Why a Shareholders’ Agreement is Important – A Guide for SMEs

October 12, 2022

By Stephen Thompson

As a business owner you will be no doubt want to minimise expenditure and maximise funds, particularly with the current fuel and cost of living crisis. However, investing in a few key legal areas, such as regulating the relationship between the founders by using a shareholders’ agreement, is of paramount importance and can pay dividends going forward.

What is a shareholders’ agreement?

A shareholders’ agreement is a legal contract between shareholders of a company. They are usually private, confidential agreements between shareholders which set out various terms agreed between them relating to their shareholding in the company and how decisions can be made within the company.

No one goes into a business with the intention of falling out with their co-founders or other investors. However, unfortunately, business disputes between founding business partners, co-shareholders, friends or family members in business together are all too common. Such disputes can be extremely acrimonious and expensive to resolve.

Problems might arise because the parties disagree on important business decisions, one of them may want to take their money out and embark on a new venture, or it might simply be that the business has not been as successful as was expected.

What is the purpose of a shareholders’ agreement?

Not only can shareholder disputes lead to expensive legal action, they are also highly disruptive to the business.

A shareholders’ agreement will help minimise the risk of a dispute as it helps the shareholders address key issues at an early stage and should hopefully regulate the relationship between the shareholders as the business grows.

In addition to regulating day to day management issues, a shareholders’ agreement can be used to address more fundamental issues such as, what do the shareholders want out of the business and also their investment?

The shareholders in a business are likely to have different priorities, both personal and business, and therefore need to make sure that they are all heading in the same direction by identifying and agreeing on how they intend to manage their respective exit strategies should the need arise.

What should a shareholders’ agreement include?

Issues that can typically be dealt with in a shareholders’ agreement include:

• should there be any obligations or restrictions on what each shareholder can and cannot do, both whilst they are a shareholder and afterwards?
• should dividends be paid or the profits reinvested? If they are to be paid, should each shareholder be entitled to the same amount?
• what entitlement does each shareholder have to any new shares that are issued?
• what happens if one of the shareholders wants to sell their shares?
• should all shareholders, no matter how small their shareholding, be entitled to be appointed as a director of the company?
• what happens in the event of a disagreement – how will the dispute be resolved if the shareholders end up in a dead-lock?

Discussing, reaching agreement on and recording these decisions at the outset, in the form of a shareholders’ agreement, should hopefully minimise the risk of a fall out further down the line. However, if the worst should happen and a fall-out is inevitable, the shareholders’ agreement acts as a code for how the disagreement should be dealt with so that the dispute can be resolved as swiftly and cost effectively as possible, allowing everyone to move on and business to continue with minimal disruption.

If you would like more information about the above or a related matter, get in touch with Steve Thompson on sthompson@darwingray.com, or call on 07970 160166 for a free, no obligation conversation. You can also find out more about shareholders’ agreements here.