We are often asked, ‘Do SMEs need shareholder agreements?’. And our answer is always ‘yes!’

One of the key documents that governs how a business is run is a shareholder agreement. However, many small and medium-sized businesses do not have one. This may be an oversight, due to naivety or being low down an ever-growing to-do list of running your business. 

So, what are the pros and cons of having a shareholder agreement?

A shareholder agreement is a contract which governs the rights and obligations of the shareholders of a company. It protects both the business and its shareholders, especially minority shareholders who may have limited say in the company’s decisions. 

Why is a shareholder agreement important to ESG strategy?

Having a shareholder agreement can also play an important role in setting out a company’s ESG criteria that measure the sustainability and social impact of a company by:

  • Establishing the expectations and commitments of the shareholders and the company on ESG matters, such as setting ESG goals, disclosing ESG performance, and complying with ESG standards.
  • Enhancing the communication and transparency between the shareholders and the company on ESG issues, such as providing regular ESG reports, engaging in ESG dialogues, and responding to ESG feedback.
  • Demonstrating the company’s long-term strategy and value creation that incorporates ESG factors, such as by linking ESG to business resilience, competitive strength, and financial performance.

A shareholder agreement is an important way to help a company integrate ESG into its ways of working. It enables easy monitoring and communication of ESG progress and challenges to shareholders. 

The advantages of SME shareholder agreements

Beyond the importance of ESG, some of the other reasons why owners of a you should have an SME shareholder agreement in place include:

  • To avoid and manage disputes among shareholders by providing a clear mechanism for resolving them.
  • To prevent deadlock situations where shareholders cannot agree on important matters by setting out how to break the impasse.
  • To protect shareholders by giving them certain rights and guarantees.
  • To restrict who can acquire shares in the company by giving existing shareholders or the company a right of first refusal over any sale of shares.
  • To regulate how dividends are paid, how profits are distributed, and how losses are shared among shareholders.
  • To define how the company is managed, who can appoint or remove directors, and what decisions require shareholder approval.
  • To safeguard the interests of minority shareholders by giving them veto rights over certain decisions that may affect their share value or dilute their ownership.
  • To plan for the future of the company by setting out what happens in case of death, disability, retirement, or insolvency of a shareholder.
  • To preserve the vision and values of the company by ensuring that shareholders share a common goal and direction.
  • To comply with any legal or regulatory requirements that may apply to the company or its industry.

The disadvantages of a shareholder agreements

Whilst there are many advantages of having a shareholder agreement, there are also some potential disadvantages that you should be aware of. These include:

  • Less flexibility: A shareholder agreement may limit the ability of the company to adapt to changing circumstances or opportunities by imposing certain rules or restrictions on how the company is run.
  • Increased minority shareholder protection: A shareholder agreement may give more rights and powers to minority shareholders than they would otherwise have under the law or the articles of association. This may be seen as a disadvantage by majority shareholders who own the largest stake in the company.
  • Difficulty in amending: A shareholder agreement may require unanimous consent of all parties to be amended. This may make it hard to update or modify the agreement as the needs or interests of the shareholders change over time.
  • Additional costs and complexity: A shareholder agreement may involve additional legal fees and administrative burdens to draft, negotiate, and enforce. It may also add complexity to the governance and decision-making processes of the company.
  • Risk of breach or dispute: A shareholder agreement may not prevent all conflicts or disagreements among shareholders. It may also create a risk of breach or dispute if one or more parties fail to comply with their obligations or interpret the agreement differently.

The possible disadvantages of a shareholder agreement do not however outweigh the benefits of having such an agreement in place, especially for smaller or closely-held companies where shareholders have a significant interest and involvement in the business. Company owners should carefully weigh the pros and cons of a shareholder agreement before deciding whether to enter into one or not. Farringford Legal’s believes, it is important from not only an ESG but also from a governance perspective, that owners have a clear foundation on which to build their business.

Every company is different and may have specific needs or circumstances that require a tailored agreement. Therefore, it is advisable to consult a legal professional before drafting or signing a shareholder agreement. Please do contact Farringford Legal should you wish to discuss any of the above with us.