Drafting a Shareholders' Agreement in Practice

When a company has two or more shareholders, good relations and verbal agreements are not enough. Drafting a shareholders' agreement for a company helps to set out in writing how important decisions are made, what each shareholder contributes to the company, and what happens if someone's plans change. The most beneficial time to enter into the agreement is when the collaboration is working well. Once a conflict arises, every word becomes more sensitive and reaching an agreement becomes more difficult.

A shareholders' agreement is not merely a document for large companies. It is also a practical tool for a private limited company founded by two friends, a family business, and a growing start-up. A well-drafted agreement does not predict that the shareholders will fall out. It gives them a clear course of action for situations where their views, contributions, or personal circumstances no longer align.

Why does the articles of association alone often fail to resolve problems?

The articles of association of a private limited company is a mandatory document, but its role is more limited. It typically sets out the amount of share capital, the nominal value of shares, the fundamental principles of management, and other matters required by law. The articles of association are visible to the commercial register and any amendment requires compliance with formal requirements.

A shareholders' agreement, by contrast, allows the parties to agree on details that they do not wish to disclose publicly or that it is not practical to incorporate into the articles of association. For example, the agreement may address the shareholders' duties, principles of remuneration, non-competition restrictions, financing obligations, and the procedure for transferring shares.

It is important to understand that a shareholders' agreement does not replace the articles of association. These documents must be consistent with one another. If the agreement provides for a particular voting procedure, but the articles of association or the law prescribe a different mandatory procedure for a specific decision, the situation must be assessed as a whole. Otherwise, the agreement between the shareholders may well be binding, yet the company's decision itself may give rise to a separate dispute.

What matters should be discussed in a shareholders' agreement?

A good agreement begins not with standard clauses, but with honest answers. Who does the day-to-day work? Who contributes money, contacts, or expertise? Do all shareholders wish to grow the company at the same pace? When might additional funding be needed?

Decision-making and deadlock

In a company with minority and majority shareholders, it must be clearly agreed which decisions are made by the management board, which by the shareholders, and when the consent of all shareholders or a specified majority is required. Matters that warrant particular attention include, for example, taking out loans, selling significant assets, admitting a new shareholder, paying dividends, and making a material change to the line of business.

Particular care must be taken in a company with a 50/50 shareholding. If both shareholders hold an equal number of votes, a disagreement may bring the entire company's operations to a standstill. The agreement may include a deadlock resolution procedure: first, negotiation within a specified period, then, if necessary, the involvement of a mediator, and only thereafter a solution involving the buy-out or sale of shares. There is no single universal model. For some companies, a mutual buy-out offer is appropriate; for others, it is more sensible to grant a casting vote to an independent adviser only on a clearly defined matter.

Contribution, remuneration, and responsibility

Many disputes do not begin over money, but over the feeling that one shareholder is doing more than another. If one manages sales, another development, and a third contributes only capital, it is worth setting this out from the outset. The agreement may specify the minimum contribution required, each shareholder's role, reporting obligations, and whether work is remunerated by way of salary, management board member's fee, or a service fee.

Vague undertakings such as "will assist in developing the company" must be avoided here. If a contribution of work is a material condition for receiving a shareholding, it must be clear what the shareholder will do, by what deadline, and what happens in the event of a material breach of that obligation. At the same time, the agreement must not make the business impossibly rigid. Roles in a growing company change, and the agreement must leave room for reasonable arrangements.

Raising capital and distributing profit

A company may need funds before it begins to generate profit. Shareholders should agree in advance whether additional funds will be provided as a loan, contributed as a share capital payment, or sought from an external investor. Consideration must also be given to whether all shareholders are obliged to contribute in the same proportion and what happens if one of them is unable or unwilling to do so.

With regard to dividends, the legal ability to make a distribution does not necessarily mean that a distribution is prudent for the company. The agreement may provide that during a specified period, any profit earned will be used primarily for growth, repayment of loans, or building up reserves. This does not remove the shareholders' rights, but helps to prevent a situation where one shareholder wishes to withdraw funds while another wishes to reinvest.

Transfer of shares and admission of new shareholders

A shareholding in a company is not always freely transferable. It may be very important to the other shareholders who joins them. For this reason, a shareholders' agreement commonly provides for a right of pre-emption or an obligation to offer the shares to the existing shareholders before selling to a third party.

It is also useful to agree on situations where a majority shareholder wishes to sell the company as a whole. A tag-along right protects the minority shareholder by allowing them to sell their shares on the same terms. A drag-along right, in turn, may allow a buyer to acquire the entire company if the required majority of shareholders consents to the sale. These provisions require precise drafting: the price, the method of payment, the guarantees to be provided by the buyer, and who bears any liability arising after completion of the transaction.

Drafting a shareholders' agreement for a company is not a box-ticking exercise

A template found online may provide ideas, but it should not be treated as a ready-made solution. A template does not know whether a company has two equal founders, a passive investor, family relationships, intellectual property, or a partner from a foreign country. Nor does a generic text reveal which risks are in fact the most likely ones for the shareholders concerned.

In practice, a workable agreement is typically arrived at by first mapping the company's ownership structure, objectives, and potential areas of tension. The parties then agree on the underlying principles and record them in a form that is consistent with the law, the articles of association, and any other agreements. If the shareholders are also members of the management board or work within the company, their employment or engagement arrangements and remuneration must also be reviewed.

The agreement should also separately address confidential information and company assets. Client lists, pricing, business plans, software, designs, and created materials may be the most valuable part of a company. It must be clearly established who owns the rights created in the course of work and what a shareholder may use after leaving the company.

When should an existing agreement be reviewed?

A shareholders' agreement is not a document that is signed at the time of incorporation and then forgotten in a drawer. A review is warranted when an investor or new shareholder joins the company, when shareholdings change, when the business expands, when a shareholder steps back from day-to-day operations, or when the company begins to generate significant profit.

Life itself may also require changes: a shareholder's financial difficulties, divorce, inheritance, or long-term incapacity for work may affect the fate of their shareholding and the management of the company. These are not pleasant matters to discuss, but an early agreement protects both the company and the shareholders and their families.

A clear agreement gives a company peace of mind in which to operate

A shareholders' agreement does not eliminate all disagreements. It does, however, help to turn a disagreement into a resolvable matter rather than a personal confrontation. When the key rules have been agreed at a time when the shareholders trust one another, the company can continue to operate even in more difficult circumstances.

If you wish to draft an agreement or have an existing document reviewed, Eurocity Law Office can help you talk through the situation, explain the options in plain terms, and prepare a solution tailored to your company's needs. A good starting point is simple: set out not only how the collaboration begins, but also how it continues fairly when circumstances change.