Theresa Grech – (Author) Partner and Head of Corporate (Cardiff) – Ince
Karina James-Wiltshire – (C0- Author) Corporate Legal Executive – Ince
If you are starting up a company with more than one shareholder, it is advisable to have a shareholders’ agreement (‘Shareholders Agreement’) drawn up – this is a contract which establishes the relationship the shareholders have with each other and the company. The Shareholders’ Agreement, together with the Articles of Association (‘Articles’), form the constitution of the company. It is not a legal requirement to have a Shareholders’ Agreement, however there are a number of key benefits of entering into such a Shareholders’ Agreement as set out below.
Provides certainty and stability
Most start-up companies adopt standard Articles on incorporation (known as the ‘Model Articles’) which contain no specific restrictions on the transfer of shares.
Without such restrictions a shareholder is free to:
1. Transfer their shares to anyone, with the risk that they may decide to transfer their shares to a party who is not known to the other shareholders; or
2. Transfer their shares to a competitor.
This can introduce uncertainty into the operation of the business and disrupt the smooth running of the company. Therefore, clauses are often included in the Shareholders’ Agreement to ensure that if a shareholder wishes to transfer their shares, they must first offer the shares to the remaining shareholders of the company. If the other shareholders do not wish to buy the shares and they are happy for them to be transferred to a third party, the Shareholders’ Agreement can state that any new shareholder must abide by the terms of the existing Shareholders’ Agreement by entering into what is known as a ‘Deed of Adherence’.
The Shareholders’ Agreement can impose restrictions on individuals whilst they are a shareholder of the company, and/or for a certain period of time after they cease to be a shareholder of the company. For example: shareholders can be prohibited to carry on any business which competes with the business of the company or entice away customers or employees from the company.
In general, the restrictions can be stricter than similar clauses which can be inserted in an employment contract, so they can prove very useful to a company should the shareholders fall out and a leaving employee shareholder decides to set up in competition to the business of the company.
A confidentiality clause can also be inserted into the Shareholders’ Agreement so that shareholders do not use or pass confidential information to any competitors of the business. These confidentiality restrictions can apply for the duration of the Shareholders’ Agreement and after its termination.
The Shareholders’ Agreement can offer protection to all shareholders whether the individuals are minority or majority shareholders.
For minority shareholders it ensures that some key decisions require the unanimous consent of all shareholders, and not just the majority or 75% of the vote (as required by the Articles and/or the Companies Act 2006). This will mean that the minority shareholders will have a right of veto over some key decisions.
Also, a ‘tag along’ clause could be included in the Shareholders’ Agreement so that in the event a majority shareholder decides to sell their shares, such a clause would allow the minority shareholders (owning less than 50% of the share capital) the opportunity to participate in the sale at the same time and price (i.e. they can ‘tag along’).
For the majority shareholders a ‘drag along’ clause could be included so that in the event there is an offer from a third party to purchase the entire issued share capital of the company, minority shareholders can in effect be ‘dragged along’ and forced to accept the third party offer and sell their shares on the same terms as the majority shareholder. It is worth noting that ‘tag along’ and/or ‘drag along’ clauses can be included in the Articles.
It is foreseeable that during the operation of the business, the shareholders and/or directors may find that they disagree about certain matters relating to the company. Disputes can be time consuming and expensive. Therefore, the Shareholders’ Agreement can be a useful tool to manage these disputes should they arise and set out various provisions to deal with them.
Are you starting a new business?
To help new businesses in these uncertain times, we have prepared a free start-up pack. The pack contains useful guidance highlighting the key actions to undertake and issues to consider so that your new business has the correct legal framework and protection from the outset – and ensuring your start-up business has every chance of success.
To download our free legal start-up pack, please complete your details here.
Want more information and advice?
For more information and advice on legal considerations for start-ups from our corporate legal team or guidance on setting up a company through our company secretarial service, get in touch with a member of our team below:
Theresa Grech, Partner and Head of Corporate, at [email protected]; or
Karina James-Wiltshire, Corporate Legal Executive, at [email protected].
Melanie Kincaid, Head of Corporate Support Services, at [email protected].
The information above is not and should not be taken to be legal advice. You should not take action or omit to take action based on this information.