Do startups need a shareholders agreement?

Starting a new business can be an exciting but complex process. Once you have formed and registered your limited company, you should consider next steps such as a shareholders agreement.

As a startup with more than one shareholder, it is important that you put in place a formal shareholders agreement to protect from unforeseen and future issues between shareholders that may affect the running of the business. The terms of the agreement can remain confidential between shareholders.

In this blog we look at what a shareholders agreement is, what is included in it, the protection it offers and how it may protect your business in the future.

What is a shareholders agreement?

A Shareholders Agreement is an important contract between the shareholders of a company. It sets out how decisions are made, what happens when a shareholder wants to leave the company, how disputes are handled and other important areas of running your business. It works together with the company’s Articles of Association to determine the rights and duties of shareholders.  

Do I need a shareholders agreement?

If you’re setting up a private limited company with more than one shareholder, you need a Shareholders Agreement.

Even if you’re setting up the business with friends or family you know and trust, it is still good practice to have a shareholder agreement in place to lay some ground rules, ensure everyone understands the agreement and avoids or lessens future conflict should things change or as the company grows.

What is contained in a shareholder agreement?

There is no set standard for shareholder agreements, it can contain whatever you want it to contain. It is important that the startup founders and shareholders agree on what goes into the agreement. Such agreements often contain clauses and information on the following areas:

What happens when a shareholder leaves, dies or becomes bankrupt

A shareholders’ agreement will usually contain provisions that deal with what happens if a shareholder dies, becomes bankrupt, leaves or retires from the business. This is an important area of protection for the future of the business.

This section may contain details of how shares are valued and priced should this happen.

What happens when a shareholder or shareholders want to sell

There may well be restrictions on who a shareholder can transfer or sell shares to. It may need approval from the other shareholder or director if the shareholder wishes to sell their share of the business. You may want a clause that states that the other shareholders are given first refusal to purchase the shares in these circumstances.

It may also contain ‘drag’ or ‘tag’ along clauses that force a shareholder to sell their shares if the majority agree to sell the business.

In circumstances where an offer to buy all the shares in a company is received, ‘drag along’ provisions enable the majority shareholders to compel the minority shareholders to accept the deal. This stops one potentially difficult shareholder from preventing or blocking a sale.

Tag along rights provide protection for minority shareholders where if the majority shareholders receive an offer for their shares, the minority shareholders can force the majority shareholders to secure that offer being extended to the minority shareholders.

Decision making process and the board of directors

As your business grows you may build a board of directors and as shareholders step away more from the day to day running of the company, so a shareholders agreement can set out what happens if the shareholders disagree with decisions made by a board of directors. It could also detail the appointment and dismissal of directors, directors pay and benefits including how and when dividends are paid.

New shareholders and future issue of shares

The agreement will usually also cover what happens if new shares are issued, as this can dilute the value of the existing shareholders’ holdings. 

Disputes

A shareholders’ agreement may contain provisions dealing with dispute resolution i.e. how disputes are resolved between shareholders. This may include employing a third-party adjudicator before deadlock hits. If shareholders are unable to be settled amicably it may contain how one shareholder may exit the company in order to end the dispute.

Capital

If a company is a start-up, a shareholders’ agreement can sometimes provide that the shareholders be invited to participate in the financing of the company, for example as working capital.  

Shareholders agreements restrictions

A shareholders’ agreement can place restrictions on a current or exiting shareholder. For example it may restrict an exiting shareholder from starting a competing business or taking customers away from the current business for a set period of time. It may contain provisions that require all directors and shareholders to keep all matters relating to company business confidential.

Voting rights

Traditionally, one share buys one vote. So in most companies, the shareholder who has more than 50% of the shares can make decisions and controls the company. However, it can sometimes be beneficial for everyone to have an equal say or equal vote or give some people greater rights. Your shareholders agreement can cover this area.

Does a shareholders’ agreement override articles of association?

No, a shareholders’ agreement will not override the Articles of Association. If there is a conflict, then the articles will prevail. However, you may include in the shareholders’ agreement a clause that states should a conflict arise, then the shareholders and directors will act together to change the Articles so that they agree with the provisions of the shareholders’ agreement.

Summary

The primary aim of any shareholders’ agreement is to protect the shareholders and the company. A shareholders’ agreement will be one of the most important legal documents that you create when launching your startup and you should ensure that it meets your needs and is tailored to your own startup.

Putting together a Shareholders Agreement can seem like a daunting process, and whilst there are templates available, it can be hard to know what to include and how to word it. It’s a good idea to invest in a lawyer to assist you with this process as this one-off cost could save you thousands of pounds further down the line.

If you have a query or want specialist advice on creating a shareholders agreement, Book a call with us.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.