Guide to our Shareholders Agreement

Posted by Stephen on 28th September 2015

Our Shareholders Agreement template should be used whenever a company has more than one shareholder, or shares are about to be transferred or issued, so that it will then have more than one shareholder. (NB This is a slightly briefer guide to the key points in the shareholders agreement template. You get the full guide to our shareholders agreement when you buy the template.)

When you buy the template, it comes as two different versions – one for companies with just 2 shareholders and one for companies with more than 2 shareholders. You get both versions of the template and a guide for each shareholders agreement (like our guide below) when you buy it. Simply download the one you need.

Why do I need a shareholders agreement?

You must have a shareholders agreement (or adequate provisions in your Articles of Association) where you have more than one person owning the company, as otherwise there is nothing to regulate what happens if the shareholders fall out or one dies. If one dies, there would be no provisions to say that the deceased’s shares should be bought by the survivor(s). His family could be left holding relatively worthless shares. In desperation, they might be have to sell them at far less than their market value. To make matters worse, in the meantime they would have no rights to appoint a director to the company, nor have access to its accounting, or other, information. In a dispute situation there would be no resolution of it unless the parties agree, which is not all that easy when you are already in a dispute.

For more explanation, read our helpful blog article: 5 Reasons Why Your Business Needs A Shareholders’ Agreement.

Are my current Articles enough?

Almost certainly “no”. The standard Articles of Association nearly all companies adopt on their being incorporated (often known as Table A or the Model Articles) do not provide such mechanisms and are generally only suitable when you have just one shareholder. You’d be left in trouble in all of the above scenarios if you were just relying on the standard Articles.

Our template resolves all these issues and helps provide a structure for the safe and effective running of the company.

When to use this template

You can use this template for any private limited company in the UK with more than 1 shareholder.

We don’t intend you to use this template where:

  • the company’s an LLP – for that you should use an LLP members agreement; or
  • the ‘company’ is in fact a partnership and not run through a limited company – here you should use a partnership agreement.

Once the agreement is in place, we would recommended you to review it every few years and whenever there is a change in shareholders.

While most of our templates have not been adapted for use in Scotland, this one has. Therefore, you can use it for a company that is registered in Scotland.

Guide to Clauses in this Shareholders Agreement

The wording below forms the main part of the guide to the shareholders agreement that comes with the template, leading you through each clause and telling you what to complete or what options to choose from.

Date – Just put the year in for now.  Complete the date when the agreement has been signed.

Party clauses – Fill in the details of the parties. If there are further shareholders, add extra clauses in a similar format, and call each shareholder Party C, Party D, etc.

Background

These clauses set out the background – the reason you are entering into this agreement. If there are more parties than A and B, then refer to them in each of the clauses (A) and (B) here.

Guide to Numbered Clauses in the Shareholders Agreement

1. Interpretation

This clause defines the main terms used. Most of them relate to the transfer of shares as used in clauses 12 to 15, so we have not commented on them here. The others are as follows:

  • “Board” – This is the board of directors.
  • “Company” – Complete the relevant company’s name and company number.
  • “Confidential Information” – This covers the types of information about the company that should be treated as confidential.
  • “Control” – This refers to how a shareholder has control over a company.
  • “Share” – This refers to issued shares in the company.
  • “Shareholder” – This refers to the shareholders of the company.
  • “Valuer” – This refers to independent experts who might be needed to value the shares if they are being sold. See clause 15.

2. Business of the Company

In clause 2.1 describe the nature of the business that the company runs. The purpose of this clause is to confine the business of the company to this unless all the shareholders agree to expand its business in different directions.

3. Directors

Clause 3.1 reiterates the general rule that the board has day-to-day control, but clause 7 overrides this in certain circumstances – see below. In clause 3.2 generally there should be at least 1 director per shareholder, so amend the minimum number of directors if appropriate.

For clause 3.3, you can either give every shareholder the right to appoint a director to represent them (in which case delete the whole of the phrase in square brackets) or specify a minimum percentage of the shares that each must own in order to have the right to appoint a director – generally this would be a fairly low percentage (in which case delete the square brackets and fill in the percentage).

