Why equal partners in a limited company need a shareholders’ agreement

This article looks at the situation where a business is set up by two or more individuals who view themselves as equal ‘partners’, but the business is in fact a limited company.

In many businesses set up by groups of friends, colleagues or relatives, the individuals often refer to themselves as ‘partners’. This is so even when the structure they use for the business is a limited company. So far as the individuals are concerned, when they call themselves ‘partners’, they usually mean that they should all have an equal say and an equal share in the business. However, a partnership is a very different structure in law to a limited company, so it is important that their intention is properly put into effect. Otherwise they could find that the reality is somewhat different.

Can there be ‘equal partners’ in a limited company?

Unlike a partnership, a limited company has a separate legal existence. To be truly equal, the ‘partners’ would need to:

• own the company equally by each holding the same numbers of shares with the same rights
  
  
• be the managers of the company by being the directors of it, and
  
  
• if they also work for the company, be employed or engaged on similar terms

In any event, the equality should be underpinned by a shareholders’ agreement and, preferably, reinforced by corresponding articles of association.

If everything is equal, why bother with a shareholders’ agreement?

If the ‘partners’ are all agreed as to how they want to run the business and what they want from it, they might well wonder why they should bother with a shareholders’ agreement. There are a number of reasons why it is worthwhile. These include setting out:

• What the business should cover – the range of products and/or services it should offer.
  
  
• How the business should be run – this might cover anything from finance for the business, contracts to be entered into by the business, giving of guarantees, debentures or other charges, granting of credit, borrowing of money, purchase of assets for use in the business, engaging staff and their terms of engagement, purchasing another business or entering into a joint venture to further the aims of the company.
  
  
• Changes to the structure of the company – changing its name, articles of association, issue of further shares, changing the rights attaching to any shares.
  
  
• What should happen if one ‘partner’ wants to sell or transfer his or her shares. Should they be allowed to do so freely? It is more likely that the remaining ‘partner’ or ‘partners’ would want to have a say in who comes in to replace the outgoing ‘partner’ in the business, but the fact is that without any agreement, they will have no such right.

The partners may agree about the issues which arise at the outset, but where other matters arise at a later date which they hadn’t thought of, and so hadn’t addressed, when the business was set up, it is not unusual to find that they may not then agree. This might be because by the time the new issue arises their ideas and attitudes have changed. It is also quite possible that had they thought of this issue at the start they may have had different ideas about how it should be addressed. The distinction between the two scenarios is that at least their potential differences would have been identified. They could then have addressed those differences before the issue arose or before a dispute ensued. By dealing with the issue at that stage, there is much more chance of reaching agreement as to a way forward. If it is not in fact possible to resolve the differences it is far preferable to find that out before a lot more time and money has been invested in the business and the issue becomes significant in practice.

What should be covered in a shareholders’ agreement for equal ‘partners?

The following are the areas I would recommend be considered as a minimum by equal ‘partners’ in a company and set out in a shareholders’ agreement between them:

• The agreed business of the company – the products and/or services it will supply
  
  
• List matters which require the consent of all (or an agreed majority) of the ‘partners’ – I say an agreed majority because where there are a number of ‘partners’, they may not want one effectively to have a veto.
  
  
• If one ‘partner’ wants to sell his or her shares for any reason, give the remaining ‘partner(s)’ the first option to buy shares and include a method of setting a fair valuation if the price cannot be agreed.
  
  
• If certain situations arise such as the death or bankruptcy of a ‘partner’, it will allow the remaining ‘partner(s)’ an option to buy the shares, with a method of setting a fair price for the shares.
  
  In either of the above cases, this allows remaining ‘partner(s)’ to have control over who is involved and who they will have to work with in relation to the business. For the outgoing ‘partner’, or his or her family, it allows them to receive a fair value for the shares.
  
  
• A procedure for completing the purchase of any shares to be transferred as a result of the above options.

When should the shareholders’ agreement be drawn up?

Ideally the shareholders’ agreement should be entered into when the company is set up so that any early points of contention can be identified when least likely to cause harm and most likely to be capable of being settled, but an agreement can be put in place at any time. It’s better to do so as soon as you can. The longer you leave it, the more likely it is that a situation may arise that you may not be able to resolve, so do it whilst the will is there.

How can we go about getting a shareholders’ agreement for our ‘partnership’ company?

If you are in business as equal ‘partners’ in a limited company, talk to Sue Mann, Commercial Contracts Solicitor about putting a shareholders’ agreement in place for your protection.

Other related articles:

Why do you need a shareholders’ agreement?

Going into business with friends or family? - Has your business got a ‘pre-nup’ agreement?

Partnership -v- Limited Company

Shareholders' Agreements


Article written by Sue Mann, Business Contracts Solicitor, July 2013

For free advice on this topic please call us on 0845 003 5639.