My clients often ask about shareholders agreements – whether it is a good idea to create one, how best to do so, and when to put one in place.

Do you need an agreement at all?

It is your choice whether to have an agreement with the other owners of your company. There is no law forcing you to make one.

The main reason to write one is that unless you do, you have much less control over important decisions made for your company – decisions that could increase or reduce the value of your share of it.

The law might give you some control over some decisions, but on other matters you’ll have none unless your agreement says otherwise.

Because these documents are used so commonly, unless the ownership structure of the business is particularly unusual, most owners, particularly of small, uncomplicated businesses, should be perfectly able to use a good quality shareholders agreement template bought online as the basis for drawing their own document.

But be aware, some templates are better than others. The coverage of key issues, the style of language and the structure of the agreement should all be considerations when choosing to buy from any legal document publisher.

Which do I recommend?

I’ve always planned to write reviews of the document templates I’ve used when helping founders set up new businesses. I haven’t quite ever managed it.

My experience is that generally you pay for quality, and there isn’t much point in putting an agreement in place unless it is of high quality.

In terms of the best templates I have seen and used, the ones I usually recommend are Net Lawman’s shareholder agreements.

There are a number of templates offered for different ownership scenarios.

Generally, the price points are high compared to some other retailers, but in my opinion the quality outweighs the cost, particularly in the number of options given and the notes that explain how to edit each paragraph. Some of these are very sophisticated documents that would take most solicitors considerable time to draw from scratch.

The standard version is now free to download, and there are no catches to doing so. Versions with even more options and those for particular situations unsurprisingly are paid-for. There is also an option to create online (rather than just to use downloaded templates).

Net Lawman’s lawyers can review your final document once you have edited it. The review service is well priced – about the same as a solicitor would charge for an hour’s work.

If you are not interesting in editing the document yourself, or if you would like additional terms included then there is also a customisation service available. Net Lawman works with a panel of independent solicitors who use the templates as the basis of a document for you, saving time and therefore money, and the cost saving is passed on to you. Pricing depends on your requirements. You request a quotation through the site, describing exactly what you need, and a fixed fee price is proposed. From there on, you work with the independent solicitor.

My second choice would be the one by CompactLaw. Here there is only a single choice of document, no review service and no online questionnaire option. However, the template itself is good.

Why put an agreement in place yourself?

Many people think that they need a solicitor or an accountant to draw up a company shareholders agreement. That isn’t true.

Often, the business owners themselves are in the best position to decide how the company should be operated.

The reason is that much of the subject matter of the document is not legal, but practical.

Of course, there is law that must be complied with, but much of the document covers practical matters which only the owners themselves can decide on.

The other common reason to write your own based on a template is cost.

A sample agreement created from a template

 

A solicitor (or an accountant) might charge a fixed price ranging from £500 to £3,000 for drawing a standard agreement. Compared to a charge-out rate of several hundred pounds per hour for working more flexibly, this might seem reasonable – especially if the cost of the agreement is split between all the owners. But when you consider that the work that the professional does is essentially to customise a template, the value for money is much less.

Solicitors themselves use templates to draw documents. Traditionally, many used what are called “precedents”, template paragraphs of text covering a single matter, to build up the document. Commonly nowadays, they download an entire document template, just as you might, from a legal stationer.

How to judge the quality of a template

Coverage of issues

A long yet comprehensive agreement is better than a short one that fails to address sufficiently all issues of control and management. Any legal contract should be to the point, but being short is likely to compromise the quality. You just can’t fit in all the important content in a document that is only one or two pages long.

If you are worried that your fellow founders or owners are unlikely to sign up to an agreement that is more than a couple of pages long, you can do two things. The first is to summarise the key points of the agreement on the first page (sometimes, the key points are called heads of terms or a memorandum) before presenting the longer agreement behind. The second is to use a document that your fellow shareholders can read and understand easily and therefore gain trust in.

Plain English – simple language and structure

A legal document does not have to contain complicated words and legal jargon in order for it to be legally binding. The idea of any document is to make sure that all parties knew what deal they were agreeing to when the document was signed. Indeed, nowadays, the inclusion of legal jargon can actually act to the detriment of the strength of the agreement.

