Do I Need a Shareholders Agreement for My Small Business?

What is a Shareholders Agreement?

A shareholders agreement is a private contract between the shareholders of a company that governs how the company is run and how the shareholders deal with each other. Unlike a company's articles of association — which are filed at Companies House and are publicly available — a shareholders agreement is confidential.

A shareholders agreement works alongside the articles of association. Where they conflict, the articles generally prevail, so it is important to ensure the two documents are consistent. A good shareholders agreement addresses all the important issues that the standard model articles do not deal with adequately for most small businesses.

What Does a Shareholders Agreement Cover?

A comprehensive shareholders agreement for a small business typically covers:

• Voting rights: How decisions are made — by simple majority, by unanimous agreement for certain decisions, or by some other arrangement. Reserved matters requiring unanimous consent are particularly important — these are decisions too significant to be made by majority vote alone.
• Share transfers: Whether shareholders can sell their shares freely or must offer them to existing shareholders first. Pre-emption rights give existing shareholders the right to buy shares before they are offered to outsiders.
• Leaver provisions: What happens to a shareholder's shares if they leave the business. Good leaver provisions typically allow a departing shareholder to receive fair value. Bad leaver provisions — for someone dismissed for cause or who breaches the agreement — often result in shares being bought at a much lower price.
• Drag-along and tag-along rights: Drag-along allows a majority to force minority shareholders to sell if a buyer for the whole company is found. Tag-along protects minority shareholders by giving them the right to sell their shares on the same terms if a majority sells.
• Non-compete and confidentiality: Restrictions on what departing shareholders can do after leaving the business.
• Dividends: Whether and how dividends are declared, and whether any minimum distribution is required.
• Deadlock: What happens if the shareholders cannot agree on an important decision — and the company cannot function as a result.

What Happens if You Trade Without One?

Without a shareholders agreement, your company is governed solely by its articles of association — usually the standard model articles from Companies House — and by company law. The model articles are entirely adequate for a company with a single director-shareholder, but they leave many important questions unanswered for a company with multiple shareholders.

Common problems that arise without a shareholders agreement include:

• A shareholder leaves or dies, and their shares pass to someone entirely unknown to the remaining shareholders — potentially a spouse, an estranged family member or even creditors in a bankruptcy
• One shareholder wants to exit but there is no agreed mechanism for valuing their shares or buying them out
• The shareholders deadlock on a major decision and the company cannot move forward
• A departing shareholder immediately sets up a competing business, taking clients and employees with them
• One shareholder believes they are entitled to a salary or dividend the others disagree with

Resolving any of these disputes without an agreement in place is expensive, time-consuming and often damaging to the business. An agreement negotiated in goodwill at the outset — before any dispute has arisen — is far preferable to trying to negotiate a solution once relationships have broken down.

When is the Best Time to Put One in Place?

The best time to put a shareholders agreement in place is when you start a business with other people, before any investment has been made, any significant value has been created, or any disputes have arisen. At that point everyone is optimistic, relationships are good and negotiating the agreement is a straightforward commercial conversation.

The second best time is right now, even if you have been trading for some time without one. Better late than never — and the cost of preparing a shareholders agreement is very small compared to the cost of a shareholder dispute.