The Myth of Shareholder Agreements

“Err, because everybody does?” was the answer given to me by a client when asked why he wanted a shareholders’ agreement (SA) for his new company.

I don’t want to take (gluten free) bread out of the mouths of starving lawyers, but don’t always assume that you need an SA.

For the uninitiated, a typical SA is a legally binding contract between shareholders, outlining shareholder rights, responsibilities and obligations.

Whilst a company’s articles of association govern the overall structure and rules about how a company is run (e.g., the proper process for calling and voting at a shareholders’ meeting), an SA is an optional document that addresses the preferences of shareholders. It covers whatever the shareholders want it to cover: rules about offering shares for sale to other shareholders first (called pre-emption rights), who gets to be a director, whether shareholder permission is needed to hire senior staff, what percentage of votes is needed to pass resolutions on specific matters, etc.

If your company has a number of shareholders, then an SA may well be a good idea (at least for the otherwise powerless minority shareholders anyway). Most businesses enter into SA’s at the outset, when everyone is on the same page, full of hope and hyper-collaborative – in other words before, you know, reality bites (so many new companies follow a similar trajectory – at the outset they are commune or kibbutz like: all burning the midnight oil together to get their fledgling to fly, shoulders to the wheel and all that. But the fallings-out tend to happen later: ironically more so when the company starts making money – because then there is something to fight over.

The main purpose of most SA’s is to have Gulliver tied down by the Lilliputians (no, not Liverpudlians). Let me explain – but it does involve a smidgen of company law. Under the main law defining company regulations (the Companies Act 2006), most matters can be decided by the board of directors, but the 2006 Act says that some things need shareholder approval (e.g., issuing new shares or changing the articles). Most things are decided by majority vote of those attending a meeting and voting (so, 51% if all shareholders are present at the meeting and vote). These decisions are called ordinary resolutions. Some topics need 75% (called special resolutions). ?So, if you own 51% of the shares you are Gulliver, the undisputed boss, probably 98% of the time. If you own 75% then you are always Gulliver the boss. You get to call the shots. So, signing an SA is to allow the Lilliputians a voice and to give them in effect a power of veto most would not otherwise have.

My advice to majority shareholders is ‘don’t give away your power too easily’ – especially if (as is often the case) the company is your vision, your drive and your project - and the others are enablers. Maybe they are genuine partners, in which case fine, but often they are not co-visionaries, they are just doing a job. Reward them, but don’t give away your project to the hired help (sorry if that sounds harsh, but too often I see people riding on the coat-tails, and wanting control and reward out of all proportion to their contribution).

The other situation where an SA is frequently entered into when it is often not needed, is if there’s just the two of you: both directors and 50-50 shareholding.? You each effectively have complete right of veto over everything, so entering an SA that gives you a right of veto doesn't add anything.

The only time that it really makes sense have an SA if there is just the two of you is if you want to future proof something that is not covered in the articles or elsewhere, e.g., pre-emption rights where you want to lock in the provision that if either of you wishes to sell your shares they have to be offered to the other first. I would say though that if you do find yourself creating an SA to lock in certain provisions because you think that the relationship with your business partner won't always be quite as collaborative, then listen to your gut’s paranoia and build will in some other protections as well. For example, make sure that you personally own the company’s intellectual property rights. That way if you are kicked out of your own business (believe me it happens) you can usually stop the coup plotters in their tracks by withdrawing the rights of the company to use essential brand names etc.

Whilst we're talking about SA's, as a general point, try not to use your SA as a partial contract of employment. It's like trying to use a tractor as a taxi. Sure, there are superficial similarities, but it rarely gets the job done.