Find a template that is written in plain English. It will be much easier to edit, particularly if you want to add in more than the odd word yourself (likely with shareholder agreements because so much of the content is personal to the owners). You will also be able to persuade your fellow owners to sign up to it more easily if they feel comfortable that they understand it. If they don’t insist on passing it by more lawyers to decode it, the overall cost will be kept down, and the agreement signed more quickly.

Linked in to this point is use of a simple structure. When solicitors use precedents to draw a document, they often cross reference paragraphs because these paragraph templates are independent to each other. A good template will have been written by a lawyer who has made sure that each point does follow on from the previous.

Help

Your document should come with help as to how to complete it. This might be in the form of notes with the template, or it might be a Q&A system, or it might be post-purchase support.

This type of document template should be straightforward to edit. The inclusion of some form of guidance indicates quality – that the person who has written the template knows what he or she is talking about, and that he or she has put time into making a well-rounded, well considered product for the end user and hasn’t just knocked off a document quickly.

Price

Price is a good indicator of quality. Free templates are available, but rarely are reasonable quality, let alone good.

The price reflects the knowledge of the person who has drawn the document. The per hour cost of a solicitor is high. Drawing a good document takes time, as does maintaining it. There is a cost involved.

Free shareholder agreement templates are unlikely to be maintained, and unlikely to have been written carefully.

There may also be another catch with free templates. You may have to provide your credit card details and take up an expensive monthly subscription (if you don’t cancel in time).

You may have to provide personal information that is subsequently used for marketing other products and services to you.

By using a template, you are already saving considerably on the price of a solicitor. The benefit of the additional saving by using a cheap template is completely outweighed by the loss in quality. The scare stories about do it yourself documents are mostly as a result of poor quality, free templates being used rather than because of the DIY aspect.

Author

This is common sense, but do make sure that you know who has written the template that you use.

The qualification of the author is second to the experience that he or she has. Many legal document retailer businesses are run by ex-solicitors, who no longer can call themselves that because of the Law Society’s restrictions on what services solicitors may offer. But often these owners have many years of experience of the law.

If there is no mention of who has written the document, be very wary. It is easy to take a template and resell it as a download. The problem may be that the seller may not know (or care) whether the template is any good, or perhaps whether it is even valid for the laws of the UK. He or she is very unlikely to maintain it in line with changes in the law.

When it was last updated

Shareholder law does not change often, but nor does it stay still. Various changes to the Companies Act are brought out every couple of years.
Make sure that the template you download has been reviewed recently and updated for any new, relevant law.

Reviews

Any reputable document retailer will publish customer reviews. These should include those relating to how good the document was, but also how good the retailer’s service was.
Some customers (likely to be solicitors or accountants) should have enough experience to be able to leave expert reviews that will give you an insight as to whether the template is well written or not.

Number of years the retailer has been in business

Established retailers are likely to sell higher quality documents. Not only would mistakes in an agreement be noticed and corrected over time, but also subsequent revisions and improvements are likely to have been made.

Technology

There are now several law technology companies offering shareholder agreement templates. You complete questions online and the document is created either as you type, or shortly afterwards.

My own opinion, and those of various solicitors I have spoken to, is that these online-produced documents aren’t usually as good a solution as downloading and editing a template offline.

There are several reasons.

One is that the deal between you and other shareholders usually requires all of you to consider all the options before committing words to paper. You can’t all huddle round a computer screen together at the same time.

A second is that while technology needs investment capital behind it, the technology itself isn’t an indicator of quality of what is produced.

These companies tend see themselves as tech companies that happen to operate in the legal industry, rather than lawyers who use technology. The attention is on the tech, and not on the document.

Lastly, because these types of agreements are so personal to the shareholders, technology can only go so far in producing a customised document. The basics will be covered, but from experience, the online shareholder agreement software tends to lack the coverage of issues that templates for download do.

Accessibility

Just as the provision of help is an indicator of a well thought out product, if a template can be edited without needing to be an expert in word processing, it shows that someone has thought about how to make a good quality document that anyone can use.

The best way of making sure there is no requirement to have your own software installed is to provide editing functionality online. That certainly is an advantage of the technology based retailers.

However, offline access also has advantages. You are likely to want to draft your document in stages, with consideration by all parties at each. You’re not likely to create it in a single session.

You will want to format it and style it.

