After training at Freshfields Bruckhaus Deringer, I joined Ignition Law, a boutique London firm that focuses on helping entrepreneurial and ambitious start-ups, scale-ups, VC-backed SMEs, and other high-growth enterprises secure investment, meet their governance obligations and rapidly scale. Given all their work with founders and early-stage enterprises, shareholders’ agreements are one of Ignition Law’s key specialisms, so I jumped at the chance when a number of the firm’s senior lawyers kindly agreed to contribute to this section. Thanks again to Francesca Yardley and also to founding partner Alex McPherson for their support and encouragement.

Shareholders’ agreement (SHA): a shareholders’ agreement is used to regulate the relationship between a company’s shareholders. This includes allocating specific rights, obligations and protections to shareholders and setting out various mechanics relating to share ownership, decision-making and the management of the company. Shareholders’ agreements should ideally be put in place when companies with multiple shareholders are first formed (as this is when shares are first issued), and certainly prior to a company securing any third-party investment.  

Investment agreement: depending on the circumstances, an “investment agreement” may be drawn up instead of a “shareholders’ agreement”. Investment agreements will typically include similar provisions to those set out in a shareholders’ agreement, as well as provisions relating to a specific investment or set of investments in the company. 

In an M&A context, shareholders’ agreements are commonly drawn up to regulate the relationship between any shareholders that will retain their equity post-acquisition, and any investors that are co-investing in the deal (including any managers that are also investing, for instance in the context of a management buy-in or management buy-out).

Parties to a shareholders’ agreement 

Most commonly, shareholders’ agreements, especially in respect of smaller companies, are signed by (and therefore bind) all the existing shareholders, although shareholders’ agreements can also be between a smaller group/segment of a company’s shareholders. The company is also typically a party to a shareholders’ agreement (although this is not a compulsory requirement), as this enables the company to take action against shareholders that breach provisions of the agreement.

Once a shareholders’ agreement is signed, parties that subsequently become shareholders may be required to abide by the provisions of that existing agreement. This can be achieved by requiring such parties to sign a “deed of adherence”, which will then bind those parties to the same terms as the existing signatories of the shareholders’ agreement. This is simpler (and more cost effective) than drafting a new shareholders’ agreement each time there is a new shareholder and requiring all new and existing shareholders to sign it. That being said, this approach may not be possible if new investors demand greater rights and/or refuse to bind themselves to certain existing obligations. 

Common shareholders’ agreement provisions

Board mechanics

Shareholders’ agreements typically contain provisions relating to the composition and responsibilities of the board, including provisions granting certain shareholders the right to appoint or remove directors (and/or board observers) and provisions stipulating whether there will be a chairperson in board meetings (and if so, whether that chairperson will have a casting vote). 

The shareholders’ agreement may also provide that certain key decisions will require the approval of specific directors – for example founder directors or investor directors – thereby essentially giving such directors a veto right over those decisions. Provisions such as these are often very important when it comes to investment rounds, as major investors will likely want the opportunity to protect their investments by exerting some degree of control over a company. 

Deadlock

Most new companies adopt the model articles, which do not provide a default position for the resolution of “deadlock” scenarios (for example, scenarios in which the directors or shareholders fail to reach a majority agreement in respect of a particular issue or proposal). Shareholders’ agreements can include mechanisms that help to ensure that decision-making won’t grind to a halt in such scenarios, for example by allocating a casting vote to the chairperson who is presiding over a meeting at which a deadlock arises. 

Model articles: a standard form set of articles of association that a company can choose to adopt and if necessary, tailor to its specific needs. This can be much quicker (and cheaper) than writing new articles of association from scratch, so many new companies either fully adopt the model articles, or adopt a majority of them and make a few amendments.

Right to appoint directors

Broadly, the default position under the model articles is that the appointment of a director must be approved by a majority of the shareholders or a majority of the board (note that removals of directors must be approved by a majority of the shareholders). This means that minority shareholders would usually be unable to influence the composition of the board. 

However, shareholders can agree in a shareholders’ agreement to depart from this default position, for example by including a provision that entitles minority shareholders (or shareholders that hold at least a specified minimum percentage of shares) to veto the appointment or removal of directors. There is also ample scope to further tailor these mechanics. For example, the shareholders’ agreement could also include provisions entitling the founders or specified investors to appoint or replace one or more directors (thus ensuring those founders or investors maintain influence on the board as the company grows and the number of directors on the board increases). 

