Use a shareholder agreement to avoid conflicts, delays and costly mistakes

If the past few years have taught us anything, it's how unpredictable the world can be and how important it is to plan ahead for challenging circumstances.

Here I discuss the importance of a shareholder agreement, especially when dealing with difficult scenarios.

A shareholders' agreement is an essential tool recommended for any company with two or more shareholders to regulate conduct between each person and make provision for potentially difficult or important decisions. There is certainly much more awareness of these agreements now than in the past, but there is still sometimes reluctance and a lack of appreciation of their value. This is especially true where there are family or other close relationships and therefore there is often a belief that these agreements will not be necessary – but most legal professionals would argue that it is better to draft the rules to promote transparency and possibly postpone or resolve any problems. future conflict.

Ultimately, a shareholder agreement allows decisions to be made from the start and ensures that shareholders are aligned before the company becomes successful.

Understanding roles

It is important to understand the distinction between shareholders as owners of the company and how this sets them apart from other members of the company. For example, directors run the company, but do not have to be shareholders. There are employees working in the company, but that doesn't mean they can't be shareholders.

The boundaries can become blurred, especially in smaller companies, where people are often involved in all three roles. Setting these clear boundaries can help you better understand who is responsible for what and ensure the business continues to run successfully, even when obstacles arise.

Putting pen to paper

Perhaps one of the most serious questions companies must ask themselves is what happens when a shareholder dies. Often shareholders will say they 'have an idea' or perhaps they have even discussed their plans on an informal basis. However, if these plans are not set out in a formal agreement, the shares can be transferred 'accidentally' in accordance with the deceased's will (or worse, in the absence of a will, according to the rules of the will). This may mean that the shares end up with the spouse, children or other family members of a deceased shareholder. The question we need to ask in this particular scenario is: will we get along against the backdrop of a very emotional period?

I have experienced variations of this scenario many times. In one example, a spouse became the owner of the shares and the remaining entrepreneurs found it very difficult to find their way, especially when it came to financial decisions. Ultimately, legal action was taken to buy back the shares. It is important to remember that in circumstances like this, which can be very emotional, people may say and do unusual things. Once harsh words are spoken, they are difficult to take back.

Dealing with the outage

At some point during a company's life cycle, shareholders will disagree on commercial decisions. It just depends on how serious the disagreement is. By recording how disputes can be resolved, shareholders can follow a procedure to reach a solution. A “Russian Roulette” provision is especially useful for 50/50 partners who face a situation where the dispute is so serious that one or more parties no longer see a way to continue working together. The premise behind this very aggressive measure is that one party offers to buy the other party's shares at a certain price. The party receiving the offer can accept the offer and sell its shares, or reverse the offer and buy the shares of the party that made the offer at the same price. The parties will not make a low bid (in case they end up selling) nor will they make a too high bid (because they will have to pay for it).

It does not work

When it comes to owner-managed businesses, there may come a time when a shareholder wants to leave the company.

A right of first refusal (also called pre-emptive right) ensures that any shareholder who wants to leave must first offer his shares to the remaining shareholders. The price can be determined by whether they are considered a 'Good Leaver', 'Early Leaver' or a 'Bad Leaver'.

An example of a 'Bad Leaver' could be someone who has stolen trade secrets and resells them to the highest bidder. In this case, they will likely receive the lowest par value and market value for their shares.

A 'Good Leaver' usually occurs when a shareholder leaves the company on good terms, for example with retirement. In that case, there is a good chance that he will receive market value for his shares.

To sell

When there is an imbalance between share ownership, there may be protection of the interests of majority and minority shareholders. If a majority shareholder wants to sell his shares, a minority shareholder is not obliged to participate in the sale. This could lead to critical delays in situations where the company is for sale, and in severe situations, majority shareholders could be forced to pay ransoms.

'Drag along' provisions can allow majority shareholders to force minority shareholders to sell their shares along with majority shareholders if the majority has accepted an offer for their shares.

Final thoughts

Creating a shareholders' agreement can be done quickly and easily. All it takes is decisiveness. The terms are largely confidential and do not involve many people. Any company with multiple shareholders should have some protection, because you simply never know when it will be needed, and it is largely agreed that most people want to protect their business from the unpredictable.

It is often a much easier process to get shareholders together and work on an agreement at the start of a new business, when everyone is likely to be on the same page and optimistic about the future.

A shareholders' agreement is just one of many tools a legal professional can discuss to support your company's broader planning and succession objectives, providing better control and peace of mind as whatever challenges arise.

Rik Pancholi

Rik joined Nelsons in November 2023 following the successful acquisition of the company he founded in 2016; Patterson's Commercial Law. As a corporate lawyer, Rik can advise on corporate reorganizations, both share and company takeovers/sales, shareholder agreements and a specialism in the accountancy sector, based on his experience as the owner of a law firm.

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