Companies, Partnerships and Directors
Shareholders’ agreements — a background guide
The contents of a shareholders’ agreement will, of course, differ for each company depending on its size, the nature of business and parties involved. Common areas covered:
A minority shareholder has no right to veto important company decisions, but may feel it is appropriate that all shareholders should approve certain important matters such as new company borrowing, granting guarantees or security, altering share capital etc. A shareholders’ agreement can build in appropriate safe guards both at shareholder and board level.
Transfer of shares
Without an agreement (and subject to what is in the articles), a shareholder may sell his/her shares to a third party - even a competitor of the company.
A shareholders’ agreement can provide a right of first refusal for existing shareholders. This ensures that the company’s ownership remains in the hands of those existing shareholders.
Death and insurance
Should a shareholder die without a shareholders’ agreement in place, his/her spouse and other family member(s) may inherit their shares. This is rarely desirable for the other shareholders. A shareholders’ agreement can instead provide for the surviving shareholders to have a right to purchase the deceased’s shares. This will typically be backed-up by a right for the deceased’s family or personal representatives to require the surviving shareholders to purchase the shares. Together, these form what we call “cross-options” – in order to ensure that business property relief from inheritance tax will be available in respect of the shares, these arrangements must be structured as options. If, instead, they are drafted as binding obligations to sell and buy, business property relief will be disallowed by HMRC.
As part of the cross-options arrangement, life insurance may be put in to place to ensure that funds are available to the surviving shareholders to purchase in this way. There are important tax consequences of these arrangements, so be sure to take professional advice. If structured correctly, the life proceeds can also be received and used in a tax-efficient way.
It is also important to make sure that the cross-options are drafted in terms wide enough to cover shares that a shareholder may have transferred into a family trust. Certain BPR schemes rely upon such transfers into trust so, again, it is vital to seek professional input.
Sale of the company
Majority shareholders often expect to have control over an ultimate sale of the company. However, a potential buyer will only wish to purchase all of the shares and not just the majority, so the majority shareholder will wish to avoid the minority refusing to sell. Without a shareholders’ agreement, the minority cannot be forced to sell - therefore it is important to provide in the agreement that the minority shareholder(s) are required to sell at the same time as the majority. This is known as a "drag along" right.
The minority shareholders, of course, will no doubt want a corresponding right to ensure that they have an opportunity to join in any sale proposed by the majority. This is known as a "tag along" right.
Disagreements between shareholders cannot always be resolved simply and amicably. A shareholders’ agreement will provide a disputes mechanism, aiming for quicker and more effective resolution - in particular where there is a deadlock on a vital decision between parties holding 50% each of the company.