You will also want to print it out or e-mail to other company owners for revision and approval.

Templates in file formats that are compatible with common word processors such as Microsoft Word, WordPerfect, Mac Pages and LibreOffice give you access to the functions of those software products. For example, track changes functionality is very useful when collaborating on a legal document.

Note that you are going to have to edit your document. You won’t find one that fits out of the box, where you simply have to fill in your names and sign. Adobe Acrobat (PDF format) isn’t a good format to use because it can’t be edited easily.

What should your agreement cover?

Although your document can cover strategy and objectives, you shouldn’t confuse your shareholders agreement with your business plan. Your agreement should cover issues relating to ownership and control, not company objectives.

Most standard templates cover:

• issue of shares to new shareholders
• duties of company officers and directors – who runs the company day to day
• how board and shareholders meetings take place and under what circumstances
• what level of shareholder approval is required for key matters
• shareholders’ rights and responsibilities
• rights of first refusal (ROFR) to buy the company’s shares of shareholders who are selling to others
• shareholders’ rights to information and dividends
• how exit is managed – what happens when shareholders sell, die or otherwise leave the company
• restrictions on ownership of other competitor companies
• restrictions on passing on shares to others, or the rights that other future shareholders acquire
• jurisdiction – make sure your agreement is valid under the law of the UK (England and Wales, Scotland or Northern Ireland), and not elsewhere

When to put a shareholders agreement in place

Every agreement balances the interests of shareholders differently. As such, they are usually best drawn up when the business relationship or interests change, such as:

• when the company is started (on incorporation)
• when minority shareholders want greater influence on decisions that are important to them
• to protect a shareholder who has lent the company money
• on the appointment or termination of directors (perhaps those who are not founders)
• as company strategy changes
• when you enter into a joint venture (JV) with another business and need to set out who is responsible for what within the joint venture company

The process for putting an agreement in place – how to do it

Putting a new shareholders agreement in place requires the approval of all company owners.

Drawing up a new agreement can be started by just one person, but eventually all business partners will want to give input.

Note that the agreement is private between the existing shareholders. The directors do not have any involvement (unless they are also owners), and the agreement is not required to be filed publicly (such as at Companies House).

We find that the following process works well.

1. One shareholder proposes to the others the structure of the new agreement (effectively summary points). He or she might use a template to identify the key points. Usually, using several templates works best.
2. A working draft is circulated, and the other shareholders are requested to add any matters that may have been missed out. These newly incorporated points are usually those that are most important to each. It is a good idea to ask why they are being included.
3. The co-ordinating shareholder lists the changes that the others have made, such as “John Smith requests that if any decision about the appointment of additional directors to the board is done on a one person, one vote basis. This is because he feels that…”. Those changes are circulated.
4. Negotiations can then take place between shareholders based on principled positions.
5. The final summary of terms is written up and agreed.
6. The agreement is drafted, using a template as the basis. Each point agreed in summary is checked to be included accurately and fully in the final document.
7. The final document is circulated to the owners. Owners can then sign, or request further changes.

Shareholders do not need to call a meeting, or be together to sign. They can sign in private. However, it may be a good idea to insist on each signature being witnessed to ensure that the signature is that of the shareholder.

Further advice

Some shareholder agreement template providers also offer a final document review service, either using in-house lawyers, or outsourcing the work to a “panel” firm.

Having your final document reviewed can provide much reassurance to all shareholders that the agreement is above board and does what it is supposed to do.

It is also much less expensive than asking a solicitor to draw up the document from scratch, and is a good alternative proposition if one of the shareholders wants a solicitor to be involved in the production of the document.

What is meant by private equity?

Private equity (PE) describes professional investment into a privately held company, usually one limited by shares. Depending on the stage in the business lifecycle that the company is in, and the risks of investing in the company, and the types of investor that invest in it, the PE investor may call itself a range of names, from business angel investor, a development capital investor, a venture capital investor or a private equity investor.

Why are PE firms such an important source of capital to private companies?

If a privately held company limited by shares wants to raise equity finance, by law it cannot just issue new shares and sell them to anyone.

There are only three possible ways to raise new capital. The company can sell shares to the certain members of the public, principally existing shareholders, employees and the close family members of both. It can convert to a public limited company (a PLC) and sell shares to anyone, although doing so requires it to have paid-in capital of at least £50,000. Or it can seek investment from a “sophisticated” investor.

