What should a shareholders' agreement include? Drag-along, tag-along and supremacy clauses

A shareholders' agreement is the most important document for the owners of a company, but what actually goes in it? I can only make suggestions, because every company is different, but there are three clauses I would want most owners to consider: drag-along provisions, tag-along provisions and a supremacy clause. Just as important is what to leave out, because a shareholders' agreement is hard to change once it is signed.

Drag-along rights explained

The first thing to consider including is a set of drag-along provisions.

In short, when enough shareholders are willing to sell their shares to a third party, they can drag along everyone else and compel them to sell their shares to that third party too. The threshold is usually above 50% of the shares.

The reason to have drag-along provisions is to allow the shareholders of a company, especially if they are investors, to maximise their chances of exiting by selling the entire company to a third party such as a private equity firm. Private equity firms and other buyers looking to buy a company want complete control and ownership, and that is why they will want to buy the entire issued share capital. Without drag-along rights, a single small shareholder could refuse to sell and block the deal for everyone. For more detail see drag-along rights explained.

Tag-along rights explained

The second thing to consider is a set of tag-along provisions. These are similar to drag-along provisions, but they work in favour of the minority shareholder.

Here is how they work. A third party, a buyer, wants to buy shares in an existing company and has found enough shareholders willing to sell. If that buyer would end up with a specific percentage of the company, let's call it the threshold, say 50%, then the other shareholders have the right to tag along and sell their shares to that buyer as well.

The reason minority shareholders want tag-along protection is simple. The buyer who ends up controlling the company might abuse that position against the minority. As a remedy, the minority shareholder can simply sell their shares at market value to that buyer and walk away, rather than being stuck as a minority under an owner they did not choose. For more detail see tag-along rights explained.

Drag-along and tag-along provisions are usually included together. One protects the majority's ability to deliver a clean exit; the other protects the minority's ability to share in it. In my experience, investors coming into a company will look for both, and founders are usually glad of the drag-along when a buyer finally turns up. The thresholds for each need to be agreed at the outset, because they decide how many shareholders it takes to trigger a sale and when the minority gets to join it.

Supremacy clause: agreement vs articles

The last clause to consider is a supremacy clause.

In short, a supremacy clause states that if there is a conflict between the shareholders' agreement and the company's articles of association, the shareholders' agreement overrides the articles.

Both documents govern how the company and its shareholders operate, and over time it is easy for them to end up saying different things, particularly if one is updated and the other is not. A supremacy clause tells everyone which document wins when that happens. Without one, the shareholders may find that the carefully negotiated terms in their private agreement give way to whatever the public articles happen to say, which is rarely what they intended. For the fuller picture on how the two documents interact, see does a shareholders' agreement override the articles?.

What not to include in a shareholders' agreement

Ideally, you would not include anything in a shareholders' agreement that is fairly temporary.

For example, you would not want to include the specific day-to-day or seasonal duties of a shareholder towards the company, especially if those duties are likely to change in the future.

The reason comes down to how the document is amended. Typically, once a shareholders' agreement is signed, it requires the consent of every shareholder to be changed. Unanimous consent, the agreement of everyone, is quite difficult to achieve, especially if you have multiple shareholders in your company. If you have written something temporary into the agreement, you may find you cannot update it when circumstances move on because one shareholder will not sign.

So keep the shareholders' agreement for the long-term rules of the relationship: how shares are sold, how the minority is protected, which document takes priority. Operational detail that changes belongs somewhere easier to update.

Shareholders and directors are not the same thing

Before you go off and draft your shareholders' agreement, make sure you understand the real difference between a director and a shareholder in a UK limited company. Shareholders own the company; directors run it. A shareholders' agreement is about the owners' relationship with each other and with the company, which is a different thing from the duties of the people managing it day to day. Getting the two confused is one of the most common reasons a shareholders' agreement ends up containing the wrong things. See shareholder vs director for the distinction.

Next steps

Write down what you want to happen in the three situations that matter most: when the majority wants to sell, when a buyer wants control and the minority is left behind, and when the agreement and the articles disagree. Those answers become your drag-along, tag-along and supremacy clauses. Then strip out anything temporary, and have a corporate solicitor draft the agreement so it ties in properly with your articles of association.