When To Update Your Shareholder Agreement

When an investor wants to put money into your business, it’s exciting. However, the legalities and boundaries mustn’t fall by the wayside. A shareholder agreement outlines the rights and obligations of the shareholders, their input into the management of the day-to-day running of the business, and how shareholders can exit the business if they want/have to. It’s a vital document that can help resolve disputes and lessen risks for both the company and the shareholders.

However, shareholder agreements can often be seen as a formality and not as a useful tool to ensure the business runs smoothly. Moreover, shareholder agreements are not always as thorough as they could be, meaning that adjustments need to be made in times of change. Navigating change in a business can be tricky, whether that’s in the economy, an internal change, or changes of circumstances among the shareholders.

Here are 7 examples of circumstance changes, and what should be considered when updating your shareholder agreement:

• If a founder wants to exit the business

When a founder wishes to exit the business, the shareholder agreement must outline the appropriate measures. Most shareholder agreements will already have adequate measures in place in the event of a founder exit, but the agreement might need to be updated if the terms of the exit require it. Those terms could be: if the exiting founder still wants a share in the business, if shareholders want to add certain restrictions to other shareholders, or if a shareholder wants to reduce the amount of stake they have in the business.

• If a shareholder passes away

A shareholder death, whether expected or unexpected, will have an impact on the shareholder agreement. When a shareholder passes away, their shares will typically go to their spouse or their estate. The shareholder agreement should outline expectations and the next steps. There are several considerations, including:

• If there is no spouse, the shares will go to the estate. This could include children or grandchildren. Do they want to be involved in the business? Is it appropriate for them to have a stake in the business? Maybe some of them want a portion of the shares, and some of them don’t.
• Does the spouse want shares in the business?
• What happens to the shares if there is no spouse or estate?
• What happens to the shares if neither want to be involved? Will they be sold to third parties or other shareholders? If they are sold to a third party, who finds the buyer?
  
  
• Succession planning

If one or some of your shareholders are coming up to retirement age, it’s a good idea to plan how they might pass on their shares. It’s advisable to work with the shareholders on this, as they will direct who they want their shares to go to, whether that’s family members or a third party. And the same questions apply here as when a shareholder passes away: is the shareholder’s successor an appropriate choice, and is the retiring shareholder responsible for finding a third-party buyer?

The shareholder agreement should be updated accordingly outlining who the shares will transfer to and when. Companies might also want to consider how much retirement notice a shareholder should provide.

• If a shareholder becomes ill

Even if all your shareholders are a long way off retirement age, life can be unpredictable. If a shareholder develops a long-term illness, whether that’s mental or physical, it can pose challenges for the business. The severity of the illness or incapacitation will have an impact on how the shareholder can fulfil their role in the business, and the shareholder agreement should reflect what happens if they no longer can. However, if the shareholder’s incapacitation is not permanent, this should be considered.

• Settling disputes between shareholders

A shareholder agreement is typically updated when there’s a shareholder dispute. They don’t always get along, especially when there are stakes in the business involved. Finance and business can cause complex situations, so it is best to be prepared.

Some causes for dispute include voting rights and income calculations. If it can’t be resolved through mediation, the disputing shareholders might choose a more public route, such as a court trial. However, this is a drastic measure. To avoid reaching such measures, it’s helpful to put a structure in place that establishes what steps can be taken when a dispute occurs.

• Decision-making evolution

Not every shareholder wants to be involved in the decision-making process. Some might start off wanting to be involved, and then as the business evolves, decide they want a stripped-back role. If a shareholder’s decision-making role has changed, this might be updated in the shareholder agreement.

Additionally, the way that shareholders make decisions and address corporate challenges will change as the business evolves. Typically, there are three methods of facing challenges and green-lighting resolutions: ordinary resolutions (50% of shareholders are in agreement), special resolutions (75% of shareholders are in agreement), and unanimous resolutions. If the company’s chosen method(s) is not discussed in the shareholder agreement, it can lead to arguments and disagreements.

If all shareholders must agree unanimously on a resolution, but this is not outlined in the shareholder agreement, and one shareholder particularly disagrees with a resolution, they could argue that the method is not officially agreed.

• Changing the shareholder’s income

While this might not be popular with your shareholders, changing how shareholders get paid can be vital to a company’s financial health. In times of financial strain, paying shareholders the same amount every month can be an immense pressure. Introducing some flexibility to payment in the shareholder agreement can ease this financial burden. Flexible dividends can satisfy both parties and if a shareholder is an employee, they could enter a salary sacrifice scheme.

Keeping a shareholder agreement up to date is an ongoing process. You probably won’t address all the possible circumstances when you create the agreement, so it’s advisable to review it regularly.