Professional investors and high net worth individuals fall into this last category. They are able to determine the risk of investing into the business, and they are assumed to be able to “afford” to lose the investment should the business fail.

What legal documents are involved in a PE investment?

There are a number of documents involved in an investment transaction: the shareholders agreement (sometimes called the investment agreement in these circumstances if it also deals with the subscription for shares); the articles of association; directors service agreements; and loan agreements. While each document covers a separate part of the deal, they are inter-related.

The provisions of the documents are likely to be those key ones covered on the term sheet to which all parties have broadly agreed, plus others that the founders are unlikely to have seen before.

Attention should be paid to all provisions to make sure that they do provide for the same deal that the founders expect.

The shareholders agreement

The majority of the investment agreement is likely to cover two sets of relationships: those between the private equity investor and the founder-owners; and those between the shareholders and the directors of the company (who may be the same people).

A PE investor invests in order to make a financial return. Along with the other terms standard in such an agreement, what will be important to it, him or her is:

• control of the business strategy, particularly relating to exit so that it can sell its shares at a profit
• control of the management through veto rights – restrictions on decisions directors can make without prior shareholder approval, and the ability to appoint and remove directors to the board
• control of share issues and transfers so that control of other matters cannot be diluted
• control of decisions to borrow or issue dividends
• protection of intellectual property and restrictions on competition if founders leave
• continuation of key staff (likely to be the founders) within the business

In addition, a PE investor is likely to require a large number of warranties from the founders. Warranties are promises as to the state of the business that are otherwise difficult to ascertain during the process of due diligence. For example, the shareholders might warrant that there are no obligations to third parties that could result in a financial payment to settle. If a warranty is found to be false, the PE investor can seek damages from the founders (the sellers of the share capital) to make good the negative impact on the investment valuation. Because the “price” of an untrue warranty is so great, private equity investors use them to force the shareholders and directors to disclose information, rather than as a means of redress.

If a funding round has attracted investment from multiple investors, then the shareholders agreement may also cover the relationship between those investors. However, alternatively, these might be covered in side-letters (private agreements) of which the founders are not aware. Another solution to issues of control might be for the company to issue multiple classes of share that each hold different rights, so that different aspects of control important to each investor separately can be given.

A shareholders’ agreement is a contract between the owners of the shares of a company. Its purposes are to protect the value of each owner’s investment, to regulate a fair relationship between them and to control the management and strategic direction of the company.

There are certain basic provisions that most well drafted documents will contain, but there are no exact requirements for content. A document will usually cover:

• the relationship between the shareholders – rights and obligations
• how the corporation will be controlled and managed, and by who
• how decisions are made
• methods of dispute resolution if disagreements arise
• what happens when a shareholder wishes to sell his shares, becomes bankrupt or dies
• restrictions on the rights of new shareholders
• equity and debt financing
• restrictions on significant expenditure, including dividends and director remuneration

Unlike the other governing document of a company – the articles of association, a shareholder agreement is a private document that is not submitted to Companies House and is therefore not available for public view.

The agreement can be between all shareholders, or just some, such as the owners of a particular class of shares. It can benefit both the owners of the majority of shares, and minority owners.

Must I have one?

Putting an agreement in place is not required by law. However, most business advisors would recommend having one in place as soon as possible after the company is formed and the first shares are issued.

It is easy to defer putting an agreement in place. Perhaps the establishing the business is more important. Or perhaps the founders are trusted family members or friends who seem to share the same goals and ideas as you for the business. Asking for an agreement may seem disrespectful.

However, the reason to put an agreement in place now, is as a safeguard for the future. It is your investment that you are protecting, but it is also that of the other founders, and the business itself. Disputes do happen often, are costly, and take management time away from the business.

Your articles of association may help you resolve problems to some extent, but a shareholder agreement is likely to give you far more protection in a greater number of circumstances.

It is easier to sort out putting in place a document earlier, while you are likely to agree on more matters, than later, when expectations and feelings may have changed. It will give you all increased confidence in your future relationship and the likely success of the business.

Drawing an agreement can be a positive exercise, similar to drawing up the first business plan, to bring all founders together on strategy and goals.

