Shareholders’ Agreements for Family Businesses

A shareholders’ agreement is the single most effective tool for preventing family business disputes. Specifically, the agreement sets out how the shareholders will work together, how decisions will be taken, and what will happen when things change. As a result, a well-drafted shareholders’ agreement addresses most of the issues that would otherwise become disputes later. Importantly, the great majority of family businesses do not have a shareholders’ agreement, or have one that has not been updated for many years. Crucially, this is one of the most expensive omissions a family business can make. As a result, putting a shareholders’ agreement in place, or updating an existing one, is one of the highest-return investments a family business can make in its own future.

This page explains what a shareholders’ agreement is, why family businesses need one, what it should cover, and how to put one in place. Specifically, it covers the contents, the timing, the practical challenges, and the consequences of not having one.

What a shareholders’ agreement is

In short, a shareholders’ agreement is a contract between the shareholders of a company. Specifically, it governs the relationship between them as shareholders, alongside the articles of association of the company. Importantly, the articles of association are a public document. By contrast, the shareholders’ agreement is private. As a result, the agreement can address matters that the parties would not want to set out publicly.

Crucially, the shareholders’ agreement is enforceable as a contract. Specifically, breach of the agreement gives rise to ordinary contractual remedies including damages, injunctions and specific performance. As a result, the agreement provides a different kind of protection from the unfair prejudice route. Importantly, contract claims tend to be quicker and cheaper than unfair prejudice petitions. By contrast, the remedies are narrower. For the wider legal framework, see the legal framework for family business disputes.

Why family businesses particularly need one

Importantly, family businesses are unusually well-served by a shareholders’ agreement. Specifically, there are four reasons.

First, family businesses operate on informal arrangements that work only as long as the family relationship is functioning. By contrast, when the family relationship is under strain, the informal arrangements collapse. As a result, the shareholders’ agreement provides a fixed point that survives the breakdown of the informal relationship. Second, family businesses face predictable transitions. Specifically, generations change. Family members marry, divorce, retire and die. Crucially, the shareholders’ agreement can anticipate these events and provide for them in advance.

Third, family businesses combine working and non-working shareholders. As a result, the agreement can manage the tensions between them by setting out a dividend policy, agreeing remuneration principles, and providing for exits. Fourth, family businesses are particularly vulnerable to the have and have-not pattern, the founder problem, and disputes about succession. Specifically, a well-drafted agreement addresses these patterns directly. For more on this, see the have and have-not pattern, the founder problem, and succession planning.

What a shareholders’ agreement should cover

Crucially, a good family business shareholders’ agreement covers a defined set of subjects. Specifically, the most important are these.

Decision-making and voting rights

First, the agreement should set out how decisions will be taken. Specifically, ordinary business decisions can be taken by the board. Major decisions should usually require shareholder approval. Importantly, the agreement should identify a list of reserved matters that need shareholder consent. For example, sale of the business, issue of new shares, change of business activity, borrowing above a threshold, or appointment of senior executives. As a result, no individual or faction can take a major decision unilaterally.

Director appointments and removal

Second, the agreement should govern how directors are appointed and removed. Specifically, the agreement can give particular shareholders or family branches the right to appoint a director. Likewise, it can specify the circumstances in which a director can be removed. Crucially, this is particularly important in family businesses where the composition of the board reflects family arrangements rather than purely commercial ones.

Share transfer restrictions

Third, the agreement should regulate the transfer of shares. Importantly, this typically includes pre-emption rights, drag-along and tag-along provisions, and provisions for compulsory transfer in certain events. Specifically, the goal is to ensure that the family retains control of who owns the business. Crucially, share transfer restrictions also support the quasi-partnership character of the company, which provides additional legal protections. For more on this, see quasi-partnership in family companies.

Dividend policy

Fourth, the agreement should include a dividend policy. Specifically, the policy sets out the proportion of profits to be paid as dividends, the timetable, and the basis on which the policy may change. Importantly, this is particularly important in family businesses with a mix of working and non-working shareholders. Crucially, a clear dividend policy is one of the most effective protections against the have and have-not pattern.

Remuneration of working family members

Fifth, the agreement should address the remuneration of working family members. Specifically, the principle should be that working family members are paid at market rate for the role they perform. Importantly, the agreement can require independent benchmarking of family member salaries. As a result, the question of whether working family members are paid fairly stops being a matter of family dispute and becomes a matter of objective measurement.

Exit mechanisms

Sixth, the agreement should provide exit mechanisms. Specifically, what happens when a shareholder wants to leave the business? What happens when a shareholder dies, retires or becomes incapacitated? What happens when a shareholder gets divorced? Crucially, the agreement should provide structured answers to these questions in advance. As a result, the family is not left to negotiate the exit terms in the middle of an emotional event. For more on exits, see settling a family business dispute.