In clause 3.4, we recommend board meetings are held every month (so all shareholders/directors are kept abreast of the finances, as it is a legal duty of each company director to keep himself informed of the company’s finances), but change this if you hold them at different frequencies. If held less frequently, we would still recommend you issue monthly management accounts to all shareholders/directors (see clause 4.1.3).

4. Accounting matters

This clause gives extra rights to the shareholders they would not have unless they were directors to see the accounts, etc during the financial year.

5. Dividend policy

You can use this clause to specify a rule about dividends. If so, please insert the percentage of the net profit after tax that you would normally be expecting to distribute by way of dividend to the shareholders. Alternatively if you do not wish to do so, you can delete the whole clause.

6. Status and obligations

Clause 6.1 implies that each shareholder is responsible to see that any director appointed by him complies with this agreement. Clause 6.2 provides that if this agreement conflicts with the Articles, then this agreement takes priority.

7. Minority protection

This clause sets out a fairly long list of issues that need all the shareholders to agree to before a change is made. It acts to give some measure of protection to a minority shareholder. You may wish to adjust it and add to it, but this list is designed to cover most key areas – to avoid changes being made on fundamental or important issues unless all shareholders agree.

There are various places where you need to insert a figure that triggers the protection. You should decide what suits you, based on the size of your company and its operations. In clause 7.1.5 you can either ban any borrowing unless all shareholders approve it (in which case delete the words in square brackets) or you can just set a limit on borrowing which needs approval if it is to be exceeded. In the latter case, keep the wording in square brackets and fill in the amount of the limit.

8. Non-competition restrictive covenants

A shareholder who is not a director would be free to complete with the company despite his owning shares in it, unless you had a clause like this in place (directors are not free to compete due to their statutory duties to the company, but this changes once they resign as directors). Therefore this clause represents an important protection for the value of the company and its shares. Without such a provision, the shares would have a much lower value (you probably would not include a figure for the “goodwill”, reflecting the profitability of the company, and the value would be much closer to the net asset of the company, i.e. the bottom line of the balance sheet) and this would be reflected in any valuation made under clause 15.

Choose a period in line 2 of clause 8.1 that this restriction lasts for after a shareholder has left the company. This can be longer than would be valid if he were just an employee. That might only be a maximum of around 6 months. The justification is that he will have just sold his shares for (hopefully) a good price. In return, the other shareholders would be expecting a good period of protection from his setting up in competition or going to work for a competitor. We would suggest between 1 to 2 years.

9. Confidentiality

This clause is to protect the company’s confidential information. While a shareholder is a director, the company is protected by the director’s statutory duties. After the director has resigned the company would not be protected, were it not for this clause.

10. Deadlock

This clause appears as two very different versions in the two templates you get when you buy our shareholders agreement. See paragraphs A and B below.

A. The version for the company with only 2 shareholders

If they are not owning the company 50/50, you may not want this clause, and may be happy for the majority to rule the roost and impose their will on the other(s) (subject to the protection offered by clause 7 to minority shareholders) – if so, delete this clause. The clause provides for the parties to try and resolve matters:

  • firstly, by discussion;
  • secondly, by the assistance of a third party mediator (who does not impose any decision on the shareholders); and
  • finally, by selling the company if that is possible.

If it is not possible to sell the company within 1 year (including selling it to another of the current shareholders) then the parties must wind up the company under clause 11. This encourages the shareholders to resolve their differences or to agree how to buy each other out.

B. In the version for the company with more than 2 shareholders

The clause is more detailed and you will want to keep it in order to provide a resolution mechanism in the event of a deadlock. It provides a solution to a minority shareholder, where the majority to rule the roost and impose their will on the other(s) (subject to the protection offered by clause 7 to minority shareholders) – the process means that the minority, who are not happy with the way the majority are running the company, can offer their shares for sale to the others and, if not bought out by them, can ultimately force the liquidation of the company (see clause 11).

The clause provides for the parties to try and resolve matters firstly by discussion, secondly by the assistance of a third party mediator (who does not impose any decision on the parties) and finally by the minority shareholder offering to sell his shares in the company to the others. If the others do not buy the shares, then any shareholder can call for the company to be wound up under clause 11. This encourages the shareholders to resolve their differences or to agree how to buy each other out. Given the length of the clause, the wording of the process may appear complex. However, it provides a robust mechanism to resolve differences between the shareholders. Without it, it would lead to stalemates and unhappy shareholders being locking to the company.

