Going Into Business? Why You Need A Shareholder Agreement

1. Exit strategy – without a shareholder agreement, a company is simply governed by the Companies Act 1993 (“Act”) and the company’s constitution (if the company has one).  The Act and a constitution will not usually provide for an exit strategy should a shareholder wish to leave the business.  Remember that it is important to consider that you or anyone you go into business with may have a change of heart or circumstances, or move to a new city/country for example.  It is always best to discuss the worst case scenarios with the other shareholders before you sign a shareholder agreement.
    

2. Restraint of trade – neither the Act nor a constitution prevent an existing shareholder from subsequently competing in the same industry as the business of the company.  Without a shareholder agreement, an exiting shareholder could take some or all of the company’s client base, contacts, technical know-how or other goodwill to a competitor or to a new company.  This is particularly relevant in a professional services firm where a company’s client base effectively comprises the majority of the goodwill of the business.
    

3. Shareholder disputes – without a shareholder agreement, shareholder disputes can be extremely difficult and costly and the Court will only grant relief under the Act in limited circumstances.  This often results in a stand off between shareholders which can be extremely stressful and have a negative impact on the business.
    

4. Death of a Shareholder – a shareholder agreement should provide for what happens upon the death of a shareholder.  Shareholders in closely held companies are also often key employees.  If a key employee dies, the other shareholders may be left dealing with that deceased shareholder’s beneficiaries as a new shareholder in the company.  This may not have been expected when the shareholders initially formed the company.  A shareholder agreement (often together with a buy/sell agreement) will provide a clear succession plan in the event of the death of a shareholder. 
    

5. Shareholder default – the Act and a standard constitution do not adequately define when a shareholder is in default.  A good shareholder agreement will provide examples of a shareholder default and will describe the process to remedy such default or provide for the exit of the defaulting shareholder.
    

6. Director appointment and voting – the Act and a standard constitution will usually provide for appointment of directors by an ordinary resolution (i.e. more than 50% of the votes by the shareholders).  A shareholder agreement will often allow a shareholder holding a certain percentage of shares (e.g. 25%) to appoint and remove its own director to represent its shareholding.  This is a particularly important protection for minority shareholders.
    

7. Employee shareholders – as discussed above, often shareholders are key employees to the business.  Without a shareholder agreement, employees can simply resign from the business and continue to be a passive shareholder in the company, simply relying on the other shareholders to increase the value of the business while they reap the rewards.  A good shareholder agreement will remove this risk.

Often, companies will not think about a shareholder agreement until something has gone wrong in the business.  We see a number of shareholder disputes which are extremely difficult to resolve and which could have been prevented by having a robust shareholder agreement in place.

Please contact us for a no obligations discussion about what is involved in drafting a shareholder agreement.  

The above information is of a general nature only. You should contact our firm for advice relating to your specific circumstances.