A key element of running a company is successfully managing your shareholder relationships. Indeed, your shareholders are often subject to change—some may wish to exit the business, while others may join. Therefore, many companies use a shareholders agreement to manage these dynamics.
A shareholders agreement acts as a contract between the shareholders who sign it, requiring them to reach a consensus over their rights and responsibilities. They must also decide how the company handles certain situations that may arise, such as shareholder disputes or share transfer processes. Given its binding nature, however, a shareholders agreement may not be suitable for all companies.
To assist you with deciding whether a shareholders agreement is appropriate for your company, this article will discuss the main advantages and disadvantages of a shareholders agreement.
What is a Shareholders Agreement?
A well-drafted shareholders agreement clearly defines the rights and responsibilities of company shareholders, and the relationship between shareholders and directors. In addition, it should act as a framework for decision-making during unexpected events, should they arise. For these reasons, shareholders agreements usually contain provisions covering the following scenarios:
- issuing dividends;
- valuing shares;
- transfer of shares;
- tag-along rights;
- drag-along rights;
- voting thresholds;
- death or liquidation of a shareholder;
- dispute resolution methods; and
- confidentiality agreements.
The contents of a shareholders agreement may seem similar to a company constitution. However, the difference between these two documents is that a shareholders agreement defines shareholders’ rights and responsibilities more comprehensively. Further, while a company constitution is automatically binding for all company members, a shareholders agreement only binds those who sign it.
Shareholders agreements are not a compulsory requirement in all countries. Because of this, it is a good idea to weigh up the advantages and disadvantages of using one.
Advantages of Using a Shareholders Agreement
1. Protects Shareholders’ Interests
Having a shareholders agreement can clarify and protect the rights of your company’s minority and majority shareholders. This is chiefly done through drag-along and tag along-rights, included as clauses within the shareholders agreement.
Drag-along clauses ensure that if majority shareholders want to sell their shares, the minority shareholders cannot refuse and must also sell their shares. Conversely, tag-along rights protect minority shareholders’ interests. Specifically, if majority shareholders sell their shares to a buyer, they must also buy shares held by minority shareholders. Therefore, tag-along rights ensure that minority shareholders are not stuck with a company controlled by shareholders over which they had no control.
More generally, a shareholder agreement can also protect the information rights of shareholders. For instance, you can include a provision that requires certain company information to be provided to your shareholders, such as a copy of the company’s annual business plan. This allows shareholders to stay informed of their investment in the company.
2. Mitigates Disputes
A shareholders agreement can settle disputes that arise between shareholders. This is because dispute resolution clauses will bind all the shareholders who signed the agreement. Therefore, having a predetermined dispute resolution process can assist in managing conflicts more efficiently.
3. Expectation Setting
Another advantage of using a shareholders agreement is that it sets expectations between shareholders by defining shareholder rights and obligations. This also reduces the likelihood of disputes arising.
For example, company funding and profits can often be a source of conflict among shareholders. Imagine that shareholders informally agree that they will each contribute equally to a company’s funding requirements. Later on, if a shareholder refuses to pay their agreed share, this could turn into a costly dispute given there is no contractual document that clearly sets out their funding agreement.
Indeed, signing a shareholders agreement requires shareholders to agree on the ‘ground rules’ beforehand. Having difficult discussions early on and pre-empting contentious issues can minimise disputes and save you considerable amounts of time and money.
Unlike a company constitution, you do not need to make a shareholders agreement public. Additionally, you can include confidentiality provisions within a shareholders agreement. This is beneficial as it ensures that the sensitive company information you disclose to shareholders is not shared with third parties.
A non-compete clause may also boost privacy, allowing shareholders to prevent shareholders from creating companies that directly compete with the company while they are a shareholder. This provision will often remain in effect for some time after the individual ceases to be a shareholder of the company.
Finally, a shareholders agreement has no compulsory requirements. This allows you to tailor a contract to your company’s needs. Without a shareholders agreement, you will have to work within broad legal principles, which may not be as suited to your company. In addition, a shareholders agreement will put you in a better position should you wish to consider future investors, purchasers or exit strategies.
Disadvantages of Using a Shareholders Agreement
1. Less Flexibility (After Signing)
However, a disadvantage of using a shareholders agreement is that it becomes rather inflexible after coming into force. Generally, for you to amend a shareholders agreement, all of the company shareholders need to agree to the change in writing. Therefore, it may be a difficult and time-consuming task to adapt a shareholders agreement to changing circumstances. By contrast, amending a company constitution generally only requires a 75% vote in favour at a general meeting.
2. Overrepresentation of Minority Interests
An overrepresentation of minority interests can also be seen as a disadvantage to majority shareholders. Indeed while majority shareholders own the highest proportion of shares in the company, minority shareholders often benefit from substantial protection in shareholders agreements through provisions like tag-along clauses.
3. Availability of Alternatives
Before your shareholders agreement comes into effect, and before you can make any amendments, you need to achieve consensus between shareholders. This can be a difficult process, particularly if you have a large number of shareholders.
A poor relationship between shareholders can be very bad for business: your company’s performance may suffer, and you may encounter costly legal action if your shareholders have disagreements over their rights and obligations. Having documents in place for expectation setting and dispute settlement, such as a shareholders agreement, can therefore be beneficial in preventing these issues from occurring.
However, a shareholders agreement may not suit everyone. Indeed, some may find the unanimous consensus between shareholders more effort than it is worth, given the availability of alternatives.