Why are Shareholders' Agreements so important

Written by Snowball Effect · Published on Mon, 19 October 2020

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A Shareholder Agreement is an essential company document that clearly defines the relationship between a company and its shareholders.

It plays an important part in influencing decision making, roles and responsibilities, and can help settle disputes.

What is a Shareholder Agreement?

A Shareholder Agreement is a document between a company and its shareholders, which sets out the rights of shareholders in regards to their relationship with the business and each other. Similar to a property agreement or a marriage prenup, it helps ensure that all parties know their rights and what is expected of them.

Shareholder Agreements are traditionally signed on or before the incorporation of a company. However, it’s never too late to establish an agreement if your company doesn’t already have one. A Shareholder Agreement can also be tailored to each company’s requirements. 

A common mistake that many people make is thinking that a Company Constitution and a Shareholder Agreement are the same. While there is some crossover between the two documents, unlike a Shareholder Agreement which is a private record, a Company Constitution is a public document and registered with the Companies Office. It includes critical information needed to operate a company, which is not already included in the Companies Act 1993. 

Why is a Shareholders Agreement important? 

A Shareholder Agreement is an important record as it helps set expectations at the outset of the relationship. It also serves as an ongoing reminder for the company of its duty to shareholders and their obligations. 

The existence of an Agreement proves valuable when difficult situations arise between a company and its shareholders, or between shareholders. It provides clear direction in instances when shareholders want to exit the company, or when shares are for sale, or when the company wishes to raise capital. Without a Shareholder Agreement, companies and shareholders can run the risk of being tied up in complicated, expensive and lengthy legal disputes. 

What’s included in a Shareholders Agreement?

Shareholder Agreements often include sensitive information about a business’ affairs, such as the roles and remuneration of shareholder-employees, rules around the selling of shares, dividends, and dispute resolution terms. 

A Shareholder Agreement will commonly include information on: 

  • How the business will operate 
  • The number of company directors and how they can be appointed or removed
  • Details around the decision-making processes at a board and shareholder level 
  • Shareholders’ roles and responsibilities 
  • Dispute resolution provisions
  • The transfer of shares
  • How shares will be valued in the event of a share transfer 
  • How and when a shareholder or director can be removed from the company
  • What will happen to shares in the event of a shareholder’s death 
  • Company funding and loan details
  • What happens in the event of shareholder-employee bankruptcy
  • Restraints of trade restrictions to protect the company 
  • Dividends and distributions which ensure all shareholders are treated equally 
  • Pre-emptive and voting rights for shareholders 
  • Drag and tag rights (which deal with what happens when shareholders in the company wish to sell)

How shareholder disputes are commonly settled

Details in the Agreement on shareholder dispute resolution are especially useful when a company or party of shareholders reach a point in their relationship when they can no longer continue working together, forcing a shareholder to exit the company. A common way to resolve this situation is by including a ‘shotgun clause’ in the Shareholder Agreement, which involves each party presenting their best price for the purchase of the other party’s shares. The party with the highest price wins the bid and purchases the other party’s shares, which prompts the other shareholder to exit the company.

What are pre-emptive shareholder rights? 

Pre-emptive rights are anti-dilution protective rights for shareholders, which apply in circumstances when new company shares are issued. This could be when a company brings on new shareholders through a capital raise. 

By including a pre-emptive rights clause in the Shareholders Agreement, it provides existing shareholders with the right to participate in the new offer of shares by buying additional shares which will enable them to retain their current percentage of the company. 

What are ‘drag and tag’ shareholder rights? 

A ‘drag’ situation occurs when the majority of shareholders want to exit the company and sell their shares to a third party. By doing this, the majority can ‘drag’ along the company’s minority shareholders, so that a third party acquisition can purchase 100% of the company. 

A ‘tag’ right provides minority shareholders with financial protection if the majority are selling their shares. The ‘tag’ right allows minority shareholders to ‘tag’ into the exit offer and sell their shares on the same terms as what the majority are selling under. 

Including ‘drag and tag’ terms in a Shareholder Agreement will help ensure that all shareholders have rights in the case of a third-party acquisition.

Interested in learning more about Shareholder Agreements? Don’t hesitate to contact our team at [email protected] or by calling 0800 SNOWBALL