The saying ‘the cobbler always wears the worst shoes” is an old phrase that most of us will have heard; it refers to those people who are so focused on serving others that they do nothing to support their needs.
This expression in my experience also all too often applies to client-focused financial advisers who in many instances do not get around to putting a shareholders’ agreement into place. Instead, they rely on memorandum and articles of association. (A similar structure will apply within a limited liability partnership (LLP), and a traditional partnership agreement should also cover similar areas.) Consequently, issues can and often do arise particularly when shareholders fall out, as well as in the event of serious illness and death.
In the last six months alone, I have encountered three instances where the lack of a shareholders’ agreement has led to at least one of the shareholders/partners having to depart to set up again because there was no shareholders’ agreement in place to deal with the issues which arose.
First, let us remind ourselves of what a memorandum of association and articles of association are. They are required for a company formed in the UK under the Companies Act 2006 and previous Companies Acts. The memorandum of association is the document that sets up the company and the articles of association set out how the company is run, governed and owned. The articles include the responsibilities and powers of the directors and how the members exert control over the board of directors.
A shareholders’ agreement is a legal contract between the shareholders that stipulates the rights and obligations of the shareholders of a company, regulating (amongst other things) the management, operation, transfer, and valuation of shares. This agreement is essential for professional services firms, such as financial intermediaries where the shareholders are nearly always also advisers delivering services to clients.
The benefits of a shareholders’ agreement are numerous (and can be shaped to suit the size and complexity of the business).
Shareholder agreements:
- Establish clear rules and procedures for the governance and management of the firm, such as the appointment and removal of directors, the allocation of profits and losses, the decision-making process, and the resolution of disputes
- If appropriately drafted, protect the interests and expectations of the shareholders, who may have divergent goals, visions, and contributions to the firm
- Ensure the continuity and stability of the firm, by preventing unwanted or forced exits of shareholders, and by providing mechanisms for the succession and retirement of shareholders
- Provide a mechanism for the retention of key staff and the attraction of new employees
- Enhance the reputation and credibility of the firm, by demonstrating its professionalism and commitment to its clients, employees, and stakeholders
- Reduce the risk of litigation and disputes, by providing a framework for the prevention and settlement of conflicts among shareholders
So, what are the key aspects to address? Here is a list suggested by an experienced solicitor that I know whose specialism is advising financial intermediaries:
- The admission and exit of shareholders, including the criteria, process, and price for the transfer of shares, the rights of first refusal, the drag-along and tag-along rights, and the buy-sell provisions
- The management and control of the firm, including the composition and powers of the board of directors, and the voting rights
- Rights to information for shareholders
- Actions which can and cannot be done without certain shareholder consent (which can, amongst other things, prevent certain shareholders being ousted)
- The valuation of shares, including the methods, frequency, and triggers for the valuation, and the adjustments for goodwill, intangible assets, and liabilities
- Rights to dividends
- The question of exit for any shareholder and how their share is valued
- The distribution of profits and losses, including the timing, amount, and form of dividends, the allocation of salaries and bonuses, and the reinvestment of retained earnings for development of the business
- Shares attached to employment – what happens to an employee who leaves under ‘good leaver’ circumstances
- Strong protective provisions for the company in the event of a bad leaver situation
- What happens in the event of death/serious illness of a key shareholder etc
- The protection of the firm’s assets and interests, including the confidentiality and non-disclosure obligations, the non-compete and non-solicitation clauses, the intellectual property rights and ownership, and the indemnification and insurance provisions
and… arguably most importantly, in my view:
- Sensible dispute resolution provisions which start with internal escalation and then provide for referral to a sensible third party where mediation is needed
So, why do many owners of financial planning firms rely on the memorandum and articles of association, and never get round to putting into place a shareholders’ agreement? When I ask our clients and other firm owners, the three most common answers are: “I kept meaning to get round to it, but other priorities got in the way.” And then “I never bothered, I have known my business partner(s) for years, and we will never fall out”, and lastly, “I have yet to meet a solicitor that talks plain English who could draft an agreement that I could understand.”
My response to all three of these “reasons” is to provide examples of what can and has happened to others and has resulted in many instances, in many years’ hard work being undone and the value of the business being significantly diminished.
In summary, another adage comes to mind; ‘prevention is better than cure’.
A shareholders’ agreement is a vital part of every intermediary firm’s planning and governance structure in building and protecting its future.