Buying out the minority shareholder

In practice, this clause strongly encourages the majority to buy the minority out. However, if the price the minority shareholder has demanded is unrealistically high, then the majority might refuse to buy him out and they might have to put the company into liquidation under clause 11. This would might mean the minority gets much less than what might have been a more realistic price for his shares as a result of that process (the other shareholders would lose out too here).

Such a liquidation would cause some disruption. Ultimately any of the shareholders can bid to buy the business back from the liquidator as part of that process, including the minority shareholder. This might persuade the minority shareholder to set a fairer price for his shares. This is particularly so if he cannot afford to buy the whole business from the liquidator or outbid the others to do so. Ultimately those shareholders with the financial power to buy the business back from the liquidator have a stronger bargaining position here. Decide if you want to keep clause 10.6. It would allow the minority to pull out of the process before its conclusion. If so, he might have to hang onto his shares instead of putting the company into liquidation under clause 11.

11. Procedure on winding up

If the parties doe not resolve matters via clauses 10 or 13, the shareholders may ultimately need to wind up the company in order to resolve them. Generally this will mean the shareholders receive a fraction of the true value of the company if they let it go this way. It acts as a practical encouragement to use clauses 10 and 13 to resolve matters in a more sensible way.

12. Transferring shares

If a shareholder wishes to sell any shares, he must follow the procedure set out here. That is to offer the shares to the other shareholders in proportion to their current holdings. Where the price he wants is excessive, the others may seek an independent valuation under clause 15 (clause 12.3). If that value is too low, the seller may pull out (clause 12.4).

13. Mandatory transfers of shares

This clause protects the other shareholders in the event of various acts of “default” by a shareholder. For example, this could be breach of the agreement, death and various acts of bankruptcy. It provides that the defaulting shareholder is deemed to have offered all his shares for sale as if under the clause 12 procedure. Clause 13.2 makes certain modifications to the clause 12 procedure. Clause 13.2.4 provides that if the trigger event is bankruptcy, then the seller will only be paid a fraction of the true value of the shares. This should be fair: since he is bankrupt he won’t benefit from this money in any case.

Clause 13.3 provides that the ongoing shareholders must buy all of the seller’s shares if these incidents occur. Alternatively, they must wind up the company in accordance with clause 11. As it is likely the other shareholders would avoid having to wind up the company, this is essentially a protection for the deceased’s estate. It should ensure that his family receives the full value of the shares. It avoids their being locked into the company indefinitely.

14. Completion of share purchase

This clause provides for how and when the sale of shares under clause 12 and 13 will be completed. Clause 14.3 provides that if a new shareholder is being admitted to the company, then he must sign a deed of adherence to agree to be bound by the terms of the shareholders agreement. (Legalo has such a template available if you need one.) Clause 14.4.2 requires any shareholder who is selling all of his shares to resign as an employee. Please consider if you wish to keep this. Once he’s sold all his shares, he is required to resign as a director in accordance with clause 14.4.1. As clause 14.6 implies, any transfer of shares attracts Stamp Duty at 0.5% of the price paid on each stock transfer form, rounded up to the next whole £5.

This is to be paid by the buyer within 28 days of completion to HM Revenue & Customs – until paid, the transfer should not be written up in the company’s registers, nor a new share certificate issued to the buyer. As clause 14.7 contains a power of attorney, the agreement must be signed properly as a deed (see below). This clause permits the other shareholders to sort the matter out even if the seller is not co-operating. This is useful during the operation of clause 13.

15. Valuation

This clause provides for an independent valuation of the sale shares if the parties do not agree their value. This also applies if it is a mandatory transfer under clause 13. It provides that the parties will not discount the valuation just because the seller’s shareholding might be a minority holding. This means that a 20% shareholding will be worth 20% of the overall value of the company. This is important and is another fundamental missing piece if you do not have an adequate shareholders agreement. You probably won’t find or an equivalent provision in your Articles of Association. This is because neither Table A nor the Model Articles provide for this.

16. Assignment

The agreement is not assignable to others.

17. Miscellaneous

This clause covers various other minor areas: waiver, variation, no partnership, costs, etc.

18. Good faith

This clause states that the shareholders will act honourably and properly towards one another and the company.

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