Many businesses are built on trust. Friends go into business together, family members are given shares in a company to help future generations, or founders simply incorporate as a box-ticking exercise. At the start, everyone is focused on growth.
That optimism, and the drive to move on to the next step, is often one of the reasons entrepreneurs succeed. It is also why some of the most important legal protections are overlooked until they are needed. By then, the conversation can be far more difficult.
A shareholders’ agreement is a private agreement between the shareholders of a company. One of the best descriptions I have heard is that it is part business pre-nup and part business plan. It sets out how the shareholders’ relationship will work, how decisions will be made, and what should happen if circumstances change.
It is also important to understand how a shareholders’ agreement sits alongside the company’s articles of association. The articles are the company’s constitutional rules and are publicly available at Companies House. A shareholders’ agreement, by contrast, is private between the parties and can include greater commercial detail and nuance. In many cases, the two documents need to work together, particularly around share transfers, decision-making and director appointments. If they pull in different directions, that can create uncertainty at exactly the point where clarity is needed.
For SMEs, a shareholders’ agreement is one of the documents I would always advise considering at an early stage. In practice, they are not as common as they should be. Many businesses are started by people who know and trust each other, and it can feel uncomfortable to talk about what might happen if someone leaves, stops contributing, wants to sell, or disagrees with the direction of the company.
But those are exactly the conversations that are easier to have at the beginning.
The process itself can be useful. Sitting down at the outset and working through questions such as who should have control, what decisions require consent, how profits might be distributed, and what happens if someone wants to exit can bring important commercial issues to the surface. That does not mean the shareholders expect things to go wrong. It simply means they are treating the company seriously and putting sensible rules around the relationship before there is pressure, emotion or a dispute in the background.
A common example is the 50-50 company. Two business partners set up together, own half the shares each, sit on the board together, and then fall out. If there is no agreed mechanism for dealing with a deadlock, the company can become stuck. Decisions cannot be made, growth becomes difficult, and the dispute can quickly become a drain on time, money and energy.
A shareholders’ agreement can deal with that situation by setting out a deadlock process in advance. That might involve a structured discussion between the shareholders, escalation to a trusted adviser, mediation, or, in more serious cases, a mechanism for one shareholder to buy out the other. The right approach will depend on the business and the relationship between the shareholders, but the key point is that the company should not be left without a route forward. Even a relatively simple process can make a significant difference, because it gives the parties something to follow at a time when emotions may be running high and trust may have broken down.
Another issue is the non-contributing shareholder. A group of people may start a company together, each holding a portion of the shares. Over time, one shareholder may decide to step away from the business but retain their shares and continue to receive dividends. Without proper leaver provisions, the shareholders who remain active in the business may find themselves building value for someone who is no longer contributing, and the shareholder who wishes to leave may find himself without a way to convert his years of grinding into a nice exit payout.
Exit provisions are often just as important as control provisions. A good shareholders’ agreement should consider what happens if a shareholder wants to sell, becomes seriously ill, dies, is dismissed from employment, or simply stops being involved. It should also consider how shares are valued in those circumstances. Valuation disputes can be difficult because the parties may have very different views of what the business is worth, particularly if the relationship has broken down. Agreeing the mechanism in advance can avoid a great deal of uncertainty later.
Succession planning can also create difficulties, particularly in family companies. Parents may have built a business and want to pass it down to their children, but not every child may want to be involved in running it. Some may be happy to hold shares without taking an operational role. Without clear rules, that can lead to arguments once the founders step back. Instead of setting up the next generation for the future, the absence of proper planning can create tension in both the business and the family, including around the Christmas dinner table.
A shareholders’ agreement cannot prevent every disagreement, but it can give the business a framework for dealing with issues before they become damaging. It can cover decision-making, consent levels for major decisions, share transfers, valuation mechanisms, leaver provisions, when and how to exit and other policies that are important to the company.
No two shareholders’ agreements should be exactly the same, because no two businesses are exactly the same. The agreement needs to reflect the company, the personalities involved, the ownership structure and the direction of travel. This is where instructing the right solicitor matters. The solicitor should take the time to understand what the business does, where it is trying to get to, and what the shareholders are trying to achieve. The aim is to work through the key questions and produce an agreement tailored to the business, rather than a one-size-fits-all document.
A shareholders’ agreement also can, and should, evolve. If all shareholders agree, it can be amended by a deed of variation or replaced with a new agreement. As a company grows, takes on investment or changes its structure, the agreement should be revisited to make sure it still reflects the commercial reality of the business and the objectives of the shareholders. Business goals, personal circumstances and long-term plans can and will all change over time. The key is to ensure that the agreement remains fit for real-world purpose, rather than becoming a document that no longer reflects how the company operates.
