The importance of a shareholders agreement to a salon business

Even best friends should sign a shareholders agreement says legal expert Paul Taylor.

When friend go into business together it can often come as a surprise when the investor then asks to see the proposed shareholders' agreement. For many, the response is 'why do we need this?We're all friends and aren't going to fall out'.

But shareholders' agreements should be considered as a necessity, rather than a luxury, and that's the reason why the investor is asking to see a copy.

A shareholders' agreement regulates the relationship between the company and its shareholders. Yet it should also regulate the relationship between the majority and minority shareholder; and the board and other shareholders. 

Starting a business with close friends may, to some, negate the need for formal arrangements. However, these friendships may not have been tested by the daily strain of running a business. A shareholders' agreement codifies a business relationship and should prevent the exploitation and manipulation of personal friendships if relations deteriorate.

A combined agreement will deal with subscription provisions (dealing with how the investor is investing); and shareholder provisions (regulating the running of the company going forward). 

Using such a combined agreement can help to save time and additional expense by dealing with both sets of issues at the same time.

An investor will typically receive comfort (known as warranties) that he's getting good title to his shares and that the material assets/liabilities of the company have all been disclosed to him.

Important consideration should be given to the business medium which will best serve the commercial and tax objectives.

Although investors often favour a limited company (they receive a share certificate, possibility of Enterprise Investment Scheme relief, and so on), advice should be taken to ascertain if, for example, a limited liability partnership should be set up. If this is the case, the parties will be negotiating a members' agreement rather than a shareholders' agreement, although many of the issues and clauses involved will be similar.

Many companies do not have a shareholders' agreement and include operational details in their articles of association. Common examples include issue and transfer of company shares; the number of directors; directors' duties and interests; and company procedures, such as the number of directors/members who need to be present at meetings. 

The articles of association need to be filed at Companies House and, accordingly, consideration must be given as to what information competitors to have access to. 

Other areas such as dividends policy; exit strategy; and how to keep managers incentivised should certainly be kept private and a main benefit of a shareholders' agreement is that it does not need to be filed at Companies House. 

The company may be launched in a blaze of optimism, but what if:

•The bank stops lending. Which of the shareholders is on standby to provide any additional funding?

•The parties fall out? How will the deadlock be broken?

•One of the employee shareholders falls ill and has to leave the company. Can he retain the shares?

The negotiation of the shareholders' agreement provides an excellent opportunity to make sure everybody is on the same wavelength before going into business together. 

UK Courts have long upheld the right of the working person to earn a living and any restrictions on this right must be reasonable. 

However, restrictive covenants contained in a shareholders' agreement/business sale agreement are generally easier to enforce. The Courts' perceive them as being part of commercial arrangements that are negotiated between business people on equal footings. There is also usually clear consideration being provided in the form of share capital or proceeds of sale. 

When the business is launched, there is normally an assumption that the managers have received shares because they are going to help drive the business forward on a daily basis. A well drafted shareholders' agreement will make it clear when departing employees can retain their shares; or when they are deemed to have offered them for sale to the company/other shareholders. There is normally a right to buy these shares, rather than an obligation.

An equally contentious issue will be the price that the shares are sold for, with employee shareholders falling into two categories:

•Good Leavers: typically means employees who have retired through ill-health or, after an agreed number of years. They will usually receive the market value price for their shares.

•Bad Leavers: typically means employees who have either been dismissed due to misconduct or breaches of the shareholders' agreement. Bad leavers will receive a lower price, which is usually the nominal value of their shares.

It may seem strange when the company has just been launched to include an exit clause. However by including plans for the future, it forces shareholders discuss their visions for the future. Any disagreements can also be resolved, thereby limiting the scope for conflict further down the line.

Including a clause that manages the duties of non-manager shareholders is also advisable. Such clauses ensure that these shareholders have no obligation to give any warranties in a future sale (other than good title to the shares).

A shareholders' agreement can be drawn up to protect a minority shareholder. This is to compensate for the fact that a majority shareholder will usually control the board and may have the power to change the articles of association. 

However, it can also be drawn up to protect a majority shareholder who is not involved in the day-to-day management of the company. In addition, it needs to strikes a balance between the board and the other shareholders about how much shareholder approval is required for key decisions.

These issues will usually be addressed in the consent matters clause. This will contain a list of key issues (merger, litigation, borrowing, granting of security etc) that need to be approved in advance by the board and/or certain shareholders. 

Those utilising a shareholders' agreement should take care to ensure it sits alongside the articles of as sociation. It is not advisable for these key documents governing the relationships between stakeholders to contain contradictory provisions.

By utilising a shareholders' agreement, the final negotiated agreement provides clarity as to the future direction of the company. However just as importantly, the negotiations leading up to signature will force the shareholders to sit down and address difficult issues. Hopefully this will ensure they have the same aspirations/plans before taking the big step of going into business together.