The importance of shareholders’ agreements for start-up companies
A shareholders’ agreement is a contract between the shareholders of a company (also called its “members”) the purpose of which is to govern the rights and obligations of the shareholders. It also establishes a framework for the operation and management of the company, thereby providing greater certainty for the parties involved.
Many new companies will adopt the standard articles of association under the Companies Acts 1963-2012 and a shareholders’ agreement is a useful way to deal with situations that are not covered by those articles. However, one important difference between a shareholders’ agreement and a company’s articles of association is that a shareholders’ agreement remains confidential whereas the articles of association become publicly available once they have been filed with the Companies Registration Office.
Company law affords relatively few rights to shareholders with the result that a shareholders’ agreement can be used to confer additional rights and powers on shareholders, in particular minority shareholders, particularly regarding the transfer of shares; for example, drag-along rights and tag-along rights, rights of veto and corporate governance matters.
Transfer of Shares
Restrictions on the transferability of shares, for example, rights of first refusal and compulsory transfers by shareholders in particular circumstances, can supplement a shareholder’s rights. They allow shareholders to restrict the transfer of shares to avoid, for example, a situation where a shareholder could find himself co-shareholder with an incompatible party.
‘Drag along’ and ‘tag along’ rights come into operation when a prospective purchaser offers to purchase the company’s shares. ‘Drag along’ rights favour the majority shareholder(s) and apply where a majority of shareholders wish to sell their shares to an outside purchaser, they can compel the other shareholders to participate in a sale of the shares on the same terms. ‘Tag’ rights favour the minority shareholder and refer to a situation whereby a minority shareholder can ‘tag along’ on the same terms if the majority shareholders wish to sell their shares.
Another important protection typically provided for in shareholders’ agreements are veto rights. These apply to certain business decisions and enable a minority shareholder to veto certain specified decisions; for example, borrowing or changing the nature of the business. Such decisions cannot be undertaken without the consent of a specified shareholder, thus protecting that shareholder’s position.
On the matter of corporate governance, one important protection for a minority shareholder is the power to appoint a director to the board of directors. Shareholders’ agreements usually state that regular board meetings should be held and provide for reasonable notice to be given to directors. Additional information rights can be granted, such as the right to receive business plans or management accounts from the board.
Deadlock can arise where the board cannot reach a decision on a matter. The shareholders’ agreement should anticipate this scenario by providing that any management disagreements which result in deadlock be resolved by way of mediation and/or arbitration thereby avoiding the cost and delay of litigation.
It is for these reasons, amongst others, that a shareholders’ agreement is an essential and worthwhile investment for all companies with more than one shareholder, particularly start-up companies. It is advisable in the early stages of a business relationship to anticipate and reach legal certainty on how to deal with any issues which may arise in the future. A bespoke shareholders’ agreement should be carefully drafted based on appropriate legal advice. Whilst many of these provisions seem straightforward, the importance of drafting a formal agreement specifically tailored to the company and its shareholders’ needs cannot be overstated.