Understanding Shareholder Agreements

Shareholder Agreements for Minority Shareholders

Shareholder Agreements for Majority Shareholders

Shareholder Agreements for 50/50 Shareholders

Common Clauses for all Shareholder Agreements

What is a Shareholder Agreement?

A shareholder agreement is a confidential contract between a company’s shareholders that provides a framework for the governance and operation of a company and sets out how future milestones for the company, such as new investment or a director/shareholder leaving will be dealt with.

Shareholder agreements are very important with regard to safeguarding the interests of shareholders, defining their rights and responsibilities, and resolving potential disputes.

Whether you are a minority shareholder, majority shareholder, or a 50/50 shareholder, a properly drafted shareholder agreement based on clear discussion and negotiation between those involved, will help protect your investment and contribute to a successful future for the company.

Each company will require its own specific shareholder agreement to suit its unique circumstances. If you would like to speak to a specialist company/Commercial solicitor about a shareholder agreement for your company, please book a consultation, without charge or obligation, using the button on this page or contact us by email or telephone. Our details are at the top of this page and HERE.

In the article below, we will set out the typical clauses that should be considered for all shareholder agreements and those that are specific to the different types of shareholder ownership; majority, minority or 50/50. We also provide real-world case studies and examples.

Shareholder Agreements for Minority Shareholders

Including the appropraite rights and protections in a shareholder agreement, will allow minority shareholders to participate more actively in decision-making, ensure transparency and fairness and protect their interests within the company. These provisions will provide a level playing field, creating a more equitable environment for all shareholders, regardless of their ownership percentage.

Veto Rights

Minority shareholders often find themselves in a situation where because of their ownership percentage, they have no control over company decisions. To address this, a shareholder agreement could include veto rights. These rights enable minority shareholders to veto certain major decisions, such as mergers, acquisitions, or changes to the company’s core business. This ensures that they have input into the key decisions that will affect their interests.

Case Study:

In a startup, Sarah owns 20% of the shares, while Johnny, the majority shareholder, holds the remaining 80%. The shareholder agreement grants Sarah veto rights over decisions concerning sale of the company and/or dilution of shareholdings. When the company considers a merger proposal, Sarah’s veto right means Johnny must take care of her interests to ensure she votes for and allows the merger to go ahead.

Information Rights

Minority shareholders often lack access to critical company information due to their limited influence. Although Section 423 of the Companies Act 2006 requires companies to send copies of financial statements to shareholders annually, shareholder agreements can include provisions that grant minority shareholders access to more detailed financial information, operational data, and other key information on an ongoing basis or upon request. These information rights enable minority shareholders to stay informed about the company’s performance, ensuring transparency and accountability.

Case Study:

In a family-owned manufacturing business, Kent owns 70% of the shares, with his two siblings each holding 15%. Their shareholder agreement provides for information rights beyond the Companies Act obligations to all shareholders. This provision allows Kent’s siblings to review financial reports, assess the company’s health, and participate in discussions about the company’s future, despite their minority positions.

Pre-Emption Rights

Pre-emption rights are an essential protection for minority shareholders, particularly in the context of new shares being issued. Pre-Emption rights give shareholders the first opportunity to purchase additional shares before the company offers them to external investors. By exercising these rights, minority shareholders can maintain their ownership percentage and prevent dilution.

Case Study:

Consider a startup where Emma owns 25% of the shares, Mark holds 40%, and they decide to issue new shares to raise capital. The shareholder agreement grants Emma and Mark pre-emptive rights. This means that before the company can sell new shares to external investors, Emma and Mark have the opportunity to provide further investment for the company and maintain, improve or at least control their ownership percentage.

Transfer/Sale of Shares

Exit terms are crucial for minority shareholders, if they may want to realise their investment at some point. Article 29 of the Model Articles of Association outlines the procedures for transferring shares but does not provide protection for minority shareholders. If a minority shareholder wants to sell, often the only realistic buyer is another shareholder within the company. A shareholder agreement can include provisions to compel the majority to buy the minority’s shares in some circumstances. In any case, it should definitely include a mechanism for valuation of shares in the event of a sale.

Case Study:

In a company where minority shareholder Carmel holds 15% of the shares, the shareholder agreement contains provisions regarding exit strategies. When Carmel wants to leave the company, she relies upon the terms of the shareholder agreement, which includes a process for evaluating and accepting offers for her shares.

