Do we need a shareholders' agreement?

When people decide to go into business together they usually start out with a shared plan or vision for the business with similar goals. So, if you have these shared plans and visions, why should you invest your time and money in putting in place a shareholders’ Agreement? At its simplest level, the answers are pretty straightforward: 1. CIRCUMSTANCES CHANGE: No one can predict when a change of circumstances may occur. Any number of events such as ill health, family break up or financial difficulty could mean that your interests, priorities and needs change and potentially conflict with the interests of the other owners (and the business itself). 2. PEOPLE DISAGREE: In running a business there are a vast number of decisions that need to be made and opportunities to be evaluated. Even with a shared vision for the business there are plenty of opportunities for disagreement. Where disagreements arise or the interests of the owners are no longer aligned with each other this can be extremely difficult to resolve. Without a good Agreement in place these disputes can be very damaging to the business and without an agreement, unraveling the relationship between business owners can ultimately result in expensive and uncertain litigation. SO WHAT IS THE BENEFIT OF HAVING A SHAREHOLDER’S AGREEMENT? A Shareholders Agreement does not have to be a complicated document, but: • the process of putting in place an agreement should help to ensure that the interests of the business owners are aligned at the outset (or identify where they are not!); • it should include a mechanism to set out how decisions are made and how disputes between business owners are to be resolved; • it should set out what happens in the event of changes of circumstances for the individual business owners. Agreeing these principles whilst relationships are good is far simpler than trying to reach agreement when the parties have already fallen out, and could avoid expensive and time consuming litigation. KEY ISSUES Whilst the law does not require a business to have a Shareholders’ Agreement, the importance of an agreement should not be underestimated and examples of issues that should be considered include:- Decision making: Without any specific agreement between shareholders the vast majority of company decisions both at director and shareholder level are made by a simple majority (more than 50%). For a business owner holding a substantial minority shareholding this may not be acceptable and a shareholder owning e.g. 25% of the shares in a business may justifiably want a right to be involved in (or veto) certain major decisions of the business. Sale of shares: Unless specifically agreed between the shareholders, a shareholder who wishes to sell their shares is not obliged to offer them to any of the existing shareholders and is entitled to sell those shares to whoever they choose. This can cause difficulties in an SME where personal relationships can be important and where the owners are often actively involved in the running of the business. Compulsory sale of shares: Without an agreement in place Company Law does not generally put a shareholder under an obligation to sell their shares in any circumstances. This can cause a number of difficulties, including: - What happens if a shareholder stops working within the business? Would you as business owner be happy for that shareholder to continue to share in the profits of the business without doing any work? Should that shareholder be obliged to sell their shares to those who are working with the business? - What happens if a shareholder is guilty of misconduct or fraud? Do they have to leave? Do they get paid for their shares? - What happens if the shareholders want to sell the company? Even if a large majority of shareholders want to sell the Company, except in very limited circumstances, without an agreement the majority cannot force a minority shareholder to sell. This could easily put off a buyer who wants to acquire the whole business and can put the minority shareholder in a very strong negotiating position when it comes to agreeing a price. What happens if a shareholder dies? Should their shares be able to go to their family or should they be sold back to those continuing in the business? What happens if there is a disagreement between business owners? The vast majority of small differences of opinion can be dealt with by negotiation and compromise but if there is a major disagreement how is this to be resolved? What happens after a shareholder has left the business? Except for some very limited legal duties there are no automatic restrictions preventing an ex-shareholder joining with the competition, soliciting customers or setting up a competing business. This could be extremely damaging for the business you have spent time and effort building up. A Shareholders’ Agreement would regularly address this business risk through the use of restrictive covenants. In summary, as well as being a framework for business owners to set out some clear principles of how the business will operate and to resolve disputes and manage expectations, a Shareholders’ Agreement is much like an insurance policy. There is an upfront cost to putting an agreement in place, but it can save substantial costs in the future if a dispute arises. Guest article by David Culshaw of Porter Dodson Solicitors.