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 shortened guide to the key points – you get the full guide 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 (like our guide below) when you buy it, so you can download the one you need.

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 and obliged to sell them in desperation at far less then their market value, and with no rights in the meantime to appoint a director to the company or to have access to its accounting or other information. In a dispute situation there would be no resolution unless the parties agree, which is not all that easy when you are already in a dispute.

The standard Articles of Association most 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.

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

This template is not intended for use 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, so you can use it for a company that is registered in Scotland.

Clauses in this Shareholders Agreement

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.

Numbered clauses

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.

In 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 need approval if it is to be exceeded (in which case keep the wording in square brackets and fill in the amount to be used as 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 have resigned as a director). 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 (i.e. a maximum of around 6 months), as he will have just sold his shares for (hopefully) a good price and 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, but after resigning as a director it 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. In 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 company is to be wound up 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 that is not happy with the way the company is being run 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, but it provides a robust mechanism to resolve differences between the shareholders, which would otherwise lead to stalemates and unhappy shareholders being locking to the company. 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 the company might be put into liquidation under clause 11, which 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, but 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, particularly 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, which would allow the minority to pull out of the process before its conclusion (if so, he might have to hang onto his shares and not proceed to put the company into liquidation under clause 11).

11. Procedure on winding up – If matters are not resolved via clauses 10 or 13, the company may need to be wound up to resolve them ultimately. Generally this will mean the shareholders receive a fraction of the true value of the company if they let it go this way, but it acts as a practical threat, to encourage them 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 – to offer the shares to the other shareholders in proportion to their current holdings. If 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, e.g. 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, with certain modifications as set out in clause 13.2. 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 (after all he will be bankrupt and therefore unable to 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 or the company must be wound up in accordance with clause 11 (this is essentially a protection for the deceased’s estate, so that his family receives the full value of the shares and is not locked into the company indefinitely, as it is unlikely the other shareholders would instead allow the company to be wound up).

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. Clause 14.4.1 requires him to resign as a director once he’s sold all his shares. 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, e.g. during the operation of clause 13.

15. Valuation – This clause provides for an independent valuation of the sale shares if their value is not agreed by the parties or if it is a mandatory transfer under clause 13. It provides that the valuation shall not be discounted due to the fact the shareholding of the seller might be a minority holding, so a 20% shareholding will be worth 20% of the overall value of the company. The latter is important and is another fundamental missing piece if you do not have an adequate shareholders agreement (or an equivalent provision in your Articles of Association – this is not provided for in Table A or the Model Articles).

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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