Mistakes to Avoid When Drafting a Shareholders Agreement

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Table of Contents

• Not Including Provisions Dealing With a Shareholder Leaving the Company
• Not Including Pre-Emptive Rights Provisions
• Not Including Privacy and Confidentiality Provisions
• Not Including a Clear Process For Deadlocks
• Not Including Clear Enough Dispute Resolution Provisions
• Key Takeaways
• Frequently Asked Questions

A shareholders agreement is a contract between company shareholders that outlines the rules for holding shares and the company’s decision-making procedures. While it is not compulsory to have a shareholders agreement, it can provide clarity and certainty for the company’s processes, particularly where conflict between shareholders arises. A shareholders agreement can address potential issues and outline processes to resolve these problems. This article explores five kinds of mistakes you should avoid when drafting a shareholders’ agreement. 

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Not Including Provisions Dealing With a Shareholder Leaving the Company

If a key shareholder leaves the company, you will want to agree to the rules that address this situation from the outset. Usually, a company will want to ensure that any key shareholders (who may also be employees or contractors) remain employed or engaged to help contribute to the company’s future success. 

Suppose a shareholder promises to commit to the company’s success but receives their shares and stops being employed in a short period. In that case, they will benefit from other shareholder’s efforts to grow the company without actively contributing themselves. 

A typical clause in this situation is to provide for a buy-out process at the company’s discretion. The shareholders’ agreement should give flexibility to the board to be able to force a buy-back process where the shareholder must sell their shares back to either:

1. existing shareholders; or 
2. the company, in exchange for fair market value. 

Otherwise, if shareholders do not wish to buy back these shares (for example, they are a very small percentage), the company could decide to let the shareholder keep their shares. Having this outlined in the shareholder’s agreement is advantageous for the company as it allows the company to be in charge of this process rather than the exiting shareholder.  

Not Including Pre-Emptive Rights Provisions

One of the key reasons to put in a shareholders agreement is to ensure pre-emptive rights provisions apply (on both an issue of new shares and transfer of existing shares). If there is no agreement in place, a shareholder can sell their shares to any third party at any time. Likewise, this third party would gain the usual rights of shareholders, including:

• requesting access to company information; 
• being able to attend shareholder meetings; and 
• voting on certain company decisions that shareholders must make. 

A pre-emptive rights process requires that if shareholders sell their shares, a company must first offer them to existing shareholders in proportion to their current shareholding. Including these provisions is favourable for the company as it provides certainty for existing shareholders from not having unknown third parties become involved with the company without prior board approval. 

Not Including Privacy and Confidentiality Provisions

Shareholders may receive information about the business. In the case of conflicts between shareholders, a shareholder may have the power to misuse such information.

Including a privacy or confidentiality provision in your shareholders’ agreement can compel shareholders to keep information private. For instance, it may cover:

• any documents, including electronic information, relating to the operation or governance of the business;
• the shareholders’ agreement itself;
• any decisions or proceedings of the shareholders;
• any decisions or proceedings of the board of directors;

These confidentiality provisions are significant as these agreements will often contain much more sensitive information than publicly available documents that are registered with the Companies Office. For instance, a shareholders’ agreement may outline:

• policies concerning the approvals required for certain company decisions;
• remuneration of directors; and 
• dispute resolution processes.

Indeed, you may not want to share such information with the general public.  

Not Including a Clear Process For Deadlocks

Deadlocks between shareholders can cause a company to fail. Deadlocks are a particular problem if shares are held evenly, such as in the case of 50/50 owned and controlled companies. 

It is essential that where there is a deadlock between shareholders, the shareholders’ agreement outlines a clear process for moving forward. These provisions should ensure shareholders can resolve disagreements quickly and efficiently. For example, a deadlock clause may provide that a particular decision is elevated to a particular person after a certain period. 

Not Including Clear Enough Dispute Resolution Provisions

Dispute resolution provisions may cover deadlocks but can also guide a broader range of situations. They will typically arise where different groups of shareholders disagree, but they have not necessarily reached a situation where they simply cannot continue in business together.

Key Takeaways

Although businesses do not need to have a shareholders agreement, it is best practice to have one. The aim is to outline the rules for shareholders and the company’s governing procedures. A shareholders agreement will help guide your business into the future and prevent future disputes. When drafting your shareholders’ agreement, it is essential to seek legal advice to avoid these common mistakes and factor them into any agreement you produce.

For assistance drafting your shareholders’ agreement, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0800 005 570 or visit our membership page.

Frequently Asked Questions