New year, new business: why start-ups need a Shareholders’ Agreement

Christian Mancier, Partner at Gorvins Solicitors, explains the importance of putting together a Shareholders' Agreement for a start-up, especially at the early stages

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A Shareholders' Agreement is a vital bit of legislation for anyone who wants to their start-up to be protected and successful

January is here, and with it comes renewed motivation to take action on goals and aspirations that have been somewhat forgotten along the way during 2017 – especially for those looking to make starting a business their New Year’s resolution.

Year on year, January sees a spike in new websites registered, with budding entrepreneurs over 10 percent more likely to start their business ventures than any other month.

Starting a new business can be stressful and exciting in equal measure. While enthusiasm and optimism are valuable in the early stages, it’s important to also be realistic and plan to protect the future of your business from the outset, especially if you’re setting up a new start-up limited company venture with one or more business partners.

Starting a new business can be stressful and exciting in equal measure

A good way to do this is through the use of a Shareholders’ Agreement.

A Shareholders’ Agreement is a legal document opted into voluntarily by all shareholders of a limited company with the purpose of regulating relationships, rights and obligations of the various shareholders as well as certain day-to-day operational aspects of the business.

A start-up can use a Shareholders’ Agreement to foretell certain scenarios that could negatively affect the progress or growth of the company. Although a Shareholders’ Agreement won’t prevent a problem by itself, it will however outline a default position on how problems can be fixed and what actions will have to be taken to solve these.

An agreement of this nature is particularly important for a new business given the unpredictable path most start-ups take in their early years. Important changes and decisions are likely to be made due to a variety of reasons so it’s imperative all parties are on the same page.

From our experience it is a lot easier to get this type of agreement signed off at the outset of the business relationship while the start-up business has a relatively low value and all the shareholders are keen to work together based on the initial excitement of the new venture. Once the business has some value, time has passed and some issues may have arisen between the shareholders, putting such an agreement in place can actually be quite difficult.

A Shareholders’ Agreement can help decide key things for your start-up such as who the shareholders are and in what proportion they hold shares/equity; the roles and responsibilities of key shareholders; the distribution of profits; restrictions on transferring shares so shares doesn’t become diluted or passed on to third parties the other shareholders don’t approve of, and how a departing shareholder’s shares are valued.

Shareholders’ Agreements are also particularly effective when it comes to solving disagreements among shareholders. By working out ahead of time how certain important decisions should be made and by whom, you can effectively solve arguments before they occur.

Examples of important decisions may include the hiring of senior level staff, whether to accept investment from third parties (and for what equity), diversification from the original core business, taking on external finance and share allocations.

For many start-ups the protection of Intellectual Property (IP) is paramount to the future success and security of the business, especially if the business is built around an original idea, a unique selling point or is breaking new ground in a particular industry.

Although an IP may not have any monetary worth while the business is in its infancy, it could potentially become your most valuable asset.

If a key shareholder chooses to leave the business, they may argue they are entitled to take particular parts of IP that they were involved in creating/developing with them, perhaps with the intention of starting their own similar company.

A Shareholders’ Agreement can decide how an IP is to be divided or retained in the event a key person choosing to leave the business can help mitigate the risk of a potential court case down the line.

Bear in mind that as your business grows and matures you will need to review and update your Shareholders’ Agreement accordingly, especially is there are any significant changes in personnel or organisational structure. We highly recommend seeking professional legal advice when putting a Shareholders’ Agreement together.