to a shareholder’s shares when certain events occur e.g. death, bankruptcy, mental incapacity, termination of employment (if the shareholder is a key employee) or if there is a material breach of the Shareholders’ Agreement.

These are often known as “buy out events” or “compulsory transfer events”, where on the occurrence of such event a shareholder’s shares are automatically offered for sale to the other shareholders or the company at a specified price (often nominal value).  

This is particularly important where a shareholder is also key employee. Shareholders’ Agreements may contain detailed leaver provisions governing the circumstances surrounding the termination or cessation of the SH’s employment.  Generally referred to as “Good Leaver” “Bad Leaver” provisions, these circumstances will ultimately determine the sale price for the shareholder’s shares on his or her exit.    

Drag along and tag along rights

Drag and tag along rights are commonly included in Shareholders’ Agreements to deal with a majority and a minority shareholder.

Drag along right provides for a majority of the shareholders to accept an offer for the sale of the entire issued share capital of the company and to force the holders of the remaining minority shareholders to accept such an offer.

Tag along rights puts a minority shareholder first. Tag along rights enable certain shareholders (usually minority shareholders) to force other shareholders (who wish to sell their shares) to procure that an offer on the same terms is made to them also.

Restrictive covenants when a shareholder leaves

The Shareholders’ Agreement should include provisions dealing with the departure of a shareholder. These are called restrictive covenants and are usually included to prevent shareholders from competing with the business of the company.

The following set of restrictions are common:

No holding out – to associate with the company or hold out being employed in any way with the company.

Non-compete – to protect the goodwill of the business and not to operate in the same geographical area of the company or for a certain time period deal with any clients of the company.

Non-solicitation – offering of employment to employees or enticing away from the company any employees.

It is usual for these restrictions to apply at any time when the party in question is a shareholder and for a time period after ceasing to be a shareholder e.g. a number of months or a number of years.  

Dividends

The Shareholders’ Agreement should include provisions on dividend policy (sharing the profit) and whether the board or shareholders will decide the payment of dividends.

Conclusion

A Shareholders’ Agreement is highly recommended where there is more than one shareholder. This is to regulate the exercise of their rights and control in relation to the company and to set out how they will commit to run the company.

A Shareholders’ Agreement may be entered into at any time in the life of a company and there are a number of things to look out for in a Shareholders’ Agreement to protect a shareholder’s interest during their ownership of the company. 

If you would like more information and advice please contact Tim Edwards, Corporate Director on 0345 20 73 72 8 or info@thursfields.co.uk

Tim Edwards Corporate director

Tim Edwards,

Director, Corporate

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