Why do I need a shareholders agreement?

Under U.K. law there is no requirement for a company to have any form of shareholders’ agreement and many will continue for years without one. However as Tim Roberts, Partner in our Business team at Geoffrey Leaver Solicitors, explains where a company has more than one shareholder it is strongly recommended that the parties do enter into an agreement to deal with certain key issues.

“Company law is modelled on the idea that all companies will have owners (the shareholders) and managers (directors),” says Tim Roberts. “Traditionally the role of the directors was to manage the company on a day to day basis with an obligation to meet with the owners once a year at the annual general meeting. If any of the owners disliked the way the company was being run on their behalf, provided they had the backing of the majority of the shareholders they could pass a resolution removing the directors and appointing someone else instead.

“The reality is that the vast majority of privately owned UK companies have a limited number of shareholders (usually fewer than 10) and more often than not those shareholders are also the directors. These ‘owner/managers’ usually have the expectation that they will continue to be actively involved in the running of the business and that any major decisions required to be taken in respect of the company will require their consent.”

In fact, under company law anyone who owns less than 50% of the voting shares in a company is often in a weak position. If they fall out with their fellow shareholders they can be removed from the board of directors by the majority of shareholders passing an ordinary resolution. Also, important decisions concerning a company can often be decided upon simply by the majority of the directors or, where shareholder consent is required, with the consent of less than 100% of the shareholders.

Shareholders’ agreements will often restrict what the company and/or the directors can do without the consent of all or at least a certain percentage of the shareholders, the point being that such provisions are usually more stringent that what would be the case under UK company law. These are often referred to as ‘minority shareholder provisions’ and usually cover decisions such as entering into substantial contracts or making major changes to the nature of the business. Such provisions will also usually fix the right of each of the shareholders to participate in the management of the company (i.e. by fixing their right to remain as a director of the company).

But what else does a shareholders agreement provide for?

The next major area most shareholders agreements will cover is succession related issues. A minority shareholding in a private company is regarded by many as virtually worthless and certainly anyone trying to sell a minority shareholding in a private company is unlikely to find many people willing to buy those shares unless all the other shareholders sell their shares to the same buyer at the same time.

This is a particular problem if a minority shareholder dies. That shareholder’s next of kin may legitimately expect that they will be able to realise the value of the shares or alternatively be able to step into the deceased shareholder’s shoes and become involved in the management of the company. The reality however is that no-one is obliged to buy those shares from the deceased shareholder’s estate and there is no obligation to allow the next of kin to become involved in running the company. Faced with this situation the next of kin will probably end up selling the shares back to the remaining shareholders for a fraction of what they might have been worth if sold as part of a sale of all the shares.

A shareholders’ agreement will often therefore contain provisions which force the remaining shareholders to purchase the shares from the estate of the deceased shareholder at a fair price. This is usually calculated by multiplying the value of the company as a whole, by a percentage equal to the percentage of shares that the deceased shareholder owned. This is usually backed up by an insurance policy so that the remaining shareholders are not out of pocket when it comes to buying the shares. A shareholders’ agreement may also contain a provision that forces the remaining shareholders to purchase the shares from one of their number in other circumstances, perhaps where a shareholder is dismissed from his employment with the company or if he retires.

The other problem that sometimes arises is where the majority of shareholders are looking to sell their shares to an interested third party but the sale is effectively blocked by a minority shareholder who refuses to sell. Strictly, a buyer could purchase the majority shares leaving the minority shareholder in place but most buyers would rather not take on a shareholder who at the very least may be capable of making a nuisance of himself and with whom they may have to share the profits.

The remedy for this is to include drag-a-long rights in a shareholders’ agreement. Such drag-a-long rights give the majority shareholders the right to force the minority shareholders to sell his shares to the same buyer (provided of course that the minority shareholder is being offered the same price on a ‘per share’ basis). In return a minority shareholder is often given tag-a-long rights saying that if the majority shareholders do find someone who wants to buy their shares they are obliged to ensure that the buyer offers the same price (on a per share basis) to the minority shareholder.

If you wish to discuss any of these issues then please do not hesitate to email either Tim Roberts or Troy Warner who are the partners in our Business team at Geoffrey Leaver Solicitors or call them on 01908 692769.