Is Having a Shareholders’ Agreement Truly Necessary?

It’s necessary to have a shareholders’ agreement if you co-own a company with someone, regardless of their relationship to you or their role in the business.

WHY 

A shareholders’ agreement provides a framework for making decisions among shareholders and directors and addresses potential unexpected situations. In the event of a sudden exit by a shareholder or director due to factors like illness, death, or relationship breakdown, a well-designed agreement will outline a clear process for the remaining business owners to follow. By establishing guidelines at the outset of the business partnership, the need for tough and emotional decisions can be avoided. The agreement should encompass various areas such as directors’ compensation, decision-making, dividends, capital raising, and most importantly, the procedure for a shareholder’s departure triggered by a specific event.

In the absence of a shareholders’ agreement, what are the consequences for my business?

The ownership of a share in a company is an asset and is not necessarily linked to a related person’s employment or directorship in that company by legal obligation. As a result, in the absence of additional contractual obligations, it is impossible to compel a person to transfer their shares.

Case Study

John, Rachel, and David are university friends who decide to establish a company that offers marketing services called XYZ Ltd. They create the company with 20 shares, with each friend owning an equal number of shares through their individual trusts. All three of them are directors of the company. As they start, they believe that they do not need a shareholders’ agreement as they get along well, and the business is in its early stages.

The business grows, and after five years, some issues arise among the friends. David receives an offer to join another marketing start-up, and as a result, he is unable to dedicate as much time and effort to XYZ Ltd as before. Rachel and John feel that David’s reduced input does not justify paying him the same director’s salary or dividend as before. When they discuss this with David, he takes offense and resigns as a director, but he wants to retain his shares.

At this point, XYZ Ltd employs several staff members, and Rachel and John begin to disagree on staffing issues. John feels that Rachel has been making unilateral staffing decisions that should have been discussed and approved by the entire Board. The disagreement escalates to the point where they cannot agree on who should be the managing director of the company.

Unfortunately, the friends never formalized critical decisions about how the company would operate. They did not establish who would be responsible for which area of the business, how decisions would be made, how directors would be compensated, and the events that would trigger a share sale. Unable to resolve their differences, the three friends are unable to buy out one another due to limited financial resources. Consequently, the business relationship becomes untenable, and they sell the business to a competitor for far less than its potential worth, and five years of hard work go to waste.