Changing the basis on which votes are decided

The most significant feature of a shareholders’ agreement is that the basis on which the shareholders make decisions can be varied.

By default under the Companies Act, motions at shareholder meetings are carried if the shareholders who between them own more than 50% of the voting shares of the company agree (in certain cases, the threshold is 75%).

Founders can agree to change this basis for certain types of decisions. There is quite a lot of flexibility.

For example, every person might have one vote, regardless of the number of shares. Or someone might have two votes, while the others have one. The changes to the rules might apply to a type of decision, such as decisions to borrow money, or in a particular situation such as when an offer has been made by an outside party to buy the company.

Being able to change how decisions are made allows both majority and minority owners greater influence over matters of company management that are important to them. Because each shareholder will have different concerns, this feature allows each one to negotiate a more favourable position for themselves that increases the perceived value of their investment in the company.

When it can be advantageous to all founders to put a shareholders agreement in place, there are very few reasons not to do so.

When a business started by two people is incorporated into a company, the founders often split the shares 50:50 because it seems “fair” to do so. At an early stage in the life of the business both founders may have contributed to it equally in terms of equity investment, and are unlikely to have spent a lot of time working for it. Both share the same vision to build the company and both are optimistic for the future.

However, 50:50 ownership of a company is fraught with difficulties. If the question was asked “How should we split ownership of our company?”, the answer would be “Any way but equally.”

The reason boils down to ultimate control. In situations where one founder disagrees with the other (perhaps about making an investment in a new piece of machinery, or about selling shares to a business angel), deadlock will occur. There is a saying “any decision is better than indecision”. That applies here. If the owners of the business cannot agree on what the business will do, the business will suffer. If that happens, both founders will suffer as the value of the business declines.

There are ways of resolving shareholder deadlock, but they aren’t particularly good options if the business is to be kept going.

Appointing an outsider to have a casting vote is also often suggested. For example, that might be someone with great experience in the industry who is appointed as a non-executive director of the company. This isn’t a bad option for resolving board level deadlock. However, shareholders are not legally bound to any third party’s views.

Under company law, certain decisions can only be made by shareholders who hold over 50% of the shares. Shareholders with 51% of the equity have the power to appoint and remove directors (and thus change day to day control) and to approve payment of a final dividend. Additionally, if your co-shareholder has over 25% of the shares, he may block any special resolution, such as one to change the articles of association of the company. In summary, if you want full control, you need over 50% of the shares and your fellow shareholders should have under 25% (either individually, or better still, between them).

There are often ways of achieving the same goals as 50:50 intends without owning the shares equally.

The first is to use different classes of shares. Different rights can be given to different classes. For example, preference shares usually have no voting rights, but the right to receive dividends before dividends are paid to ordinary share holders.

The second is to specify in the shareholders agreement which shareholder has rights to vote on certain matters. For example, you could agree that you co-founder has no rights regarding payment of dividends until your loan to the company has been repaid. There are some matters that can’t be changed by using a shareholder agreement, but it is a good option.

The best and simplest alternative is for one of the founders to own slightly more of the company than the other. If one of you has invested debt into the company, or came up with the original idea, the other may be open to accepting a minority position. It will certainly save a lot of headaches further down the line.

One of the functions of a shareholders agreement is to set out clearly the differentiation in roles between shareholders and directors. Shareholders are not responsible for the day to day running of the company, but will want say on decisions that affect the value of the company, the risks it takes and loss of control. As such, the agreement between them should set out what decisions shareholders make, the process that is followed, and the power each of the shareholders has in the process for any particular matter.

Background information about the share structure

The start of a shareholders agreement usually states the background to the agreement. Information given here such as the number of classes of shares, the number of shares in each class, and total share capital is for memorandum purposes.

Transfers of shares clauses

Shareholders may want to restrict transfers of shares in certain circumstances in order to keep control of the company between known people. Restrictions may include:

• to trusts, where the trustees who are not necessarily “qualified” to make shareholder decisions gain power to do so
• to a family member, where again in the view of other owners, that person may not be suitable to vote or maintain the obligations he or she must
• to associated companies, where control of the associated company cannot be influenced by the shareholders

Transfers may be allowed, but the rights associated with the shares (or some of them) are not transferred, or are delayed in transfer, or are transferred in certain conditions. For example the owners may agree:

• that if any other of them wants to place shares in a trust for family members in order to reduce the value of his or her estate for inheritance tax purposes, voting rights on certain matters are lost, but other rights remain
• that a shareholder must have been employed in the business for at least two years before he or she can vote on certain matters

Note that shareholders have certain statutory rights (i.e. rights given by law) that cannot be reduced. Thus restrictions may not be completely effective.

