Newly formed companies often do not worry about having a Shareholder Agreement. Optimism is high and everyone is getting along well. Money can be tight, so making formal arrangements is seen as an unnecessary expense. However, it is as the company grows and matures that problems can begin.
The importance of a Shareholder Agreement
A Shareholder Agreement is perhaps one of the most important documents a privately owned company can have. It provides a method for:
- Resolving shareholder disputes
- Preventing the personal circumstances of one shareholder affecting the company or other shareholders
- Defines the powers of the shareholders
- Defines the procedures and limits within which the company operates
- A shareholder agreement also provides clarity and peace of mind to all shareholders about what can and cannot be done and what happens if there is a dispute if things go wrong.
Common problems which can be avoided by using a Shareholder Agreement
Disagreements between shareholders cannot always be ended simply and amicably. A shareholder agreement will provide a structured procedure for dispute resolution, allowing disagreements to be resolved more quickly and effectively. Having an agreed structure can often stop conflict before it even begins.
Death or Divorce of a major shareholder
Should a shareholder die and there is no shareholder agreement in place, his/her spouse or other family member could take their place. They probably would not know much about the company and may well cause problems, whether intentionally or not. A shareholder agreement can prevent this by providing a way for shareholders to have a right of first refusal to purchase the deceased’s shares.
Similarly, should a shareholder get divorced, then their former spouse may turn up at board meetings and cause problems out of spite. Again, a shareholder agreement can prevent this.
Sale of Shares
Without a shareholder agreement, a shareholder may sell their shares to anyone. For example, in the event of a dispute they could sell them to a competitor. Alternatively, personal financial difficulties may force the sale of the share to the highest bidder. Again, this may not be in the best interests of the company.
A shareholder agreement can include a provision giving a right of first refusal, which means that existing shareholders have the right to purchase shares in advance of anyone else. This can be to a set formula or by matching the price of an outside bidder.
Controlling Finances and Obligations
Did you know that, without a shareholder agreement in place, your fellow shareholders are able to enter into contracts and other commitments on behalf of the company without proper consideration to the effects they may have? This could spell disaster for the company and the other shareholders. By signing a shareholder agreement, an individual’s ability to do this on behalf of the company can be limited to an appropriate level, with an agreed procedure for levels of commitment required by the company above this. This will ensure all shareholders’ exposure to risk is minimised as people overstepping agreed structures will become personally liable. In practice, this part of a shareholder agreement gives confidence to all concerned and makes for good profitable decisions within the business.
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