Quite simply, a shareholders' agreement is a contract entered into between the shareholders of a limited company. They are similar to a partnership agreement between individuals, and set out the relationship between the shareholders for the protection of their investment.  

Most SMEs (small to medium sized enterprises) are owner-managed businesses which are run using a private company, limited by shares-most frequently consisting of between 1-5 shareholders/directors.

New companies  can be set up quickly and cheaply, usually using accountants or company formation agents.  These companies will have a basic set of articles of association, which are the constitution of the company, setting out rules by which the company will be regulated. However, in many cases, the basic set of articles does not adequately cover all important issues which are likely to arise during the lifetime of the business.

One big advantage of a shareholders' agreement is that it is a private document which can be between the members of the company and the company itself.  It is not registered at Companies House and so will not be in the public domain.

There are many points which can be covered in a shareholders' agreement, but here are five important matters which are frequently included.

1.  How can you sell your shares? 

Many shareholders do not appreciate that there is no automatic right to require the other shareholders or the company to buy your shares at a fair value.  The others can simply do nothing, or worse, they could try to take action to reduce the value of your shareholding.  A well drafted clause in a shareholder's agreement can give a shareholder the right to require the other shareholders or the company to buy back shares, failing which the company would have to be sold and the shares realised that way.  This will usually force the other shareholders to make a reasonable offer for the shares of the outgoing shareholder.

2.  Regulating the proceedings of directors.  

Directors are responsible for running and regulating the activities of the company.  They could, however, take decisions which adversely affect the shareholders, particularly minority shareholders.  It is usual to include in a shareholder's agreement a requirement to obtain consent from a requisite minority of shareholders to taking important decisions, for example borrowing money, removing directors or issuing new shares which could water down the existing shareholdings of minority shareholders.

3.  Restrictive covenants.

It is often overlooked to include restrictions for the protection of the goodwill and business of the company.  These can be inserted to prevent shareholders from soliciting business from customers or clients of the company or setting up in competition, or misusing confidential information.

4.  Dividend policy.  

In the early years of a new business,  it is usual to restrict the right of shareholders to receive dividends. This enables the company to retain sufficient of its profits to provide the necessary capital resources for future trading.

5.  Deadlock or dispute resolution.  

Litigation is a costly way of resolving disputes when they arise.  Frequently the cost of bringing an action in the Companies Court would exceed the amount in dispute between the shareholders.  It is often better to provide in the shareholders' agreement for arbitration or other dispute resolution in the unfortunate event that the parties are at loggerheads.

There are many other areas which can be covered in a shareholders' agreement.