Setting up a new company requires a great deal of preparation and planning, and when a company is established with two equal shareholders, there is one more step that you must take to protect each of your interests.
That is, there must be a Shareholders Agreement in place. After all, issues can arise in a shared company situation, and if there are disputes, any decisions will be in a deadlock until a compromise can be reached.
By including certain elements in Shareholder Agreements, it is possible to avoid disputes from escalating and relationships breaking down. A company created without a sufficient Shareholder Agreement in place is fraught with potential problems and legal issues.
It is vital that you do not use a generic Shareholder Agreement template. An agreement needs to be developed and tailored to your company based on the factors you need to consider.
What is a Shareholders Agreement?
A Shareholders Agreement is a contract that sets out the rights and obligations of shareholders in regards to their ownership of a company. The company itself may also be a party to a Shareholders Agreement.
A Shareholders Agreement is important because it dictates what should happen if the company changes or something happens to a director.
What does a Shareholders Agreement need to contain?
Roles and obligations
When drafting your Shareholder Agreements, it is important at a very fundamental level to include a clear description of the role and obligation for each founder of the company. That way both parties are entirely clear about their responsibilities, and can be accountable to this agreement.
You should outline:
Details of all arrangements between the shareholders, including areas of responsibility.
Hours that each partner works.
Obligations to meet certain standards or performance criteria.
Duties each party is obligated to perform.
How each party will be remunerated for their work.
How management decisions will be made outside each partner's specific field – e.g. staffing and wages.
It is important to be very specific from the beginning when drafting Shareholder Agreements as it will save you confusion and troubles later on.
Share management and transfers
If new shares are to be issued, you will need unanimous approval. This is because if a 50% majority can call for new shares, it means that the other party runs the risk of their share in the company being diluted.
- If one party wants to sell their shares, the other party must be given the opportunity to buy their shares first. This is known as a first right of refusal
This is particularly important when there are only two shareholders as it means that you have the opportunity to buy the other shareholder out, instead of potentially allowing a third party to buy half of your company.
Dispute resolution procedures
It is important to have dispute resolution steps outlined so that you can resolve any matters effectively and efficiently. Your Shareholders Agreement should outline how you will resolve disputes – whether through mediation, negotiation or through another type of alternative dispute resolution process.
Set this up prior to any disputes taking place and you will have a procedure to follow
Save your professional relationship with clear dispute resolution factors in place
Default, termination and restraint clause
Every Shareholders Agreement needs a clause that explains what will happen in the event of a default.
An example of a default might include a situation where a shareholder is incapacitated through injury or mental illness, or where a duty is breached which would bring the company into disrepute.
If a shareholder chooses to leave the company, the Shareholders Agreement needs to explain how the arrangement between the founding partners will end.
It is important to protect the interests of the other party that there is a restraint clause which prevents a shareholder from engaging in trade with a competing company or organisation, within a set distance and for a set period of time.
Event of death
The parties must come to an arrangement with regard to the unfortunate situation where one of the two shareholders either become seriously ill or dies. In general terms, this would require the parties to have an option arrangement between themselves whereby the surviving partner can exercise the right to buy the interest of the injured or deceased partner.
This will require the parties to plan the method of payment by the surviving party to the deceased party.
This could be by way of insurance policy whereby either party takes a policy on the life of the other party.
Your Shareholder Agreement checklist
At a base level, a Shareholders Agreement must contain:
Roles and responsibilites
Dispute resolution procedures
Share management and dividend distribution
Rights and shares
Restraint of trade
Termination events – such as death, default or trade sales
Weight of votes
Of course, you will need to seek legal advice prior to drafting to ensure you have not missed anything vital. Our business lawyers understand the nuance that goes into managing a company and can work with you to outline anything important that may not have been considered.
Common issues with Shareholders Agreements
Circumstances can change with shareholders, and it can be difficult to draft a Shareholders Agreement with all possible issues considered. Many issues can arise where circumstances change beyond what each party may consider possible.
Disputes can arise, and without a properly drafted Shareholders Agreement often the parties end up in a protracted legal battle with the only option left being to wind up the company. A comprehensive Shareholders Agreement can prevent matters escalating before they need to.