The importance of a shareholder agreement to you and your shareholders

By Robert Parry, Managing Director, Forensic Accounting & Investigations, Quantuma

There’s an apocryphal tale about a doctor who, bored of saving sinking individuals from a river, decided to go upstream and stop them falling in.

At the risk of doing me, my lawyer clients and competitors out of work, it feels a bit like that with the number of shareholder disputes coming down my river in recent times.

Many friends, family and colleagues have got together to form companies. Buoyed by their unquestionable loyalty and spirit of adventure, they dive straight in without a care for how they will get out.

Years go by (not many in some cases), and the water starts to get lively. Some enjoy the rapids; others start to sink and need to get out before they go under or take others with them.

The message is to plan your way out before anyone jumps in.

Even if you’re already in business, it’s not too late to get a well drafted shareholder agreement (SHA) in place. See your company’s solicitor or corporate law specialist who can draft one for you.

Be cautious of off-the-shelf solutions because your company’s circumstances might not fit the standard.

Apart from all the clever clauses that deal with management rights, ability to appoint a director, remuneration policy, dividends, change of business approvals and who gets what on a sale etc, it’s important that the SHA covers how different classes and quantities of shares are valued for an exiting shareholder.

As well as being instructed in cases where there was no SHA in place, I have been instructed in cases where (none of my solicitor clients at fault, obviously) the SHA has been badly drafted. In some cases, the valuation clauses are vague. At worst they can be contradictory.

For example, inter- changing the terms market value and fair value, which to most valuers are different things. Decide what you want to pay an exiting shareholder.

Do you want them to receive full pro-rata value for their shares? Or are you happy for them to get market value of a minority holding, which is highly likely to be less than pro-rata (possibly much less)? Unless you’re the controlling majority, the exiting shareholder could be you, so that should focus your mind on being fair whilst everyone is still co-operating.

If you’re a founder who has given shares to “loyal” employees as an incentive, do you want them to be able to keep shares if they decide to go to a competitor? I’ve seen it happen.

Changing a dividend policy is tricky if there’s an established pattern. It hurts to keep paying dividends to a defector. Far better to have defined terms for them to sell or give up their shareholding depending on good or bad leaver status.

So, what happens if there’s a fallout and you have no SHA?

It takes ages to resolve, costs more and, sadly, such disputes often become acrimonious. I’ve seen more than one case where second-generation shareholders have not maintained the same cordial relationships as the original founders, which is such a pity. So please, in short, get proper legal advice

to protect your company (and your relationships hopefully). Get a well thought through shareholders’ agreement properly drafted without delay.

For those that don’t, my solicitor clients and I will be waiting down the river and ready to help if the worst happens.