Similar to restrictions of transfers, situations in which a transfer may arise may be restricted. The most common of these is prohibiting a charge over shares, i.e. offering the shares as a guarantee for a loan or a mortgage, where non-repayment would mean that the borrower becomes a shareholder.

Obligations

Owners between them should agree what each commits to do in relation to the business. These can include:

• a commitment of time, such as to attend in person or by telephone a certain number of shareholder meetings each year (so as to ensure that at least a minimum number of shareholders vote on each issue)
• the maintenance of payment of life insurance policies required in order to pay for the exercise by the others of cross option agreements and similar arrangements
• to notify all the other shareholders as soon as possible of any material event such as litigation against the company
• the obligation to disclose management level information to the other shareholders

Shareholder meetings

You should agree how many shareholders need to attend a meeting, and whether attendance must be in person or could be via telephone or video conference. Decisions for a small start-up ideally need to be made by all founders.

It is common to appoint a chairman to manage the meeting and ensure that every member is able to speak and be heard. The chairman also usually has a casting vote, which gives him or her superior power over certain decisions. There is no requirement in law for this position however.

Within the shareholders agreement, you may want to agree that the position of chairman will be rotated between shareholders, such that no founder can hold the position again before all others have held it, unless one agrees to waive his or her right.

You are also likely to want to remove the right of the chairman to a casting vote, and instead replace it with another mechanism for resolving deadlock. For example, if you cannot agree on a matter, you may decide to vote on a different basis (such as a show of hands, rather than share ownership) or eliminate one of the possible choices in subsequent rounds of voting.

One of the functions of the shareholder meeting is to make sure that all owners are aware of what is happening in the company. One of the directors is likely to present an update to trading compared to the plan agreed at the last meeting. Documents such as management accounts should be circulated in advance.

The chairman may also ask shareholders in advance for questions or matters to raise at the meeting in order to have a timetable and give each owner the opportunity to address important matters to him or her.

Policies

You should consider having policies in place that determine how decisions about the following are made:

• the business plan (remember an exit plan is likely to be important to at least some owners)
• debt financing matters – short term working capital, longer term loans (particularly those secured by company assets), and debt investment by third parties (such as convertible debt)
• equity investment by new shareholders (when venture capital is raised)
• payment of dividends
• remuneration of directors and other senior employees

You may also want to have policies regarding directors:

• how directors are appointed and removed, and who has power to do so
• whether an executive director must also be a shareholder, and if so, what holding is required as a minimum
• whether there will be a limit to the number of directors (so as to balance thorough consideration of matters with the ability to make decisions)

Common matters for shareholder decisions

The decisions that shareholders are likely to make are fairly limited, since the day to day running of the company should be left to the directors.

Matters that are important to vote on usually are those where:

• there could be a significant operational risk to the business
• there could be a change of control of the business
• value could be transferred from shareholders (usually to another shareholder, or a party connected with another shareholder) unknowingly otherwise

Votes at shareholder meetings may be on:

• issue of new shares or other alterations to share capital
• buy back by the company of its own shares
• change of accounting reference date
• change in the nature of the company’s business, or the start of a new business
• expansion into a new market
• purchase of sale of assets of significant value, or the disposal of a business
• entering into major contracts
• mergers
• formation, disposal or acquisition of subsidiaries
• acquisition of shares or debentures of another company as part of a joint venture
• loans guaranteed against company assets
• authorisation of loans in excess of the limit that directors may take out
• loans made by the company
• factoring of debt (selling rights to receive debts to someone else)
• capital expenditure in excess of the limit that directors may make
• transactions involving intellectual property
• unusual transactions
• changes to bank signatories
• legal action by the company
• transactions with “connected persons”
• political donations
• appointment and dismissal of directors
• directors’ remuneration
• dividends
• alteration of the articles of association
• winding up the company