What is a shareholders’ agreement, and why do you need one for your business? – Shareholders

What is a shareholder agreement, and why do you need one for
your business?

In 2024, businesses are looking at ways to start or continue
their operations while having a stronger focus on managing
risks.

Often, an overlooked way of managing ongoing and future legal
risk in business is by preparing a shareholders’ agreement.
These agreements have several benefits including safeguarding the
interests of owners, mitigating conflicts, and the provision of
peace-of-mind to shareholders.

What is the difference between a Shareholders Agreement and a
Constitution?

A shareholders’ agreement can provide clarity, stability,
and a well-defined framework for the legal relationships among a
company’s shareholders.

Distinguishing a shareholder agreement from a company
constitution is important. While both govern the internal workings
of a company, a shareholders’ agreement is a private,
contractual arrangement between shareholders, focusing on their
rights and obligations and tailored for them. In contrast, a
company constitution is usually a more generic document outlining
the company’s structure and management. A constitution may be
required to be filed with regulatory authorities, whilst a
shareholders’ agreement remains confidential among the involved
parties. A constitution sets the company’s broad framework,
where a shareholders’ agreement delves deeper into the
specifics of shareholder relationships, offering more flexibility
and customisation to meet the unique needs of the stakeholders.

Defining roles and responsibilities?

Shareholder agreements go beyond establishing a contractual
relationship, they craft a detailed roadmap that delineates the
roles and responsibilities of each stakeholder. This clarity
minimises conflicts and fosters an environment where each
shareholder understands their unique contributions.

Consider what decisions can be made at director and shareholder
level. For many small to medium-sized companies, the shareholders
may be the same as the directors (not always the case). The
shareholders’ agreement can be used to define what authority
directors have, such as powers to adopting or varying a business
plan, acquiring, or divesting business assets or entering into
commercial agreements. A shareholders’ agreement may allow this
kind of decision-making or limit it.

By outlining the scope of authority, this forms the foundation
for effective decision-making and collaboration.

Streamlining the decision-making process

Defining clear decision-making roles is essential for a
successful business. Shareholder agreements are crucial in ensuring
efficient decision-making by establishing transparent processes and
preventing ambiguity and gridlock.

Clearly defined voting procedures and thresholds in shareholder
agreements streamline decision-making for asset acquisition or
disposal. For example, directors can authorise the purchase of
assets up to the value of $50,000 without shareholder approval, but
higher-value acquisitions require shareholder approval, possibly
with a special majority. Clarity reduces legal risk and aligns
strategic choices with company objectives.

Drag along and tag along rights

Shareholder agreements play a crucial role in scenarios where
influential majority shareholders dominate. They safeguard minority
shareholders through mechanisms like tag-along rights and
anti-dilution clauses, which promote equity and inclusivity.
Conversely, while ensuring the protection of minority interests is
paramount, shareholder agreements often incorporate drag-along
rights as a pragmatic measure. This provision empowers majority
shareholders to compel minority shareholders to join in the sale of
the company, promoting unity in potential exit scenarios and
maximising value for all stakeholders. This mechanism strikes a
delicate balance between safeguarding minority rights and promoting
cohesive decision-making in strategic company transactions.

Dispute resolution

Even with the best of intentions, given the unpredictable
landscape of business, disputes are not uncommon. Shareholder
agreements are designed to turn potential conflicts into
opportunities for resolution. In a scenario where two (or more)
shareholders are in dispute, a shareholder agreement may set out
dispute resolution processes. These may include engaging in a
mediator or facilitator and provide impartial opinion on the issue
that is binding on the parties.

Alternatively, if the dispute can’t be solved or there are
irreconcilable differences, there may be a process outlining the
exit of one or more shareholders, or even a trigger to wind up or
sell the business.

Through the inclusion of arbitration or mediation clauses, these
agreements pave the way for efficient and amicable conflict
resolution, ensuring minimal disruption to business operations,
including avoiding costly and protracted litigation.

Confidentiality clauses

Shareholder agreements contribute to a company’s resilience
by incorporating confidentiality clauses. These provisions
safeguard proprietary information and prevent shareholders from
engaging in activities that could compromise the company’s
competitive advantage. The inclusion of these clauses enhances the
overall security and stability of the business.

Restraints and non-compete clauses

Restraint clauses offer essential benefits for
business stability and protection. These clauses seek to ensure
that departing shareholders don’t engage in activities
detrimental to the company’s interests.

Non-solicitation clauses restrict the departing
shareholder from soliciting clients, employees, or suppliers of the
company, preserving key relationships. These provisions foster a
secure environment for investors by mitigating the risk of internal
competition and protecting proprietary information.

One scenario where this may be important is where a key employee
is allowed to buy equity in the company with a view to one day buy
out the (original) business owners. That new shareholder may wish
to protect the goodwill and relationships once they are able to
complete the share buy-out.

Another scenario may be in circumstances where a shareholder
wishes to depart the company (perhaps because of a dispute) and it
would be important for the remaining shareholders to protect their
business from possible competition from that departing
shareholder.

Overall, restraint clauses enhance corporate governance, promote
long-term sustainability, and provide a legal framework that
encourages trust and collaboration among shareholders.

Strategic succession planning

Beyond day-to-day operations, shareholder agreements extend
their influence into long-term strategic planning, particularly in
succession scenarios. These agreements include provisions that
ensure a seamless transition of ownership and control, mitigating
risks associated with leadership changes.

Consider the decisions to succeed the managing director of the
company in circumstances where they may retire or unexpectedly
depart. Similarly, an active shareholder in the business may wish
to allow children (or a specific child) to succeed them in the
business.

By incorporating foresight into succession planning, shareholder
agreements contribute to business continuity and sustained
growth.

Addressing death or permanent disability

Following on from the above, a critical aspect often overlooked
is the potential impact of the death or permanent disability of a
shareholder. This scenario is one that often arises unexpectedly
and, once it does, if there are no provisions to deal with it, it
may already be too late.

Well-crafted shareholder agreements anticipate such scenarios,
outlining clear procedures for the transfer of shares, valuation
methodologies, and the protection of the deceased or disabled
shareholder’s interests.

These provisions provide stability during tumultuous times,
ensuring a smooth transition of ownership while safeguarding the
financial well-being of the affected party’s heirs or
beneficiaries.

Building trust and elevating investor confidence

Investors seek stability and assurance in their investments. A
well-structured shareholder agreement becomes a testament to a
company’s commitment to governance and transparency, therefor
enhancing investor confidence. In an environment where trust is
paramount, businesses with comprehensive shareholder agreements are
better positioned to attract and retain investors, fostering a
positive trajectory for growth.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.