EveryMonth (Feb 2010): Are Shareholder’s Agreements a Good Idea?

You’ve made the decision – you’re really going to set up your own business. You’ve taken advice, and it seems the best way forward for you and your team is to create a limited company. Do you need a shareholders’ agreement?

Actually, a better first question for the entrepreneur is, “Should I retain 100% ownership?” Inviting someone else to join you as a shareholder often seems like a good idea. But think carefully through the implications and don’t be sentimental. Becoming a shareholder may increase someone’s motivation to help grow the company, or bring vital investment capital. But equally, shared ownership, particularly of an owner-managed or family business, can complicate relationships, sometimes fatally.

There Is Some Protection…

If you do decide to go into business with someone else, your company’s Articles of Association will give you some automatic protection. For example anyone owning more than 50% of the shares can appoint or remove Directors, and if owning more than 75%, can make decisions like changing the company’s constitution, or winding it up. So as long as you remain a controlling shareholder (holding more than 50% of the voting shares) you will rarely need a Shareholders’ Agreement.

What If You Have Less Than Half the Shares?

If nobody will own more than 50% of the shares in your business, you may need a Shareholders’ Agreement – and an institutional investor will almost invariably require one. This generally gives minority shareholders ‘veto’ rights: contrary to the general law, they may restrict the Board’s power to run the business.

Though this sounds fine, exercising this right may in practice be impossible without causing irreparable harm. The business may be critically dependent on the knowledge, skills and client relationships of a single Director – you’d be mad to force the Board to let them go! Make sure you understand these commercial and economic realities before worrying about legal agreements.

You can probably see by now that 50/50 ownership may be fraught with problems: there are good reasons for one shareholder to have a controlling interest. If you do decide on 50/50 ownership, you may need an agreement on how to break deadlocks in case of dispute.

What Happens If Somebody Leaves?

What happens to someone’s shares if they leave the company? Should they be allowed to keep them, or be forced to sell? And who sets the valuation? There’s no right answer, so take advice, but if the remaining Directors decide to buy back the shares it’s often fairer to get an independent valuation from an accountant.

So, Do You Need A Shareholders’ Agreement?

In the majority of straightforward cases, probably not – the standard legal protection included in your company’s paperwork will be adequate for most owner-managed businesses. Be careful however over jumping too quickly to the conclusion that ‘equal shares’ are best, and think carefully how you will resolve disputes and buy back shares if people leave.

You can download a more detailed fact sheet from our website, or call us for an informal chat about your situation. Contact James Hunt on 0845 868 0962 or email