Why every UK business with multiple owners should consider a shareholders’ agreement

When forming a company with two or more founders, the owners typically focus on product, funding and initial clients. Control, investment and what happens if an owner leaves can often feel like low-priority issues. However, these issues are much easier to address while your relationship is still positive.

A shareholders’ agreement can be put in place between some or all of the shareholders and, often, the company. It is a private agreement that supplements the company’s articles of association. It can be tailored to the company’s ownership structure, so that the shareholders know how to exercise their rights. The agreement can also set out how issues will be handled.

What can a shareholders’ agreement cover?

It can cover how decisions are made, what information is provided, share transfers and what happens if the company needs further funding. It can also deal with dividend policies, board appointments, confidentiality, non-competition (if enforceable), dispute resolution and exit strategies.

The agreement should reflect the owners’ relationship. If you are in a start-up with two equal founders, a detailed deadlock clause is likely to be needed. In a family business, succession and transfers of shares to family members are likely to be key points. If there is an external investor, the agreement will almost certainly need reserved matters, investor consents and anti-dilution clauses.

Decision-making/Reserved matters

Many of the company’s decisions are governed by the Companies Act 2006 and the company’s articles. The agreement can provide contractual clauses which set out how the shareholders will vote. Matters such as issuing new shares, changing the nature of the business, significant borrowing, sale of substantial assets and related-party transactions would typically require shareholder consent.

The list of reserved matters should be balanced. If unanimous consent is required for everything the company does, the company will be very difficult to run. If the list is too narrow, minority shareholders will have little influence over decisions which can significantly affect their investment. The agreement should clearly distinguish day-to-day management decisions from decisions that affect the company’s risk, capital or ownership.

Share transfers/Exit

A shareholders’ agreement will typically restrict transfers of shares to third parties. It can give existing shareholders a right of pre-emption, so that they can buy shares before they are sold to anyone else. This helps to preserve the existing ownership structure and to keep out unwanted competitors or other unsuitable third parties.

Tag-along rights can be included to give minority shareholders the right to join a sale by a majority shareholder. Drag-along rights can also be included to enable a qualifying majority to require minority shareholders to sell into a genuine whole-company transaction. When drafting these clauses, consider carefully what triggers the rights, how the price is set and what notice is required.

Provisions will be needed for a shareholder’s death, long-term incapacity, insolvency or serious misconduct, or for a founder who stops working in the business. A forced transfer clause should be very clear about how the shares will be valued, when a transfer can happen and how the price will be paid. If the clause is vague, it could cause a dispute.

Deadlock (equal shareholders)

A 50/50 split can be attractive, as both founders have an equal economic interest. However, if the founders disagree on a key issue, neither of them has a majority to decide it. A deadlock clause should therefore be included, with a step-by-step process to resolve the issue. This can include negotiation, mediation, a decision by an independent expert or a well-structured buy-out.

A mechanism that allows one shareholder to propose a price and the other to decide whether to buy or sell may seem simple. However, it can be unfair if one party is in a much stronger financial position. The mechanism should suit the company and the shareholders’ ability to fund an exit.

Minority protection/Information

Minority shareholders may want regular access to financial information, budgets, management accounts and news of important developments. Clauses in the agreement can help to ensure that they are kept informed. Any such clauses should be compatible with confidentiality and the company’s legitimate interests.

A shareholders’ agreement cannot override mandatory statutory rights. It should be read together with the company’s articles, the Companies Act 2006 and any investment documents. If they conflict, the position can become very complicated and the documents may need to be formally amended.

Articles of association vs shareholders’ agreement

The articles of association are a public document. They are binding on the company and its members in accordance with company law. A shareholders’ agreement will typically be a private contractual document. It can include personal undertakings (e.g. non-compete clauses) and can typically be amended only by unanimous consent. The articles can generally be amended by special resolution, which requires a majority of at least 75%.

When should a shareholders’ agreement be drawn up?

Ideally, it should be drawn up before the owners begin trading or when new shareholders join. It should also be reviewed when the company raises investment, issues new shares, appoints new management, expands internationally or undergoes a significant change in ownership. A basic agreement taken from an unrelated business is unlikely to deal with the risks relevant to yours.

Positive conversations

Putting a well-drafted shareholders’ agreement in place encourages the owners to have difficult conversations early and calmly. It can also help to manage expectations, provide a way out of deadlock and reduce uncertainty if an owner wants to exit. While it will not prevent every dispute, it provides a much more structured way of resolving them.

We advise businesses and shareholders on how best to structure their company, how to deal with investors and how to resolve shareholder disputes. We will consider the company’s articles, ownership structure, funding and practical remedies for breach.

Frequently asked questions

Is a shareholders’ agreement a legal requirement in the UK?

No. All companies must have articles of association, but a shareholders’ agreement is not a legal requirement. Without one, the owners will rely on the articles and the Companies Act 2006, which may not reflect their commercial relationship.

What is the difference between the articles of association and a shareholders’ agreement?

The articles are a public document, as they are filed at Companies House. A shareholders’ agreement is private. It can include personal undertakings (e.g. non-compete clauses) and can typically be amended only by unanimous consent. The articles can generally be amended by special resolution, which requires a majority of at least 75%.

What should a shareholders’ agreement include?

Typically, the following standard terms will be included: reserved matters (unanimous or majority vote), board appointments, pre-emption rights, drag-along and tag-along rights, good and bad leaver provisions, dividend policy, deadlock, restrictive covenants and dispute resolution.

When should a shareholders’ agreement be signed?

Ideally at incorporation or when new shareholders or investors join. It is much easier to agree terms when the relationship is positive.

Are you setting up a company with co-founders or investors? Get in touch with our corporate and commercial team at Scornik Gerstein LLP to discuss whether a shareholders’ agreement is right for you and what should be included. Alternatively, contact us here.