Risks of no shareholders’ agreement

Hello! I am Gemma, a legal assistant at Lawyer Destroyer. It is a pleasure to meet you.

Starting a business with others is an exciting time, but if you do not put a shareholders agreement in place, you leave yourselves open to a huge amount of risk, stress, and expense down the line.

The legal position:

When you form a company in England and Wales without a specific shareholders agreement, the relationship between the business owners is governed simply by the Companies Act 2006 and the company's Articles of Association. Most new companies use the default rules provided by the government, known as the Model Articles.

While these default rules provide a basic framework to run a company, they do not cover the practical, messy realities of a business partnership. They offer very little protection if the owners fall out, someone wants to leave, or you want to sell the business.

What can go wrong:

Deadlocked decisions. If you own the business equally with someone else and you disagree on a major decision, the company can quickly grind to a halt. Without an agreement detailing a tie-breaker or a sensible dispute resolution process, neither of you can force a decision, and the business suffers.

Founders walking away with their shares. This is an incredibly common problem. Suppose your business partner decides to quit and get a different job, leaving you to do all the hard work. Under the default law, they get to keep their shares. They will continue to benefit from your future hard work and can claim a portion of any future dividends or sale price. A shareholders agreement usually includes what are known as leaver provisions, which force a departing owner to sell their shares back to the company or the remaining owners at an agreed price.

The inability to sell the company. If a larger business wants to buy yours, they will usually want to buy all of the shares. If a minority shareholder refuses to sell, they can block the entire deal. An agreement solves this by including drag along rights, meaning the majority can force the minority to sell their shares on the same fair terms.

Selling shares to strangers. Without specific restrictions, a shareholder might try to sell their shares to an outside party, or even a competitor. While company directors have some limited powers to refuse to register a transfer under the default rules, it can result in a messy legal fight. A proper agreement ensures that anyone wanting to sell must offer their shares to the existing owners first.

Minority owners having no voice. If you own less than half of the company, the majority shareholder can outvote you on almost everything. They could stop paying dividends, remove you as a director, or completely change the direction of the business. You can use a shareholders agreement to list key decisions that require the consent of all owners, protecting the minority from being bulldozed.

The practical consequences:

When major disputes arise without a clear rulebook, the practical reality is very damaging. Resolving a dispute between owners who have stopped communicating is incredibly draining. The company often loses focus and value, and staff can become unsettled.

If you cannot agree on an informal way forward, your only options might be expensive and lengthy formal litigation. This could involve an unfair prejudice petition to the court, or even applying to have the company forcibly wound up and closed down. Court action over shareholder disputes is notoriously slow, risky, and financially devastating for a small business.

Practical next steps:

1. Have an open and friendly conversation with your business partners now, while you are all getting along, about what should happen in a worst-case scenario.

2. Write down a list of scenarios to agree upon. Ask yourselves what happens if someone dies, falls permanently ill, stops pulling their weight, wants to retire, or gets a divorce.

3. Gather your current company documents, particularly your Articles of Association, to see exactly what framework you currently rely on.

4. Have a shareholders agreement drafted that clearly reflects your shared expectations and rules.

Please let me know if you would like me to explain any of these points in a little more detail!