Shareholder and Partnership Agreements – Have you done yours?

At Backhouse Solicitors our commercial law experts often see businesses with no formal shareholder or partnership agreements in place. Unfortunately, this lack of documentation only really becomes an issue at a crunch time for the business when problems are starting to occur, and it is at this point it would be really helpful to have the rules in black and white.

So why does this happen? If you are running a business, you will probably appreciate that it is often a question of priorities. The legal agreements governing the relationship between shareholders or partners were never the most important thing on the to-do list because the main focus was on building and expanding the business. Or perhaps there were several directors working for the company, but their exact roles and duties were never defined and often adapted to meet changing needs so were never set in stone.

If you do not have shareholder or partnership agreements in place for your business, then now is the time to make sure you never fall into the same trap as others. If something were to happen, we don’t want you to be caught out, thinking “I really should have put this in writing!”, so to help get you started, here is some useful information to think about.

Question: What happens if a shareholder who is also working for the company leaves and is employed elsewhere? Is there a way to stop them from holding onto their shareholding once they have left the company?  

Answer: Yes – you need a shareholder agreement. This is an agreement between some or all of the shareholders of a company which regulates their relationship, the ownership of the shares and the management of the company. Most importantly, it also acts as a safeguard and provides shareholders with protection should things ever go wrong.

Shareholder agreements can provide for many eventualities within a company, and we would always advise putting these in place from day one. Even if you are setting up a business with a close friend or family member it is essential to agree everything upfront so that should a disagreement ever happen both parties’ assets are fully protected.

Question: But what about contracts of employment, won’t they take care of the legal relationships?

Answer: Only partially – whilst you may have a contract of employment in place with a working shareholder, this will relate only to their employment by the company. There will be nothing in the contract to govern the individual’s interaction with other shareholders, nor the sale of the shareholding.

It is much harder to claw back shares from an individual when there is no agreement in place to confirm each party’s obligations to the other shareholders. Shareholder agreements usually include terms to ensure that should an employee/director shareholder cease to work for or be actively involved in, the company, they must transfer their shares immediately upon termination.

Another common term within a shareholder agreement is that all other shareholders will have a right of first refusal when one wishes to sell their shares. Without this a shareholder could, in the worst case, sell their shares to a competitor!

What if you want to sell the business but another shareholder is objecting? You can include “drag-along” rights into the agreement, which allow the majority shareholder to force minority shareholders to join in the sale of the company. Whilst it may appear unfair to the minority shareholders, provisions can be made to ensure that they will receive the same valuation for their shares as the majority shareholder.

Question: If you have set up a business with a close friend or family member as a partner, what happens if you have a disagreement and they decide they no longer wish to be involved? How do you protect your business if they leave to set up on their own or join a competitor?

 Answer: You need a partnership agreement. Much like a shareholder agreement, this is a legal document detailing each partner’s contribution, obligations and liabilities to the business. Importantly it will also agree how profits are to be shared. A good partnership agreement should cover every likely eventuality and therefore they are often very complex documents that should be drafted under legal supervision.

Much like an employment contract, you can set out restrictions for all partners in the business, preventing them from competing, soliciting clients/customers or poaching staff members. Unlike employment contracts, you can set much longer time limits for the restrictions in partnership agreements. This will provide the remaining partners with more security that the outgoing partner will not endeavour to harm the business. If the outgoing partner breaches one of the restrictive covenants, the remaining partners may then seek an injunction against them.

Partnership agreements are also important where partners have invested different sums into the business or have contributed personal property or assets. It may be that any property constituting the main office or base for the business is to be treated as partnership property, but if it belongs to one partner only this will need to be confirmed in the partnership agreement. Similarly, the agreement would need to set out whether the business could remain in the property if the proprietor left the partnership, and if so, upon what terms.

These documents ensure that every party in a business knows where they stand, what their obligations are, and what will happen if there is a sale or a dispute. These important agreements tend to get overlooked as the business is operating ‘just fine’ without them… until there is a problem.

Business relationships between individuals and the company or partnership are much clearer and secure when everything is written down in black and white. It really is all about eliminating those grey areas for peace of mind.

If you own a business and don’t already have shareholder or partnership agreements in place, we will strongly recommend doing this as soon as possible. At Backhouse Solicitors our Commercial Law team have the expertise and experience to help – to find out more and to book a free initial consultation contact a member of our legal team today.

Tel:          01245 893400
Email:     info@backhouse-solicitors.co.uk
Visit:       17 Duke Street, Chelmsford, CM1 1JU
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