Tag-Along

Minority shareholders should be wary of tag along provisions. Their effect is to allow majority shareholders to sell the Company without referring to the minority. If a majority shareholder decides to sell their shares to a third party, tag along provisions in the shareholder agreement might say that if a certain percentage of shareholders agree, say 75%, the minority lose the right to object and must go along with the majority’s decision. They must simply “tag along”.

Case Study:

In a family-owned business, Shane holds 80% of the shares, and his two siblings own 10% each. The shareholder agreement includes tag-along rights for the siblings. When Shane receives an offer to sell his shares, his siblings have no option but to go along with the sale, even though they think Shane is selling at too low a price.

Shareholder Agreements for Majority Shareholders

Majority sahreholders want rights and protections in a shareholder agreements that help them to maintain control over the company, preserve their strategic vision, and protect the value of the time and money they invest into the company.

Decision-Making Authority

Shareholders can exert control over a company by passing resolutions at a members meeting. According to section 282 of the Company’s Act, Ordinary Resolutions require a simple majority (51% or more) of the votes cast. Under s283, Special Resolutions require a majority of at least 75%. Under Part 2, section 4 of the Model Articles of Association shareholders can overrule the company’s director by passing a Special Resolution and can remove directors from office with an Ordinary Resolution (s168 Company’s Act). Majority shareholders can exert significant control over the compnay is they have a high enough percentage. If they do not have 75% of the shares or want more contorl in any case, a shareholder agreement can include provisions that reserve some dicesions to the shareholders alone and require a simple majority only to be passed.

Case Study:

James is the majority shareholder in a manufacturing business, holding 70% of the shares, while his two siblings each own 15%. Their shareholder agreement states that on some important matters, such as mergers, new investments, or the appointment of key executives, shareholders agreement is needed but that a simple majority of shareholders is all is required. So, Janes, even though he has only 70% of the shares and regardless of the directors’ views has the ultimate authority in these matters.

Drag-Along Rights

Majority shareholders should include drag-along rights in a shareholder agreement. These rights allow them to sell the whole of the company without interference from minority shareholders that may either object to the sale or want to hold the majority to ransom. These provision make sales much easier and ensures that majority shareholders can realise the value of their interest in the company on their terms.

Case Study:

In a startup company John owns 80% of the shares, and Sarah, the minority shareholder, holds the remaining 20%. The shareholder agreement includes drag-along rights for John. When a larger company expresses interest in acquiring the startup, John can rely on these rights to compel Sarah to sell her shares alongside his, meaning that he can negotiate on his terms with the buyers.

Voting Agreements

Diffenerent classes of shares can be issued with different rights. The two main rights are the right to receive dividends and the right to count as a vote in members meetings. A majority shareholder should include in a shareholder agreement provisions that will preserve their ability to control the company and/or their rights to most of its profits. This is done by setting out the rights that will attach to existing shares and importantly, to any new shares issued. (Such different classes of shares by convention are given different letters to distinguish them. For example, “A” and “B” and are often referred to as Alphabet shares.)

Case Study:

John owns 100% of the shares in his company but wants to give 30% of the shares to his employees to give each of them a share in the company’s profits. He still wants to be in sole control. So, the shareholder agreement he gives to each of his employees sets out that he retains “A” shares which have both voting rights and rights to a dividend and they are receiving “B” shares, which have rights to a dividend only

Shareholder Agreements for 50/50 Shareholders

A company with a 50/50 shareholding is bound to find itself, at some point, in deadlock. If the parties can’t agree, if each is a director and a 50% shareholder then the company will be frozen. Neither the Companies Act 2006 nor the Model Articles of Association provide any assistance.

However, a shareholder agreement can help you navigate the challenges of equal ownership by putting mechanisms in place to make decisions possible and where there is confilct, resolve the disputes.

Avoiding Deadlock

To avoid deadlock happening in the first place, provisions can be put in a shareholder agreement, along with directors service contracts.

One of the two owners can be granted, by agreement, the deciding voice in the company or each shareholder can be appointed as the deciding mind behind the company in rotation, three months for each person.

Alternatively, each person could be given authority for different areas of the business.

Case Study:

James and William run an accountancy practice, Each is a director and a 50% shareholder. When it comes to making decisions for the good of the company, it is agreed that James will have sole aurhtority with regard to marketing and finances and William will have sole authority with regard to the operations and client care.

