Many businesses operate as limited companies. However, shareholders, who are the owners of a company, do not often have in place the right documentation to protect their interests. One of the best ways for shareholders to protect their interests is to enter into a shareholders’ agreement which sets out in detail the rights afforded to each shareholder. A lack of certainty created by not having a shareholders’ agreement in place can often lead to disputes amongst the shareholders which can be costly to deal with.
Memorandum and articles of association
In addition to any relevant legislation (in particular the various Companies Acts), in the first instance, a company will be governed by its memorandum and articles of association. Prior to the Companies Act 2006, a memorandum of association set out the objects of a company which in effect were limits on what a company could or could not do e.g. what type of business it could trade in. As a result of the Companies Act 2006, a memorandum of association for new companies does not say much more than the first shareholders of the company wish to form a company.
The articles of association set out how the company operates. The articles of association will deal with issues such as how directors and shareholders meet, quorums for directors and shareholders meetings, how shares are to be issued and how shares are to be transferred.
Many companies are incorporated using articles of association based on standard provisions set out in legislation (e.g. on the “model articles” introduced by the Companies Act 2006) with little or no amendment. The problem with these forms of articles of association is that they are by their very nature generic, and accordingly do not take into account the specific commercial concerns of the shareholders in relation to the operation of the company.
A company is legally obliged to file its memorandum and articles of association at Companies House and this then becomes a public document which can be viewed online.
As a company’s memorandum and articles of association is a public document, shareholders may wish to deal with other arrangements separately. These arrangements are often set out in a shareholders’ agreement, which is a private document.
A shareholders’ agreement, as the title suggests, is a separate contract made between the shareholders, relating to the operation of the company. Such an agreement will usually cover issues that are similar to those covered in a company’s articles of association but, within the confines of the law, can cover whatever the parties to the agreement wish.
Although each document will be different, a shareholders’ agreement will typically deal with some or all of the following:
- The right for a shareholder to hold a seat on the board of directors.
- Who the chairman of the board of directors is to be and whether that chairman will have a second or casting vote in the event of an equality of votes on an issue.
- Whether the consent of certain shareholders is required before a company can take certain actions such as disposing of the company’s assets, issuing new shares, or winding up the company. This is particularly relevant for shareholders holding a minority of shares in the company as it allows them to “punch above their weight”.
- Whether the company is to have a particular policy on dividends.
- Is intellectual property created by the shareholders to be vested in the company? This is particularly relevant in industries where intellectual property is an important asset of the company e.g. the IT industry.
- What procedure if any is to be followed if a shareholder wishes to sell his shares? This is a highly important issue, particularly in private companies. Remaining shareholders will often be working very closely together and do not want to be dealing with just any third party whom the selling shareholder decides to sell his shares to. Often a pre-emption process is followed under which the selling shareholder is obliged to first offer the shares for sale to the remaining shareholders before (if that is what the shareholders agree) a sale can take place to a third party. The shareholders’ agreement will usually also deal with the mechanism for deciding on a price for these shares to be sold.
- The process to be followed in the event of the death, incapacity or insolvency of a shareholder.
When negotiating shareholders’ agreements, it is always important to bear in mind that each shareholder may have different priorities. This may depend on a number of factors including the percentage of shares held by that individual and the respective duties of the shareholders. Someone who holds the majority of the shares in a company could be concerned about being chairman of the board and having a casting vote. Someone who holds a minority of shares in the company could be concerned about ensuring that he is a director whilst he is a shareholder so that his voice is heard (even if he can be outvoted). As with all negotiations, compromise will of course have to be reached between the parties so that a deal can be struck.
Benefits of a shareholders’ agreement
Some of the major benefits of having a shareholders’ agreement can be summarised as follows:
•When parties go into business, at the outset in particular, there is usually a lot of trust and goodwill between the shareholders. All parties are looking for the business to succeed and often little attention is paid as to what would happen if a difference of opinion were to arise. Also, many discussions may take place either orally or in writing between the parties regarding the operation of the company and the relationship between the shareholders. A well drafted shareholders’ agreement will set out clearly in writing the results of those discussions, therefore reducing the potential for future dispute.
•By having specific discussions about what is to go into a shareholders’ agreement, it focuses the minds of the parties who may not have previously thought of addressing particular scenarios.
•Unlike the articles of association, a shareholders’ agreement is a private document, and that can be of benefit to the parties, especially if there are very sensitive commercial details that are to be included in the document.
Although there is naturally a certain degree of effort and cost required in putting an effective shareholders’ agreement in place, there are substantial benefits of entering into such a document. It is never too late to put a shareholders’ agreement in place. By agreement they can always be amended and updated as circumstances change. A properly thought out shareholders’ agreement can be looked upon by the shareholders as a form of insurance policy, which protects their interests as the business, hopefully, grows and becomes more successful.