Part of ADG Legal’s Corporate Insights series
Many businesses begin with a simple idea shared between people who know and trust each other, whether it is two friends spotting an opportunity, former colleagues deciding to build something together, or family members pooling their resources.
Everyone gets excited, interests are aligned, and the prospect of a serious disagreement seems so remote. Against that backdrop, discussing what happens if somebody wants to leave, stops contributing, or disagrees with a major decision may feel unnecessarily pessimistic. That is often exactly when a shareholders’ agreement is most valuable.
A shareholders’ agreement is not a prediction that the relationship will fail. It is an agreement about how the relationship will work if circumstances change; and in business, circumstances almost inevitably change.
Friendship does not answer commercial questions
At the beginning, founders often have a shared understanding of their respective roles. One partner will manage operations. Another will bring clients. Someone else will provide most of the funding.
The difficulty is that informal understandings rarely answer the questions that arise later.
What if the business needs more money and one shareholder cannot contribute? Can a shareholder start another business in the same industry? Who decides whether profits are distributed or reinvested? Can your friend sell their shares to someone you have never met?
These are not questions of friendship or trust. They are questions of governance, economics and control.
A properly drafted shareholders’ agreement converts the parties’ expectations into rules that can be referred to when memories differ or interests no longer align.
The 50/50 problem
Consider two friends who establish a company together and each owns 50%. While they agree, the structure appears perfectly fair; however, what happens when they do not? Without an agreed deadlock mechanism, an equal partnership can become an equal paralysis.
A shareholders’ agreement can determine which decisions require unanimous approval and, importantly, what happens when unanimity cannot be achieved. Depending on the business and the shareholders’ intentions, this may involve escalation, mediation, buy-out mechanisms or another agreed route for resolving the impasse.
The objective is not to decide today who will be right tomorrow. It is to agree today on a process for dealing with tomorrow’s disagreement.
What happens when somebody wants out?
A shareholder may eventually want to leave for reasons having nothing to do with a dispute. Their priorities may change. They may relocate, retire, need liquidity or simply receive an attractive offer.
That raises another set of questions. Can they sell freely? Should the remaining shareholders have the first opportunity to buy? How should the shares be valued? Can a majority shareholder sell the entire business and require the minority to participate?
Transfer restrictions, rights of first refusal, tag-along rights and drag-along rights can address these issues before an actual sale puts everyone’s interests under pressure.
Money deserves particular attention
Friendships can survive many things. Unclear money arrangements are considerably more challenging.
If one shareholder contributes AED 2 million and another contributes expertise and industry relationships, what exactly does each receive in return? Is the AED 2 million equity, a shareholder loan or a combination of both? If further funding is required, who must provide it? What happens if only one shareholder provides funding?
Similarly, an agreement should address how and when profits may be distributed and whether shareholders working in the business receive salaries or other remuneration independently of dividends.
Clarity at the outset can prevent a contribution made in good faith from becoming a source of resentment later.
Protecting the friendship by planning for change
Perhaps the most important misconception is that asking for a shareholders’ agreement signals distrust, but it need not be.
In fact, negotiating a shareholders’ agreement while the relationship is strong can be significantly easier than trying to agree on the rules after a dispute has arisen. When interests are aligned, shareholders can discuss difficult scenarios objectively. Once substantial money, control or competing interests are involved, those same conversations become much harder.
A good shareholders’ agreement does not attempt to regulate every conceivable disagreement. Nor does it replace trust between business partners; instead, it provides a framework around that trust.
Your business partner may be your friend today and remain your friend for decades. The shareholders’ agreement is there to help ensure that a business disagreement does not have to change that.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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