This is one of the great many questions I get asked in my working life.
As a solicitor, I would always suggest a shareholder agreement to create certainty, but for clients, it’s a matter of assessing risk as to whether one is needed against the initial cost, which can be a difficult balance for start up businesses.
The main reason parties have a shareholder agreement is to govern their relationship as a group on how a company can be run and what it can and cannot do. To a new business starting out, this is seemingly unnecessary as you are only just working out how you do things together, but in my view, prevention is better than cure. The best way to think about a shareholders agreement is to consider it the strategic bible of your agreed core values, rules and approaches that are likely to come up in the next few years.
The advantages of a shareholders agreement is twofold
a) its terms can remain private between the parties
b) you can agree to do almost anything the way you wish to
Typical topics covered in a shareholders agreement could include how dividends are paid, the treatment of different share class types, how decisions are made and what topics need a unanimous consent.
Increasingly, I am instructed to deal with small companies who have attracted investment and act for them while managing the relationship with the investor. In turn, a shareholders agreement is entered into to govern the new incoming shareholder and the treatment of its investment, such as when it can see a return on its investment, having staged investments over a certain period of time, or whether the investor can be represented on the board of directors.
Another absolutely vital consideration is the way in which shares can be transferred between the parties, or to third parties. It helps maintain the control of the share ownership while helping keep a smooth working environment. The last thing parties want is an outside party to be transferred shares if there is no mechanism in place to offer those shares to the other remaining shareholders.
Therefore, by having a shareholders agreement from the outset, you can nail down the issues, put it in writing and help pre-determine any outcomes or plans for the future, as far as possible. Most of the time it’s not referred to unless is really needs to be. For example, if there is a dispute, you can dust it off and refer to it for the agreed way forward to find a suitable resolution. The cost and time of dealing with a shareholder dispute can be exhausting and very emotive for a new company and ultimately could cost them significant investment. Large investors certainly do not want to get involved with shareholder disputes, and will withdraw from investment discussions if this is a concern. The very presence of having a uniformed approach already in place, could encourage investors you have clear plans and approaches as you have thought about what you want to achieve as the business grows.
Of course, things change and so does your business so annual reviews are of course recommended. It could need to be updated to ensure it accurately reflects what the shareholders want to achieve over time. Where possible, try to take advice early to work out what is best for you, as an investor, or as a shareholder, in order to help minimise your legal risk in the future.
Nicola Lucas – Nockolds