Shareholders Agreements

The Importance of a Shareholders’ Agreement in Closely-Held Companies

When establishing a company with individuals known to you—be they family members, friends, or long-standing business associates—it may be tempting to consider a Shareholders’ Agreement as unnecessary or excessive, particularly where the enterprise is small in scale. There may even be a concern that proposing such an agreement could be perceived as a sign of distrust.

However, regardless of personal relationships, it is prudent to formalise the rights and obligations of shareholders from the outset. The unfortunate reality is that disputes can and do arise, even among the most amicable of business partners, especially where financial interests are involved. Relying solely on the Articles of Association may not offer sufficient protection in all circumstances. The absence of a written agreement can result in costly and protracted legal disputes which could otherwise have been avoided.

Where a company has multiple shareholders—especially where shareholders hold differing voting rights—it is highly advisable, if not imperative, to put in place a comprehensive Shareholders’ Agreement.

Purpose and Benefits of a Shareholders’ Agreement

A well-drafted Shareholders’ Agreement can govern a broad range of matters including:

• capital contributions and future financing of the company;
• management and operational control;
• dividend policy;
• mechanisms for the transfer of shares;
• procedures for dealing with deadlock situations; and
• methods for valuing shares.

The agreement not only regulates the relationship between the shareholders inter se but also between the shareholders and the company. It effectively serves as a private constitution tailored to the specific needs of the business, supplementing the company’s Articles of Association.

For shareholders, such an agreement provides clarity on their rights and responsibilities. For instance, it can set out the process for selling shares to a third party, voting procedures, and the appointment or removal of directors. For the company, it offers a procedural framework that can assist directors in navigating issues such as granting share options or dealing with conflicts between shareholders.

Protection of Minority Shareholders

In many cases, minority shareholders may find themselves in a vulnerable position, particularly where decisions can be made by those holding a simple majority (i.e., over 50% of the shares). A Shareholders’ Agreement can serve as an essential safeguard by, for example, granting minority shareholders veto rights over key decisions or requiring unanimity or supermajority consent for fundamental matters affecting the business.

Key Provisions Commonly Found in a Shareholders’ Agreement

Although the precise contents will vary depending on the nature of the business and the parties involved, a typical Shareholders’ Agreement may include provisions dealing with:

• the scope and nature of the company’s business activities and intended growth trajectory;
• dividend policy (i.e., allocation between shareholder distributions and reinvestment);
• directors’ remuneration and terms of employment;
• borrowing limits and funding obligations;
• procedures for appointing and removing directors;
• share allocation, transfer restrictions, and pre-emption rights;
• approval requirements for acquisition or disposal of major assets;
• winding-up procedures;
• dispute resolution mechanisms (e.g., mediation, arbitration);
• restrictive covenants applicable to founders upon exit;
• Tag-Along Rights: enabling minority shareholders to sell their shares on the same terms as majority shareholders in the event of a third-party offer;
• Drag-Along Rights: permitting majority shareholders to compel minority shareholders to sell their shares upon receipt of a bona fide offer for the entire issued share capital.

Conclusion

In summary, a Shareholders’ Agreement is a vital document that brings certainty, stability, and foresight to the corporate relationship between shareholders. It can prevent misunderstandings, minimise disputes, and provide an agreed mechanism for addressing issues before they escalate. Regardless of the closeness of the parties involved, it is a key instrument in promoting the long-term success and governance of the company.