Are they important? Yes, they are so important, that they might (in many cases) be considered absolutely necessary. Going into business with someone is a major life event and it should be treated with respect. That respect should extend to putting in place an agreement to regulate the relationship, through its ups and its downs.
Sensible business people know that when they are working hard with others to create and increase the value of their company, it is important to protect that value. So why not start the protection process with the area over which owners have most control, themselves.
The absence of an agreement regulating the owners’ relationship, both on a management and share ownership level, can, in our experience, lead to uncertainly, followed by paralysis, followed by expensive disputes.
A shareholders’ agreement can add value for the company’s shareholders in a variety of ways; here are three examples of useful provisions:
- Right of first refusal
A shareholder wishing to sell his shares can be forced to offer them to the remaining shareholders, before he is allowed to sell them to an outside party (if at all). This creates the opportunity for the continuing shareholders to remain in control of their company.
The method of calculating the value of the sale shares can also be set out and is recommended so as to avoid any disagreement which could delay a share transaction and cause unnecessary and unwanted internal disputes.
- Deemed transfer provisions, good leaver and bad leaver
What happens if a shareholder acts to the detriment of the company? How can the other shareholders ensure that he leaves without having to buy his shares at an unaffordable price? The shareholders’ agreement can set out circumstances that would make such a shareholder a bad leaver and automatically trigger a right for the other shareholders to buy the bad leaver’s shares.
Such circumstances could include: where the shareholder becomes bankrupt, sets up in competition with the company or where he is employed by the company e.g. as a director and he is dismissed for gross negligence.
If a shareholder leaves as a bad leaver, the shareholders’ agreement can stipulate his shares will only be worth their nominal value (for example £1 per share), thus allowing the other shareholders to purchase those shares at an affordable price.
- Cross options and life policies
When a shareholder dies, his or her shares pass to his or her estate. In most cases this means that a deceased shareholder’s estate will own shares it doesn’t want and the remaining shareholders won’t be able to afford to buy those shares from the estate.
To resolve this situation, a shareholders’ agreement can provide that every shareholder must take out a life policy and when a shareholder dies, the life policy proceeds can be used by the remaining shareholders to buy the deceased shareholders’ shares from their estate for the value of the life policy. Everyone wins - the remaining shareholders retain control of the company and the estate receives an amount for the shares that the deceased shareholder wanted. If the company increases in value, it is up the shareholders to ensure the life policies do likewise.
Is it time to protect the value of your shareholding?