Reserved matters

Shareholders’ agreements usually set out a list of “shareholder reserved matters”, meaning matters that cannot be decided without shareholder approval. Such approval might need to be unanimous, or the shareholders’ agreement might set out different voting thresholds that apply to decisions relating to different matters. For example, a shareholders’ agreement may stipulate that some matters must be approved by more than 50% of the shareholders, other matters must be approved by 75% or more of the shareholders, and a select few matters can only be approved if a majority of the shareholders and a specific named party (e.g. the founder or a key investor) vote in favour. The latter scenario would essentially give such named party a veto right over the relevant decisions. Common examples of “shareholder reserved matters” include: 

• Changing the nature of the company’s business or its location;
• Changes to the company’s share capital (e.g. the issue of new shares, or buyback of existing shares); 
• The sale or transfer of the company’s most valuable or important assets; 
• Borrowing or offering guarantees on the company’s behalf that exceed a specified value; 
• Entering into contracts on the company’s behalf that exceed a specified value;
• Appointing or removing directors; and/or
• Agreement of, or amendment to the company’s business plan.

Although including these provisions can be beneficial for minority shareholders and can encourage investors to invest (as these rights can enable investors to exert some degree of control over key decisions and thus protect their investments), it is important to ensure that the board still retains some degree of autonomy, otherwise it may be difficult for the company to avoid deadlock scenarios, pass decisions quickly and ultimately evolve and grow efficiently and effectively. 

Restrictions on transfers of shares

Shareholders are often concerned about how (and to whom) other shareholders can transfer their shares. For example, founders of smaller businesses may not want existing shareholders to transfer their shares to competitors or unknown parties, whilst minority shareholders may want to preclude larger shareholders from acquiring controlling stakes. The default position in law does little to alleviate such concerns, but shareholders’ agreements can be drafted to afford shareholders certain additional protections. For example, the terms of a shareholders’ agreement may: 

• Oblige shareholders to first offer their shares to other shareholders before they are able to sell them to a third party; 
• Restrict shareholders from transferring their shares to competitors or even to anyone who has not been approved by one or more of the other shareholders; 
• Regulate the price at which shares may be transferred, for example by setting out valuation mechanisms; and 
• Require new shareholders to sign up to the existing shareholders’ agreement (via a deed of adherence), thereby binding such shareholders to the terms that bind the existing shareholders. 

 Good and bad leaver provisions

“Good leaver” and “bad leaver” provisions can determine what happens to the shares of an employee shareholder (i.e. a shareholder who is also an employee) who resigns, is dismissed, retires, or dies. These provisions are usually included to incentivise key employees – typically founders and senior managers – to remain at the company for at least a few years.

The circumstances under which a person’s employment terminates will determine whether they are a “good” or “bad” leaver. The parties can define these categories in a shareholders’ agreement however they see fit and even add further categories (for example, a third “intermediate leaver” category). The implications of being a good or bad (or intermediate) leaver will depend on what is agreed between the parties, although shareholders’ agreements often build in flexibility to afford the board some discretion when determining how to treat an employee whose employment has terminated.

"Good leaver” provision: “good leavers” are generally employees who remain with the company for at least a specified minimum period of time or whose employment ceases by reason of retirement, serious illness, or death. Typically, a “good” leaver can retain a proportion of their shares (if not all of their shares), and can transfer any remaining shares for their market value as it stands on the date on which their employment terminates. This means that if the market value of the shares has increased since the leaver originally became a shareholder, that leaver will profit from this rise in value. 

“Bad leaver” provision: “bad leavers” tend to be employees who either resign before working at the company for a long enough period of time or are dismissed with cause. Bad leavers are usually required to transfer all of their shares for nominal value (or market value if this is lower).

Drag-along and tag-along provisions

It is also common for shareholders’ agreements to include provisions that protect both minority and majority shareholders by including what are known as “drag-along” and “tag-along” provisions.

“Drag-along” provisions: these protect majority shareholders by stipulating that minority shareholders can be forced to sell their shares if the majority shareholders want to sell 100% of the company, on the same terms as have been negotiated by the majority shareholders for the sale of their own shares. Majority shareholders are essentially given the right to “drag-along” the minority shareholders if the company is acquired. This is important, as most buyers will want to acquire 100% of a target company rather than risk being left with a (potentially uncooperative or even hostile) minority shareholder group. In this sense, a drag-along provision can facilitate an exit route for majority shareholders.

“Tag-along” provisions: these protect minority shareholders by stipulating that majority shareholders can only sell their shares (or a specified portion of their shares) if the minority shareholders are offered the opportunity to sell their shares on the same terms and at the same price. Minority shareholders are essentially given the right to "tag-along" with the majority shareholders during a sale process. Tag-along rights are designed to ensure that larger investors (e.g. private equity firms) cannot leave smaller investors (e.g. managers) behind when “exiting” their investment (i.e. selling their shares).

