No shareholder agreement: the consequences
- John Deane
- Updated: Thu, 6th Oct 2016
What if you are a private company shareholder. You hold shares under standard articles of association, articles automatically downloaded when the founders set up the company. Alas,relying on standard articles of association often depletes your shares’ valuation.
Problems if no shareholder agreement
Any company with two or more shareholders should have a shareholders agreement. It:
- Defines shareholder’s responsibilities;
- Ensures the company’s smooth running;
- Reduces shareholder conflict.
Under English Law, shareholder’s agreements enjoy confidentiality. The articles of association is publicly available through Companies House. A shareholders agreement together with the articles of association solves the following problems:
Requisite consensus to enable company sale
Minority shareholder could block your company’s sale. The solution is tag and drag along rights. Then all the company’s shares are saleable.
A typical drag along right enables a majority of shareholders to sell the company. Minority shareholders are dragged into the sale on the same terms. So buyers can acquire 100% of the company.
Tags along rights protect minority shareholders. Minority shareholders may not want to retain their shares in a company under new management and control. Typically, if a majority sell their shares to a purchaser, then the purchaser must offer to buy the minority shareholder’s shares on the same terms.
Require shareholders who leave the company to sell their shares
Often managers award shares to incentivise people working in the business. However, if an employee or director leaves the company, they retain ownership of those shares. Commercially this may be undesirable, as it dilutes the profits for those who remain.
Departing shareholders sets up competing businesses
Restrictive covenants prevent departing shareholders setting up in competition after they sell their shares. Often we include provisions preventing an ex-shareholder poaching employees, suppliers or customers, for two years.
Pay different dividends
Different share classes enable you to pay different dividends to different shareholders. This is popular if different shareholders contribute different amounts to the business. Different share classes can also carry different:
- Voting rights;
- Rights to capital payments on sale or liquidation.
Sometimes when shareholders do not agree, there is stalemate. We add simple dispute resolution clauses to resolve deadlocks, that:
- Refer to a third party expert or arbitrator;
- Trigger a pre-determined buy-out mechanism. i.e. one side buys the other’s shares a pre-determined price.
- Wind the company up.
As part of of the corporate team, I regularly advise shareholders and businesses on issues relating to the holding of shares, reorganisations and sales. Why not call or email me to arrange an informal discussion.