The roles and different powers of the two are set out in a shareholder agreement and accompanying directors service contracts.

Deadlock Resolution Mechanism

Dispute resolutions procedures should also be included in a shareholder agreement.

Special procedure. A shareholder agreement can include a term that in the event of deadlock, a simple procedure is put in place, such as each party exchanging a written statement andor a meeting being called.

Mediation: the shareholders agree that if the dispute continues then a mediator will be appointed to help the parties reach an agreement.

Third party appointment. the shareholders can agree that in the event of a disagreement a trusted third party will be appointed to make that decision only and all parties will be bound by their decision.

Case Study:

Steven and Mark co-founded a real estate development company, with each holding a 50% stake. Their shareholder agreement outlines a mediation process as the first step to resolve deadlocks. If mediation fails, the agreement stipulates that they will resort to arbitration. This mechanism ensures that crucial decisions can be made, even when the co-founders cannot reach a consensus.

Buy-Sell Agreements

Buy-sell agreements, also known as “shotgun clauses” provide a structured method for resolving disputes between 50/50 shareholders. In the event of irreconcilable differences or a desire to exit the company, these agreements allow one shareholder to initiate a buyout of the other’s shares at a predetermined fair market value.

Russian Roulette or Texas Shoot Out?

A “Russian Roulette” clause in a shareholders agreement allows either party to serve a notice that sets a price on the company’s shares and then elects to either buy or sell at that price.

The second party then has the chance to serve a counter notice to either buy or sell their shares at the same price.

Each party agrees that either an unanswered first notice or the counternotice is binding.

This clause favours the party with the largest financial resources, as a notice to buy must be accepted if the other party cannot raise the funds to back a counteroffer to buy. So, you might choose a “Texas Shoot Our” Clause

In a Texas Shoot Out clause, each party must simultaneously put in a notice that either offers to buy the other’s shares or offers to sell their own shares.

If both parties offer to buy, the highest bid wins. If one party offers to buy the other must sell. If no one offers to buy the company is wound up.

Case Study:

Steven and Mark, in their 50/50 partnership, have a buy-sell agreement in place. As Steven put up all the money to get the business off the ground he insists that a Russian Roulette clause is adopteed. Steven knows that if he offers to buy the company, Mark will have to sell as he will not be able to rasie the fund to buy Steven’s shares.

Common Clauses for all Shareholder Agreements

Anti-Dilution Clauses:

Issuing new shares, most often to investors or to employees, will lead to the percentage share of a company owned by existing shareholders being reduced. Shareholder agreements often contain anti-dilution clauses to set rules and guidance for new share issues, including amongst other matters in what circumstances can new shares be issued, is the approval of all or just a majority of shareholders requited, what rights will newly issued shares have and will the holdings of existing shareholders by treated equally.

Case Study:

In a growing software company, the board decides to issue new shares to raise capital. The shareholder agreement includes anti-dilution provisions requires 100% approval of all shareholders for this to take place. All shareholders do agree, so new shares, with voting and dividend rights can be issued, with each shareholders’ interest being reduced in proportion to their original holding.

Transfer of Shares and Right of First Refusal Clauses:

Shareholder agreements often grant existing shareholders the right of first refusal when a shareholder intends to sell their shares to a third party. This allows shareholders to purchase the shares before external buyers are approached. Ownership remains within the same group, either at the same proprotion or with one shareholder increasing the level of their ownership.

Case Study:

In a family business owned by four brothers and sisters, one party wants to leave the business and sell their shares. They inform the other three siblings that they have lined up an external buyer for their shares at an excellent rate. The others do not want outside influence in the Company so rely on the right of first refusal clause to ensure that they buy the shares. The other three also rely on the Dispute Resolution clause within the shareholder agreement to determine a fair price for the shares.

Non-Compete Clauses:

To prevent conflicts of interest and protect the company’s interests, shareholder agreements may include non-compete clauses. These clauses restrict shareholders from engaging in competing businesses or activities that could harm the company.

Case Study:
In a startup, one of the shareholders, John, decides to exit the business. The shareholder agreement contains a non-compete clause that prohibits John from starting a competing tech company or working for a direct competitor for a specified period after his exit. This protects the company’s intellectual property and market position.

