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Formal shareholder agreements are the business equivalent of a pre-nuptial contract

Almost half of marriages in the UK end in divorce and, unfortunately for small businesses, the chances of an irreconcilable dispute at boardroom level can be almost as high. The law can't stop disputes occurring, but signing a shareholder agreement can go a long way to ensuring the company runs smoothly, while catering for any unfortunate circumstances.

This article looks at the importance of private agreements for shareholders in limited companies, but the same principles apply to people in business partnerships. It is equally important for firms to enter into a formal agreement, not least as this prevents them having to operate under the Partnership Act 1890.

The long and short of it

The first thing to remember is that a shareholder agreement can be as straightforward or as complex as you want it to be. Whether a shareholder agreement is flexible or strict, specific or general, 50 or just five pages long, all of them do the same thing - provide a mechanism for major decisions to be made within a company; a means for disputes to be resolved; and a way in which a shareholder can leave the business.

Even though it is a valuable commercial document, most small companies don't have one, mainly because when things are going well in a business, and the shareholders are getting on, people don't want to discuss hypothetical problems.

As a result, agreements tend not to be written up or even thought about until it is too late.However, a successful business with a long-term future will always benefit greatly from a formal signed agreement from the start.

As long as it is agreed and signed by all relevant shareholders, it is possible to include any clause. Perhaps the most frequently used 'standard' clause is 'minority protection'. This relates to shareholders with less than 50 per cent of the share capital of the company and ensures that decisions cannot be made unless there is unanimous consent from the board. It is an extremely powerful way of ensuring major disputes do not occur.

Other common clauses can include which bank the company will use, who will sign the cheques, who can employ staff, when board meetings will be held, and when a decision can be made by one person, rather than by two or three. Clauses concerning the restriction of transferring shares and details about whether shares can be gifted to family members for tax purposes, without having to offer them to the other shareholders, are also common.

Insertions about the future funding of the company could include a commitment from the shareholders that they will aid future funding or will approach a bank and will be willing to give guarantees.

Agreements can also be used to resolve a situation when someone wants to leave the company.Whether the split is amicable or not, it is usually in everyone's interest to make the dissolution as quick as possible. If there's a dispute and one shareholder wants to leave, it is usual practice for the leaving party to sell his or her shares back to the remaining shareholders.However, it is not always this simple. The individual leaving may claim that they have put in more effort over the years and attempt to get more than just a pay-off for their equity. A mechanism to resolve these possible tensions needs to be addressed early on.

Normally, if a shareholder dies, retires, resigns or becomes bankrupt, agreements can allow an option so that the shareholder who commits or suffers one of these 'events' has to sell his or her shares to the others at an agreed price. If a price cannot be agreed, then the company's accountant can be asked to determine the price. This gives security to the remaining shareholders because it prevents a third party, such as a trustee in bankruptcy, from taking an interest in the company. Also the agreement can restrict the selling or leaving shareholder from setting up in competition against the company.

Recent additions

Shareholder agreements are always in a state of transition and there are new clauses being inserted all the time. One, for example, that is becoming more and more popular is known as the 'Russian Roulette' clause. This relates primarily to a company with two shareholders.

If shareholder A and shareholder B both hold 50 per cent of shares in a company, A can go to B and offer to buy their shares for, say, £5,000. B has to take some action within 14 days - either to sell at that price, or to buy out the other shareholder. Within those 14 days B can come back to A and offer to buy A's shares for the stated sum of £5,000. A has laid themself open and has no right to refuse B's offer (if made within the 14-day period). Therefore, A has a responsibility to themself to pitch their offer at a reasonable value. This clause can focus shareholders' minds about the value of the company and stop shareholders making unrealistic offers for the other shareholders' shares when it is clear there is a breakdown of the relationship and both parties can no longer work together.

All companies with more than one shareholder, or firms operating as partnerships, can benefit from such an agreement. In joint ventures, too, it is possible to state that if any one partner leaves, they won't be able to sell all their shares for more than £1. This obviously brings 'commitment' to the relationship or at least concentrates the mind. In general, whether you are a new business, or an established one that is currently running smoothly, shareholder agreements can certainly pay dividends.

Joe Alyward is a corporate solicitor at Glaisyers Solicitors. Tel 0161 832 4666, email pja@glaisyers. com, or visit www. glaisyers. com

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