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Why Do Companies Need a Shareholders Agreement?

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For companies, large or small, a Shareholders Agreement is an absolute necessity. As soon as your shareholders grow beyond just one, there needs to be some way of governing the relationship between the shareholders and between the shareholders and the company – that’s what a Shareholders Agreement does. Creating a Shareholders Agreement is not a legal requirement in law so many smaller businesses simply don’t have one.  However, there are some very compelling reasons why you should.

Shareholders fall out

Practically speaking, it doesn’t matter if you’re in business with your partner, your best friend or a member of your family, shareholders in business can fall out. Close relationships can make it even harder to battle through the problems without a clear and impartial document that sets out in clear terms what the rights and requirements are.

The law doesn’t stop shares being transferred

Many people who start a company assume the law protects them against fellow shareholders transferring their shares to a third party, generally this is not the case. A Shareholders Agreement should contain a clause to stop a shareholder from transferring shares without first offering them to the other shareholders – without a Shareholders Agreement this restriction does not exist.

Protection for minority shareholders

The Shareholders Agreement can be used to introduce protections for minority shareholders that otherwise wouldn’t be in place. For example, making some operational decisions of the company subject to the approval of either a majority of shareholders or all shareholders. A Shareholders Agreement can also include “tag along” clauses that allow minority shareholders to “tag on” to a majority shareholder where there is a share sale in which the majority are trying to sell only their shares rather than looking for a buyer for all the shares.

Clarity on shareholder classes

Companies often have different classes of shareholders and the Shareholders Agreement is crucial in setting out the rights each one has. This could be with respect to voting, dividends etc. The agreement can also specifically state what happens if there is a voting deadlock.

Good leavers and bad leavers

One essential part of a Shareholders Agreement is a clause that forces a departing employee to sell any shares they hold. This helps to protect against someone outside of the company having any influence over – or being able to block – essential decisions. A good leavers clause could then apply to someone leaving on good terms and would usually give that person fair value for the shares they hold.  Alternatively, a bad leavers clause could be invoked which would apply to someone not leaving on good terms and provides for lower or nominal value under those circumstances.

It’s worth noting that a Shareholders Agreement is a private contract between shareholders, which means there is no requirement to make it a document of public record at Companies House. As such there is no issue in including commercially sensitive or confidential information and clauses. If your business is looking for external investment then a Shareholders Agreement will be crucial.  It not only demonstrates business stability but is a clear sign for an investor that they are coming into a well-organised company.

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