Removing a Director

Under Section 168 of the Companies Act, shareholders have the power to remove a director by ordinary resolution, which requires only a simple majority vote (over 50%). However, shareholders can agree not to exercise these rights in a shareholder agreement or in the situation where some shares are held by directors, their shares can be given weighted voting rights on the issue of removing a director.

Case Study:
David has set up a new company and has brough three people on board to help him. He gives each of them a role as director and 15 % of the shares. As time passes, David finds he is continually outvoted at directors’ meetings by the other three working together against him. He calls a shareholders meeting to use his 55% of shares to remove each of them as directors but discovers in the shareholder agreement, all shareholders agreed the statutory powers to remover directors would not be used. A director can now only be removed by a majority vote of the board of directors. David cannot remove any of the directors voting against him. He has lost control of his company.

Voting and Decision-Making:

Although the Companies Act and the Model Articles of Association provide a foundation for corporate governance and shareholder rights, companies have significant flexibility to tailor their Articles and to create comprehensive shareholder agreements that align with their specific needs and preferences. Shareholder agreements typically define how major decisions are made within the company. This can include specifying the threshold for majority votes, supermajority requirements for significant decisions, or unanimous consent for exceptional matters.

Case Study:

A shareholder agreement for a real estate investment company outlines decision-making protocols. While day-to-day operational decisions can be made by the company’s directors, major decisions, such as acquiring a high-value property, necessitate unanimous consent among the shareholders. This ensures that crucial decisions stay with the shareholders and align with the shareholders’ collective vision.

Dividend Policy:

There are some restrictions on the payment of dividends set out in the Companies Act 2006, which for private limited companies are concerned with having sufficient profits in the company to be able to pay a dividend. The procedure for paying dividends is usually set out in the Articles of Association and must be complied with. However, as long as these provisions are followed, shareholders can set out any term they wish concerning the payment of dividends, such as frequency, calculation method and level according to share class. Dividends are often of the upmost importance to shareholders and the terms concerning payment of dividends should be carefully considered.

Case Study:

Victoria, Thomas and Mark start a company. Their shareholder agreement includes a Dividend Policy to ensure equitable distribution of profits. The policy outlines that dividends will be calculated annually based on the company’s net profit after taxes. The policy also specifies that the board of directors can adjust the dividend amount based on the company’s capital needs for growth. This policy ensures transparency and fairness while allowing the company to reinvest in its expansion when necessary.

What Constitutes A Quorum:

A quorum refers to the minimum number of shareholders (or their proxies) required to be present for a meeting to have the authority to make decisions binding on the company. Setting a quorum ensures that important decisions are made with the participation of the number of shareholders sufficient to ensure transparency and fairness in running the company. In a shareholder agreement, quorum requirements can be customised to suit the company’s needs and the nature of the decisions being made. A quorum is typically expressed as a specific percentage of the total shares or a fixed number of shareholders who must be present or represented at a meeting for it to proceed.

Case Study:

In a family business, the shareholder agreement stipulates that for major decisions, such as approving a merger or significant acquisition, a quorum of at least 90% of the total shares must be present. This requirement ensures that the decision is made with substantial shareholder involvement and prevents a small group of shareholders from unilaterally deciding the company’s fate.

Termination of Agreement

Shareholder agreements will typically contain termination provisions. Termination clauses can protect shareholders’ interests by ensuring that they have the ability to exit an agreement that no longer serves their needs. Termination clauses may be triggered by specific events, such as the sale of the company, the departure of a key shareholder, or a change in ownership structure. Termination clauses also allow companies to adapt to changing circumstances and avoid being bound by outdated agreements.

Case Study:

A company’s shareholder agreement includes a termination clause that allows any shareholder to propose the termination of the agreement with at least 60 days’ notice. If all shareholders agree to terminate, the agreement dissolves. This provision offers flexibility for shareholders to adapt to evolving business strategies or accommodate new investors.

Let’s Talk

A shareholder agreement is essential for the stability and growth of your company; however the shares are divided. It will serve as the foundation for shareholder relationships, helping to avoid conflicts and provide a framework for decision-making. Whether you’re a minority, majority, or 50/50 shareholder, understanding and carefully drafting these agreements is a crucial step in protecting your interests and ensuring the smooth operation of the company now and in the future. If you would like to speak with a specialist company/commercial solicitor about a shareholders agreement for your company, please use the Book A Consultation button on this page or contact us by email or telephone. Our details are at the top of this page and HERE.