An Introduction to Shareholders’ Agreement-Why are they important?

A shareholders’ agreement (“Agreement”) records the arrangements between the shareholders and directors of a company regarding the ownership, government and management of the company. Companies are not required to implement an Agreement by law. However, implementing an Agreement is recommended as it is designed to address areas regarding governance and control of business activities, whether external or internal, which a company constitution or the Companies Act 1993 may not specifically address.

For example, the Companies Act 1993 may not provide specific guidance regarding the process for shareholders exiting a company. This is where an Agreement can be used by shareholders to outline the process and minimise any potential disputes and associated costs between exiting and continuing shareholders.

Generally, an Agreement sets out matters including, but not limited to:

  • How initial and continued shareholder funding is made and minimising shareholders exposure to capital risk;
  • The procedure for board meetings;
  • How the profits are distributed to shareholders;
  • The appointment and removal of directors and shareholders;
  • The transfer or sale of shares, i.e. offering shares to existing shareholders, how shares are valued and the number of shares permitted to be transferred in order to safeguard tax benefits;
  • Shares which are issued to employees of the company, i.e. employee shares, and how these are transferred when employment ends;
  • Shareholder voting rights and the number of shares in the company;
  • What decisions may be made by directors, what decisions require shareholder approval, and if shareholder approval is required, whether this is by majority, special resolution or unanimity; and
  • How disputes are resolved.

An Agreement provides a number of benefits for different types of companies. Companies with more than one shareholder are encouraged to at least consider the advantages of an Agreement. Companies with only one shareholder may consider that while there is only one shareholder it is not necessary to have an agreement.
An Agreement seeks to remove the ambiguity amongst the shareholders and directors, and provides direction to manage unforeseen circumstances as well as providing guidance for the day-to-day operation of a company.

Agreements are especially useful when there is no majority shareholding, commonly seen in smaller companies, as there is an increased risk of shareholder disagreements. Therefore, to ensure the maintenance of functional shareholder relationships, it is equally important for smaller as well as larger companies to have an Agreement.

The Agreement can include specific and sensitive details (unlike a company constitution which is available to the public) regarding the rights and obligations of the parties involved in the company and/or the rights attached to shares. This protects the interests of the shareholders and directors. Furthermore, under section 32 of the Companies Act 1993, amending a company constitution only requires a special resolution of the shareholders (which is generally 75% of the shareholders entitled to vote). An Agreement may provide that it can only be varied by unanimous agreement amongst the shareholders and accordingly, minority shareholders are further protected.

A constitution can only be implemented once a company is incorporated; however, an Agreement may be executed beforehand. This can be very beneficial where a company must meet specific deadlines for a transaction from the outset of the formation of a company.

An Agreement can provide stability to not only the existing parties involved but also to other external parties such as potential shareholders and creditors.
An Agreement can provide customised administration and protection for shareholders and directors which a constitution may not have the capacity to provide. It can be easy to delay the execution of an Agreement when a new business relationship is formed; however, it is during this initial stage of forming a company, that an Agreement should be put in place. This ensures that all parties involved understand the governance and ownership of the company from the outset. An Agreement aims to reduce additional costs, time and stress resulting from potential shareholder disputes and accordingly, it is an invaluable document which all companies should consider, if not implement.

Whether you are looking at starting a company or wish to provide more clarity among directors and shareholders within an existing company, it is best to seek legal advice to discuss an Agreement suitable for your needs.