Is a Shareholders’ Agreement really necessary?

It’s the beginning of a new year; you and your business partner(s) share the same vision for an exciting new adventure.  You trust and know each other well, at least you think you do.  Is it really worthwhile spending time and money on putting a shareholders’ agreement in place when you’re not even legally obliged to? 

The answer is, without a doubt, yes – and in our latest blog we will explain why and will look at just some of the pitfalls that could arise should you choose not to.

Start as you mean to go on

Putting together a shareholders’ agreement forces you to think about the many and varied issues and scenarios that your company might face during its lifecycle and what each shareholder’s expectations are.  It is much easier to talk through these issues with your business partners whilst everyone is on good terms, and before problems have had a chance to arise.

While in the early days it may be difficult to imagine a scenario that could negatively impact the health of your business, it is unlikely, as your business develops, that you will always see exactly eye-to-eye with your fellow investors, or that your personal objectives will at all times coincide.  It is likely eventually that one investor will want to exit before the other(s) do.

What then happens if one person wants to sell, and the other does not?

Your shareholders’ agreement gives you a framework in which you and your business partners will work together.  It forces everyone to talk through potential problem scenarios in advance.  In reality, doing this at the outset effectively reduces the risk of disputes arising in the future.  Everyone knows what they are committing to, and what is expected of them.

Failing to work all this through at the outset can have catastrophic consequences.  Disputes between shareholders can, in the absence of an agreed framework, cause a viable and profitable business to fall to pieces, depriving owners of the substantial value that they might otherwise have obtained on an ultimate sale of the business.

Here are some of the key issues that your shareholders’ agreement will provide clarity on:

Who can do what without the consent of the others?

You never want to discover that your co-investors have chosen a moment when you are on holiday, or off sick, to commit the company to something that you were not in favour of.  Your shareholders’ agreement will set out a defined list of things that can only be done with the consent of all parties.  Importantly, this will include – amongst other things – issuing new shares (which would dilute your own) or appointing new directors.

Who is contributing what to the business?

If one party is lending money, how and when would they get that back?  If you are contributing your time and resources, is everyone agreeing to pull their weight equally?

Who gets what dividends?

You may want to ensure that the business has a minimum level of working capital to fund growth.  This may mean agreeing on conditions or limitations to dividends.

What happens if one of you wants to sell or leave, and the others don’t?

In practice, this is the single biggest cause of shareholder disputes which (in the absence of a shareholders’ agreement) can lead to business collapse.  No matter how much you all like each other and enjoy working together, eventually one of you will want to leave or sell.  It is wishful thinking to assume that you will all reach this point simultaneously.  So if you need one big reason – over and above anything else – to commit to a shareholders’ agreement, this is it.

Unlike PLCs listed on a Stock Exchange, when it comes to private companies, there is no “market” for selling your shares, and no framework for establishing what shares are worth.  Shares in private companies are only worth what someone offers to pay for them.

Furthermore, there are very few people who will be interested in buying part, but not all, of the shares in a private company.  Most likely you will only achieve an exit at a value if (a) your co-investors agree to buy you out; or (b) you and your co-investors agree that under certain circumstances, and at a certain point, you will all agree to seek a buyer for the business.

If your co-investors do want to buy you out, your shareholders’ agreement needs to detail the circumstances and the terms.  Crucially, the agreement needs to provide a mechanism for valuing the shares or the business.  In the absence of that, your shares are potentially worth nothing at all.

The agreement will also determine whether or not your co-investors are obliged to buy you out under certain circumstances, or whether they simply have an option to.  The two scenarios are very different.  In the latter, you and your co-investors will have to think about how you will deal with a disaffected shareholder who has lost interest, but nevertheless continues to hold their shares, and/or continue to be a director, and potentially obstructs the day-to-day running of the business.

Finally, if you have ever wondered what people are talking about when they mention “call options”, “put options”, “drag along” or “tag along” rights, these are in fact just legal terms for addressing your potential scenarios for exit in a shareholders’ agreement. The terminology sounds more complicated than it actually is, and your lawyer should be able to steer you around it painlessly.

Your shareholders’ agreement needn’t be an overly long or complicated document.  But it will potentially ensure that you don’t lose substantial shareholder value in the future.  Goldstein Legal can help you draw up a bespoke shareholders’ agreement that suits your company’s needs.  Equally, we can review existing documents to ensure that they are still fit for purpose.

Speak to one of our expert commercial lawyers today.