Other minority shareholder protections

In addition to the “tag-along” provisions outlined above, shareholders’ agreements can also include certain other protections for minority shareholders. For example, provisions could stipulate that certain decisions may only be passed with unanimous approval, meaning minority shareholders would effectively have a right to veto such proposed decisions (regardless of the size or proportion of their shareholding).

Shareholder behaviour

It is also possible to include clauses in shareholders’ agreements that oblige shareholders to act in the best interests of the company, rather than in accordance with their own individual interests. For example, shareholders may be required to act in “good faith” and/or to comply with certain restrictions (known as “restrictive covenants”). 

Such restrictive covenants could, for example, preclude shareholders from setting up, investing in, or engaging with competing companies, or from soliciting the company’s employees, clients or suppliers. The shareholders’ agreement could also stipulate that these restrictions will apply not only whilst a party is a shareholder, but also for a specified period of time after they cease to be a shareholder. 

Confidentiality 

Companies will typically require employees to agree to confidentiality provisions before commencing their employment. This is usually achieved by incorporating confidentiality provisions into their employment contracts or by requiring them to sign standalone non-disclosure agreements. 

However, shareholders who are not employees may not be bound in the same way. Including confidentiality provisions in shareholders’ agreements can therefore ensure that shareholders who are not also employees cannot exploit or disclose confidential information to which they are granted access in connection with their shareholding. Note that because shareholders’ agreements are private documents, they can include detailed confidentiality provisions that make reference to the operations of the business and even sensitive commercial information, as such information will not need to be publicly disclosed. 

Intellectual property

It is very common for shareholders’ agreements to include a clause stipulating that the company will own any intellectual property rights that shareholders have developed in connection with their engagement with the company. 

Information rights 

Shareholders’ agreements will typically set out a list of certain documents or categories of information that the shareholders will be entitled to under the agreement. These rights will be negotiated between the shareholders and the company/board, but tend to include the right to receive progress updates, access to the company’s business plan (as it evolves over time) and financial information (for instance bi-annual profit and loss statements). 

Articles of association vs. shareholders’ agreements

There is typically some overlap between the default rules set out in articles of association, the provisions of the Companies Act and the clauses often included in shareholders’ agreements. Where this is the case, which rules should prevail? Well, shareholders’ agreements can be used, in effect, to supplement, amend or override some (but not all) of a company’s articles and certain statutory thresholds, particularly in the context of regulating decision-making processes. Whilst a company’s articles of association or certain Companies Act provisions may entitle an individual to vote or act in a certain way, a provision to the contrary in a shareholders’ agreement could mean that such individual – assuming that they’re a shareholder and have signed the shareholders’ agreement – would be in breach of contract (i.e. in breach of the shareholders’ agreement) if they simply relied on the relevant article to justify their actions. 

For example, if four friends start a business together, each acting as directors and equal shareholders, they could agree that one party may only be removed as a director if all four of them vote in favour of the removal (thus protecting their collective interest in remaining as directors). In such circumstances, although three out of four votes would be enough to pass the necessary decision under the Companies Act 2006 (and in accordance with the company’s articles of association, assuming that the company has adopted the model articles), the parties are able to circumvent this by contractually agreeing in the shareholders’ agreement not to pass the decision unless all parties agree that it should pass. 

Shareholders have a choice as to whether certain matters should be included in a shareholders’ agreement or in the company’s articles of association and there are various reasons why a proposed provision might sit better in one document rather than the other (a few of which are set out below). 

Confidentiality 

Articles of association are public documents, as they must be filed with Companies House. In contrast, shareholders’ agreements do not (usually) need to be filed, meaning shareholders can use them to privately attain further rights and bind one other to various additional obligations. For this reason, matters reserved for shareholder approval (which might include sensitive commercial insights into how the company operates) will typically sit in a shareholders’ agreement. 

Enforcement and remedies 

A shareholder cannot bring a claim directly against another shareholder who is responsible for a breach of the company’s articles of association. Instead, a shareholder would have to rely on the company bringing the action, which may be unrealistic if the shareholder in breach is also a director with influence on the board. In contrast, a shareholders’ agreement gives each shareholder the right to bring a claim for breach of contract directly against any shareholder in breach of its provisions. 

However, remedies for breaches of shareholders’ agreements are likely to be limited to claims for damages (which may be ineffective or difficult to quantify), whereas more effective remedies may be available for breaches of articles of association. For example, a court could potentially render a purported share transfer void if the transfer was in breach of the articles.