Shareholders Agreement – the key reason a small business needs one as much as a big one

Many small businesses do not appreciate the importance and value of a clear and well thought out shareholders agreement. Here’s why it’s so important. The vast majority of companies in the UK are very small, typically family owned businesses. Owners of those businesses tend to believe they can rely more on informality than a large

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Many small businesses do not appreciate the importance and value of a clear and well thought out shareholders agreement. Here’s why it’s so important.

The vast majority of companies in the UK are very small, typically family owned businesses. Owners of those businesses tend to believe they can rely more on informality than a large company with many shareholders who don’t care about the business except in pure financial terms. In fact, the typical small family business is often more prone to problems and disputes later.

Any shareholder dispute necessarily damages a business and can literally destroy an otherwise thriving enterprise. Often, the closer the relationship between the parties and the more involved the parties are in the day to day business, the greater the scope for a dispute.

Quasi Partnerships – certainty vs fairnesss

Most small businesses are run in similar ways to partnerships. Features of such companies are that they are often :-

  • started by individuals, family or otherwise, with a close relationship
  • where the shareholders are prepared to reinvest profits rather than look to draw all available profits in dividends
  • there are small number of shareholders and where the shareholders tend to have day to day involvement.

The law, for some decades, has recognised that these types of limited company are somewhat different to other types of company and treated them as quasi partnerships.

What does this mean in practical terms ? Law is generally about rules and whether a rule works for you or against you, having rules creates certainty. Without a high degree of certainty there would be chaos and business couldn’t function properly.

However, sometimes, strict application of rules can create unfairness and consequently, in some limited areas of law, the courts have been prepared to involve equity (fairness) principles so that the strict application of the law application doesn’t create unfairness. In this sense, there can be a difficult balance between law and equity.

Applying this to company law

Small companies which are quasi partnerships are different to other companies and this has resulted in the courts applying some equitable principles. However, to be effective, equity relies to an extent on discretion, and discretion means a degree of uncertainty, and uncertainty is a big problem if you are involved in a legal dispute

The right document to create certainty and avoid a dispute ?

If you have small business or a family business, you may believe that you don’t need a shareholders agreement or a bog standard agreement may be all that is required.

The difficulty with having no agreement is that if there is a dispute, typically an application based on an argument of unfair prejudice by 1 or more shareholders against another or others, either or both parties may ask the court to exercise equitable discretion. Save for a few well established situations with clear case law precedents (such as where a minority shareholder in a quasi partnership type company will be entitled to the full rather than discounted value of his or her shares on being bought out by the remaining shareholders), because there is a wide degree of equitable discretion with quasi partnership type companies, in the absence of a clear shareholders agreement or carefully considered articles, it may be difficult, in a dispute, for lawyers to clearly advise the parties what the outcome should be. This means increased risk.

In the situation where a standard type shareholders agreement or articles of association have been used, all parties may believe that because they have an agreement in place, they have certainty. However, the court may still apply equity to override what are clearly ill-considered, standardised documents.

To minimise the risks of such uncertainty, a well thought out shareholders agreement, where all parties have clearly considered their current and possible future positions and areas of dispute will often be the best way to balance the need to be aware of the issues that can arise for small companies and to have evidence to use in court that equity shouldn’t come into play.

It is also important, for the reasons given above, to stay alert to changes in situations where a shareholder agreement should be updated or formally varied and to comply with any agreement entered into after full consideration.

commercial law • Debbie Serota

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