Why do I need a Shareholders’ Agreement?

• Posted onJanuary 30, 2017

Why do I need a Shareholders’ Agreement?

We set out below the reasons why you ought to have a shareholders’ agreement. The main reason is to protect minority shareholders (shareholders owning less than 50% of the shares) against majority shareholders (those owning more than 50% of the shares).  Therefore, if there are only 2 equal shareholders who are also the only directors then arguably one of the main reasons for a shareholders’ agreement does not apply.  However, disputes are common and a shareholders’ agreement will help avoid and resolve disputes.

Why is a minority shareholder vulnerable?

If a shareholder owns more than 50% of the shares (majority shareholder) he/she effectively has “control” of the company and could manipulate the affairs of the company to his/her advantage. For example, the majority shareholder could appoint additional directors and take control of the board of directors of the company.  With this majority he/she could transfer assets out of the company, dilute the shareholding of the minority shareholder, etc.  It is a good rule of thumb to say that a majority shareholder has control of your company.  Therefore, the minority shareholder needs protection. The shareholders’ agreement will set out what are known as “Reserved Matters” which are actions that might disadvantage the minority shareholders. The agreement will provide that no Reserved Matters can be actioned without the consent of all shareholders.

Dividend policy

Often there is a conflict between the interests of the shareholders about how much profits of the company should be paid out by way of dividend.  A common scenario is where a wealthy investor who is financially independent does not need dividend income and prefers all profits to be retained within the company to help it grow, whereas a young entrepreneur may want as high a level of dividend income as possible from the company as this may be his/her only or main source of income. These two positions need to be reconciled.

Exit

What happens if a shareholder dies, suffers serious ill health and can no longer work in the business or simply wants to retire? The agreement will address each of these circumstances, for example, in the case of the death of a shareholder it is usual for the continuing shareholders to have the option to buy the deceased’s shares but it might also be agreed that the deceased’s estate will have the option to sell the shares to the continuing shareholders.  But would that be affordable?  It may place an unrealistic financial burden on the continuing shareholders. Options to mitigate against this problem could be for each shareholder to take out life insurance which would be paid to the company or the continuing shareholders and used by them to fund the purchase of the shares from the deceased’s estate.

We think that an initial meeting with WSP Solicitors at this stage may probably be the most important meeting that you could have with your solicitor. This is a golden opportunity for you and your business partner(s) to discuss with us what you are each hoping to achieve by your involvement with your new company and to ensure that your rights and responsibilities as directors and shareholders are fully understood and agreed.  Indeed we think this meeting is so important that we will usually attend it free of charge and without obligation.

If you would like to get in touch with our specialist commercial law team, you can contact us here

You might also like to read our article on Forming a Company