How to structure a shareholders' agreement: covenants, drag-along and reserved matters

The shareholders' agreement is arguably one of the most important documents for any company. It sets out how the shareholders deal with each other and with the company itself. But how should you structure it? There are three provisions I would build the agreement around, one drafting point that catches people out, and one question about how the agreement sits alongside the articles of association.

Restrictive covenants in a shareholders' agreement

Restrictive covenants are restrictions on what the shareholders can do. The obvious example is that shareholders should not compete with the company.

It sounds basic, but without it there is often nothing stopping a shareholder from setting up, or working for, a rival business while still holding shares and seeing the company's information. The covenants put that beyond doubt and give the other shareholders something to enforce if it happens.

Drag-along rights explained

You might one day want to sell the entire company, for example to a private equity buyer or to a competitor. A buyer like that will ideally want all of the shares, not most of them.

Drag-along provisions deal with this. If a specified threshold of shares is met and those shareholders are willing to sell to a third party, everyone else can be dragged along and required to sell their shares to that third party too. The threshold is for you to set, but the principle is that a minority cannot block a sale the majority wants. In practice the threshold is often set at the level the founders or main investors expect to hold between them, so that the people who built the company can deliver it to a buyer when the time comes.

Reserved matters and shareholder consent

The third thing to include is a list of decisions that are reserved for the shareholders and require shareholder approval. These are the matters the directors cannot decide on their own.

My top tip is to pay particular attention to how you define shareholder approval or shareholder consent. Assuming you are satisfied with a simple majority, meaning more than 50%, there are two main approaches:

• All voting shares. Count all of the voting shares in the company and base the 50% calculation on that. This tends to be the greater number, so the bar is higher.
• Shares present at the meeting. Base the 50% threshold on the shares actually present at the relevant general meeting. Shareholders who do not turn up are not counted, so a decision can pass with the support of fewer shares overall.

Neither approach is wrong, but they produce different results, and the agreement should say clearly which one applies. If it does not, you will find out which one it means at exactly the moment the shareholders disagree.

Shareholders' agreement vs articles: supremacy

Which document overrides which if there is a conflict? In short, the articles of association override the shareholders' agreement, unless the shareholders' agreement contains a clause known as a supremacy clause, which says that the shareholders' agreement overrides the articles.

So if you want the agreement to win, it needs to say so. If it is silent, assume the articles take priority and check that the two documents do not contradict each other.

Using share classes instead

A shareholders' agreement is not the only way to control how shareholders interact. Another strategy is to issue different classes of shares, so that rights such as voting and dividends are built into the shares themselves rather than agreed in a separate contract. I cover that in classes of shares explained and, if you want to do it yourself, how to create different classes of shares.

Next steps

Start by listing the decisions you want reserved for the shareholders and deciding how a majority will be counted. Then add restrictive covenants and a drag-along threshold that reflects how you expect an eventual sale to work. Have a corporate solicitor check the agreement against the articles of association, and include a supremacy clause if you want the agreement to prevail.