What you should include in a shareholder agreement

When starting a business, spirits are high and thoughts are that it will be a raging success. This tide of optimism often means that the creation of a shareholder agreement is overlooked. However, you need an agreement that clearly sets out what needs to happen if the business fails.

To ensure there is certainty, a shareholder agreement should include sections on: The positive obligations of shareholders; rights of veto; the issue and transfer of shares; the right to appoint directors; dispute resolution.

1. Positive obligations of shareholders

The shareholders’ agreement should include:

• The activities the company will carry out along with its intended rate of growth.
• The intended exit route and the timescale for achieving it.
• The company’s dividend policy: The agreement should state what profits need to be paid out as dividends and the proportion that will be retained to fund the business.
• The composition of the board of directors and senior management team, and their remuneration and other terms of employment.
• Levels of permitted borrowing.
• Future funding: How much will be needed? What form will it take? How much will each party will put in? Will third parties be allowed to contribute and on what terms?

2. Rights of veto

Parts of an agreement can stipulate that certain decisions usually taken by directors or shareholders cannot be made unless all shareholders agree to them. This gives minority shareholders the right to veto any decision that may harm their interests. It is vital that the rights of veto are clearly laid out.

Rights of veto are usually set up with regard to decisions to:

• Issue further share capital
• Change the company’s articles of association
• Buy or sell a business, or any asset of more than a certain value
• Buy or sell a significant stake in another company
• Acquire or dispose of any premises
• Appoint or remove a director
• Award directors or employees more than a certain level of remuneration
• Dismiss a director or employee who is remunerated above a certain level
• Borrow above a certain level
• Grant security over the company’s assets
• Incur capital or hire purchase commitments above a certain level
• Take out or vary insurance other than for full replacement value
• Buy any of the company’s shares back from a shareholder
• Take action to wind the company up
• Prevent favourable contracts or arrangements between the company and its directors or shareholders other than on agreed terms

3. Issue and transfer of shares

Often, a shareholders’ agreement will allow minority shareholders to veto any issue or transfer of shares. These agreements can also require the company (on an issue) to offer the shares to existing shareholders, pro rata to their holdings before they can be issued to anyone else. The same usually applies when a shareholder decides to transfer his or her shares to an outside party.

If a pro-rata offer must be made, the agreement needs to provide a means of valuing the shares – by reference to an expert or arbitrator, or according to some formula in the agreement.

4. Rights to appoint directors

Shareholder agreements often have provision aimed at protecting outside investors’ interests, by allowing them to appoint a director to the board of the company.

5. Dispute resolution

Agreements may contain a mechanism for resolving disputes, such as referral to a third party expert or arbitrator.

A buy-out mechanism can also be included. For example: If a dispute occurs, one side buys out the shares of the other at a price determined in accordance with the agreement. It can even provide that, in the event of an unresolved dispute, the parties agree to vote to wind the company up.

The issue of which party buys out the other, and at what price, can be extremely difficult to negotiate. Agreements can become quite complex. One solution, is to say that one shareholder can offer his shares to the others at a price of his choosing. If they accept, they pay the price he has set.

To stop the seller from setting an unrealistic price, the agreement also provides that, if the buyer does not accept the offer, he becomes obliged to sell his shares to the seller, and he to buy them, at that price. The seller will not want to set too high a price for his shares, because he may end up having to buy other shareholder’s shares at that price himself.

As noted, these agreements can become quite complex. However, not having a clear set of rules regarding shareholders and their rights and duties may land up causing you more headaches than is necessary

Our UK business migration experts can help you set up a shareholders agreement. Give us a call on +44 (0) 20 7759 7584 or send an email to ukbusiness@sableinternational.com.