Why do we need a Shareholders’ Agreement?
It makes sense for company shareholders to have a Shareholders’ Agreement to regulate the relationships between them. General company law provides shareholders with some rights and protection but, by having a Shareholders’ Agreement, the shareholders can include and provide for issues which specifically concern their business. It ensures all the late night agreements are in one place so if something happens there is a blue print on how to handle it.
This is important whether you have a large group of shareholders or where the company is starting out with just 2 shareholders. No matter how close shareholders may be as individuals, it is still very wise to build in protection and think about potential issues which may arise and how they could be dealt with. Think of it as a type of insurance for the company shareholders and the company from future disputes which eat up time and cash and get in the way of the day to day business. It’s not unusual for shareholder disputes to be so time consuming that they can bring the company to its knees with no work being done until the dispute is resolved.
Why do we need some matters reserved just for shareholders to deal with in the Shareholders’ Agreement?
The day to day running of a company is undertaken by the directors of that company, not the shareholders. Sometimes, at least initially, because the shareholders and directors may be the same people, the roles can get a little blurred.
However, it is important to always bear in mind that shares are the shareholders’ investment into the company and directors do not always have shares but instead, are officers/employees of the company.
Therefore, one issue that shareholders must always consider is that of reserved matters. By this we mean issues which the shareholders want to have some input into and which are not just totally left to the directors as part of the general day to day running of the company to deal with.
Of course, all company directors have legal obligations, including the fact that they must deal with matters in the company’s best interests, but there are a few issues which immediately spring to mind that shareholders should consider.
For example, capital expenditure (such as spending large sums of money on a single item or project or taking on a large loan) or making major changes, such as changing banks, accountants etc; hiring, firing and compensating the most senior management; taking on major commitments and entering into major agreements. All these issues, will have an effect on the company and will, ultimately affect the value of shares (the shareholders’ investment).
In view of the impact that decisions like borrowing a large sum of money to buy a new piece of equipment can have on the company it makes sense for company shareholders to be able to have their say on what should and should not happen. By including these as reserved matters in the Shareholders’ Agreement, shareholders can have their vote on these issues. If they are not included as reserved matters then shareholders may find that they simply have little or no say in the way the company is run and the manner in which their investment is dealt with.
So having reserved matters simply means planning for issues that could potentially cause the company considerable damage, making sure that shareholders have a vote on them and building this into the Shareholders’ Agreement. This makes it a sensible way forward for any company.
What type of consent?
Having decided that there are matters that should be reserved for shareholders’ input, do you want to go for absolute agreement, so that all the shareholders have to agree on a matter or, for just some of the shareholders to agree (and if so, what percentage)?
Majority consent – all shareholders’ consent?
There may be reserved matters that shareholders feel absolutely must be agreed on by all shareholders before a decision can move forward. This will depend on the size of the company and what it sells, but a prime example would be taking on a loan of a certain amount which will reduce profits or may make a business unstable long term.
Alternatively, particularly where there are more than just 2 shareholders, you may feel that having something like 75% of shareholders consenting provides a sufficiently balanced safeguard.
What if shareholders are unreasonable?
It is possible to include that consent should not be unreasonably withheld or delayed.
Are you worried that there might be a dispute?
Like anything else in life, shareholders will have disagreements and, if you have a number of shareholders, this may be something which can be resolved more easily by using arbitration clauses or mediation.
However, where you need all shareholders to consent, particularly for example with two equal (50% each) shareholders, this may be a huge problem and can cause a “deadlock”. A Shareholders’ Agreement allows you to build in what will happen in a deadlock situation so that you know in advance how to deal with the situation should you ever have to face it. Of course there are various ways of dealing with a deadlock and you can sit down and consider what would be right for you as shareholders before the worst happens. You can also add in timescales so that a situation is not allowed to run on indefinitely.
What are the benefits of having a basic Dividend Policy in a Shareholders’ Agreement?
Dividends are part of the shareholders’ return on investment – the amount of money that is paid to shareholders if a company makes a profit. Staring up, when it is not making any profit, thinking about dividends may seem unnecessary. However, once the company starts to make a profit the shareholders will generally expect to see a return on their investments (i.e. the shares they bought) and this is paid by way of a dividend. Having a dividend policy agreed as part of a Shareholders’ Agreement allows shareholders to think about dividends at the outset and consider the effect that dividends may have on both the company and themselves.
A dividend policy within a Shareholders’ Agreement will usually include:-
(1) Confirmation that the profits of the Company are to be shared in proportion of shares held. So a shareholder who owns 20% of the shares would expect 20% of the profits.
(2) Dividends can be paid on an interim basis during the company’s financial year – this allows a company to pay something part way through the financial year and then finalise the position with a final dividend at the end of that financial year. However, most companies prefer final dividends so dividends are dealt with and declared once a year because declaring any dividend (including an interim one) means
- having a directors’ meeting so that the dividend will be formally declared
- that Minutes of the directors’ meeting have to be recorded/kept
- completing paperwork about the dividend which shows what has been agreed and paid
- making calculations to show the tax position – the “dividend tax credit”
Consequently, most Shareholders’ Agreements will agree payment of final dividends at the end of the financial year. However, having an option, such as confirming that the company accountant may still advise payment of interim dividends if they are advantageous to the Company, will allow flexibility to follow professional financial advice
(3) Whilst a company shareholder will expect a return on their investment by way of dividend payments they will also appreciate that there is a balance to ensure that any company has some profit reinvested for company growth (and of course larger dividends in the future). However, to protect their return (dividend), shareholders generally include within the Shareholders’ Agreement an agreed percentage of profits that will at least be repaid as dividends. For example, the shareholders may agree that at least 50% of the annual profits will be used as dividends.
However, there may be a situation whereby the shareholders would like greater investment returns (dividends), such as if the company is particularly profitable and already has good reserves. Therefore it is possible to include that, whilst 50% of the annual profits will normally be used to pay dividends, in the event that 75% of shareholders agree otherwise, more (perhaps 70% of the annual profits) or less (perhaps 20% of the annual profits) will be used to pay dividends.
Talk to Law Hound today on 01244 300413 without obligation to see how our bespoke affordable shareholder agreement service can help protect you and your business. Our consultancy takes all the shareholders through what they need and creates a working document that fully reflects your business.