Shareholders’ Agreements – Why do you need one?


Shareholders’ Agreements – Why do you need one?

It’s always a question of priority when setting up a private business – every dollar is precious. If a dollar is to be re-invested, it needs to be well invested.

We often hear business owners wondering why they should invest in a Shareholders’ Agreement

  • “we get along really well”
  • “we’ve known each other a long time”
  • “I trust him or her”
  • “if we have a problem, we’ll just work it out commercially”.

And that might well be right. But like any relationship breakdown, the circumstances and timing are often unpredictable and so is the response. Plus, money is involved (often a lot of money), so the stakes are high.

The importance of investing in a Shareholders’ Agreement

A good Shareholders’ Agreement for your business will never be exactly the same as one for any other business and what should or should not be included will always reflect the business’ specific circumstances. While all Shareholders’ Agreements have some level of similarity, the particular options for each of the relevant issues are nearly endless. Your Shareholders’ Agreement needs to be carefully prepared to accommodate the needs of the particular business and the particular business owners. There is no such thing as one-size-fits-all! The “pre-packaged” agreements you can buy off the shelf can be poorly drafted, generic and certainly will not have taken into account the particular, unique circumstances of your business.

Things to consider when drafting a Shareholder’s Agreement include:

  • the dynamic and relationship between the shareholders, such as the percentage of shares held and what is being brought to the table by each business owner;
  • whether the business is a start-up or mature;
  • shareholder expectations in terms of future capital/debt funding;
  • the long term objectives of the company (e.g. remain private, look to sell or float in the medium term);
  • the nature of the business’ assets- e.g. a going concern dependant for its value on continuing to trade, or a collection of more “passive” assets;
  • if you have an employee shareholder and he / she leaves the company, do they still retain their shareholding? A breakdown in relationship can create a range of problems; and
  • how do you best protect the business from an outgoing shareholder establishing a competing business.

What could go wrong?

If there is no Shareholders’ Agreement in place, and a dispute (or even a decent difference of opinion) arises, it is more likely that a value destroying dispute and perhaps litigation will follow, as there is no agreed “set of rules”. Where there is no guidance on how disputes should be managed, a “free for all” situation can result.

In the absence of a Shareholders’ Agreement, a dispute may well end with a court ordering that the company be wound up. This would result in high litigation costs, both financial and emotional, the appointment of a liquidator, destruction of serious value built up over many years of hard work as well as loss of any control over the outcome.

Indeed, even if none of the parties want to litigate, the stalemate and inability to move forward with the business will see value diminish or disappear – sometimes very quickly.

These problems can largely be avoided through the use of a Shareholders’ Agreement which sets the rules and adequately predetermines the management of disputes.

Conclusion

A good Shareholders’ Agreement will set out a map for running the business and resolving issues, acting as a framework for dealing with unexpected events. When drafting a Shareholders’ Agreement, the skill is not just reading what’s in the agreement, it’s the experience of knowing what is not in the agreement. Sometimes leaving something out is to your advantage. Sometimes it’s not. It’s also knowing what the other options might be. Ultimately, any outlay in expense incurred from investing in a Shareholder’s Agreement will be cheaper than dealing with a dispute or court proceeding down the track when things do not go to plan.


with Elissa Raines, Lawyer