Key ways to protect yourself as a shareholder in a shareholder agreement

Last Updated: July 24th, 2022

Having the right shareholder agreement will depend upon the number of shareholders, whether the shareholders are also directors, the plans for the comapny and many other factors. Getting good, experienced advice to clarify what you need in your agreement is recommended. Some of the key issues to consider in most small to medium size businesses include :

Using the shareholder agreement to force a compulsory transfer of shares

If an employee director stops working for the company do you want that person keeping the shares?  Retaining shares is often not in the employer’s nor the remaining shareholders’ interests.  But, without a shareholders’ agreement forcing the transfer of shares the ex-employee or director will be allowed to retain shares indefinitely.

Avoiding shareholder disputes

In a shareholders agreement there can be a variety of formulas for share valuation. The benefit of share valuation clauses is they minimise the risk of shareholder disputes. The most common disputes arise over the value shareholders’ can demand for their shares if they either want to exit or are forced to transfer shares under a compulsory transfer provision.

Using a shareholder agreement to prevent a shareholder blocking a transaction

A shareholder can refuse to sell his shares even if other shareholders think the sale is a good deal. This risk can be removed with a shareholders agreement.

Protecting the rights of a minority shareholder

Shareholders agreement s are very commonly used to enhance the powers of minority shareholders granted under the Companies Act. In effect, the shareholders agreement can overwrite the Companies Act or the articles of association to give minority shareholders more rights to all or any of the dividends, voting or capital.

Using shareholder agreements to manage directors

You may find it impossible, or at best difficult, to remove directors if you have not secured this power in the shareholders agreement. The process under the Companies Act can be speeded up via the shareholders agreement. In practice if a director is not performing, delay in removing him can be commercially damaging to the business.

Avoiding conflict with directors

It pays to have considered and to have documented in the shareholders agreement :

  • Which directors are required to be actively involved in the running of the company and who are the decision makers?
  • Who determines salary and bonuses?
  • Are there certain actions the shareholders need a power to veto?  There will be no veto powers unless you have included them specifically in the shareholders agreement (or the articles but this is then public).

Shareholder agreements and dilution of shares

Your investment can be diluted without your approval if you have not taken steps to protect your position contractually with the other shareholders.  Directors and shareholders need to consider dilution carefully and weigh up preserving capital against using new share capital for funding.

Restricting the activities of shareholders

A shareholder does not owe any fiduciary rights to other shareholders.  There is only a fiduciary obligation placed on directors.  This means that if you do not build into a shareholder agreement restrictions, a shareholder may abuse his position. A way to prevent abuse is to include restrictions on the shareholder in the shareholders agreement.

The length of time after ceasing to be a shareholder that the restriction can apply does have to match the business needs.  But periods of up to 2 years are not uncommon.  Different restrictions can last for different amounts of time. We can talk to you have what would be suitable for your business.

Pricing the shares on transfer before exit

The value to be paid on a transfer of shares in a private company where there is no “market” is often an area of difficulty. Often there is little or no published material reporting values of similar transactions and so a mechanism is needed for share transfer value. The shareholder agreement can cover off certain aspects to reduce this vulnerability and set out a pre-agreed formula.

Put and call options over shares

A shareholders agreement gives the parties flexibility to create options over shares. The common options include :

  • Call option for the company to issue shares – here, a shareholder is given the option to “call” on the company to issue further shares, i.e. create more shares for the benefit of the shareholder. Another variation of a call option is where the company or a shareholder(s) can call on another shareholder to buy more shares.  The circumstances in which the call can be exercised are set out in the shareholders’ agreement.
  • Put option over shares held – with a put option a shareholder or the company can force a shareholder(s) to sell  shares. Like a call option, this option is usually subject to certain conditions. The key condition here is usually price, the fall back being fair value determined by an expert. We can advise on valuing shares in private companies.

 

 

 

 

 

 

 

 

 

 

 

 

Catherine Gannon

Catherine is an extremely experienced solicitor and deals with all types of corporate and commercial matters and advice and also tax law. She is well known for turning complex problems into solutions, priding herself on always finding a way. In her spare time she runs Gannons!

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