Valuation of shares

Seventh, the agreement should set out how shares will be valued on an exit. Specifically, the agreement can specify a formula, a methodology, or an expert valuation procedure. Importantly, valuation provisions are some of the most argued-about parts of family business shareholders’ agreements. As a result, getting the valuation provisions right at the outset saves significant cost later. For more on valuation, see family business valuation in a dispute.

Dispute resolution

Eighth, the agreement should include a dispute resolution clause. Specifically, the clause should require the parties to attempt mediation before issuing proceedings. Importantly, this is consistent with the direction of travel in the Civil Procedure Rules and the Court of Appeal’s decision in Churchill v Merthyr Tydfil County Borough Council [2023] EWCA Civ 1416. As a result, the dispute resolution clause provides a structured route through any disagreement rather than leaving the family to choose between accepting the situation and going to court. For more on the mediation route, see why mediation is usually the right starting point.

Confidentiality

Finally, the agreement should include confidentiality provisions. Specifically, the parties should be required to keep confidential the affairs of the company and the contents of the agreement itself. Importantly, this protects the business from disclosure of sensitive information during any dispute.

The provisions specific to family businesses

Importantly, family business shareholders’ agreements should include certain provisions that ordinary commercial agreements do not. Specifically, the following are particularly useful.

• First, provisions about in-laws. Specifically, what happens to a family member’s shares on divorce? Can in-laws inherit shares directly? Crucially, these questions are difficult to address once a divorce is underway. By contrast, they are relatively easy to address in advance.
• Second, provisions about succession to the next generation. Specifically, the agreement can provide for shares to be held in trust for the next generation, or for shares to pass under defined arrangements on death.
• Third, provisions about the founder’s retirement. Specifically, the agreement can specify when the founder will retire from executive roles, and on what terms. As a result, the founder problem is addressed in advance rather than left to surface in due course.
• Fourth, provisions about family disputes specifically. For example, a requirement to attempt family mediation before any legal mediation. Likewise, a provision for a family council or family forum.
• Fifth, provisions about non-family executives. Specifically, what powers can be delegated to non-family management? How is the chair of the board chosen?
• Finally, provisions about disengaged family members. Specifically, what rights do family members have if they no longer participate in the business? Crucially, this is one of the most under-addressed areas in family business shareholders’ agreements.

For more on the issues these provisions address, see the passive shareholder and the role of the non-executive director.

When to put a shareholders’ agreement in place

Crucially, the best time to put a shareholders’ agreement in place is when the family is functioning well. Specifically, when everyone is on speaking terms, no one is in dispute, and the agreement is being put together collaboratively. By contrast, the worst time is when a dispute is already developing. Importantly, the further along a dispute is, the harder it becomes to agree on a fair set of provisions. As a result, the agreement that would have been simple two years earlier becomes the subject of months of negotiation.

In practice, the most common triggers for putting an agreement in place are these. First, the founder’s retirement is approaching. Second, the next generation is joining the business. Third, the family is bringing in outside investors. Fourth, the family has just experienced a near-miss with a dispute that prompted reflection. Fifth, the family is engaged in a significant transaction such as a sale or a major refinancing.

Importantly, the best families anticipate the triggers rather than wait for them. Specifically, they review and update the shareholders’ agreement every five years, and at every generational transition. As a result, the agreement is always current rather than always behind. For more on this preventive discipline, see preventing family business disputes.

What an old or absent shareholders’ agreement costs

Importantly, the cost of not having a shareholders’ agreement, or having one that is out of date, is significant. Specifically, the family is exposed to the full range of family business disputes covered elsewhere in this hub. As a result, the cost of a single contested unfair prejudice petition can easily exceed £500,000 in legal fees. By contrast, the cost of putting a shareholders’ agreement in place is typically a small fraction of that figure.

Crucially, the cost calculation is asymmetric. Specifically, the saving from a good agreement only materialises if a dispute would otherwise have developed. By contrast, the cost of the agreement is incurred whether or not the dispute materialises. As a result, some families calculate that the agreement is not worth the cost. Importantly, this calculation almost always underestimates the probability of a dispute. Notably, the probability of a family business experiencing a significant dispute over a generation is high. As a result, the expected cost of a dispute, weighted by probability, almost always exceeds the cost of the agreement.

For the broader cost picture, see the cost of family business litigation.

The interaction with the articles of association

Importantly, the shareholders’ agreement does not replace the articles of association. Specifically, the articles are the company’s constitutional document and govern the relationship between the company and its members. By contrast, the shareholders’ agreement is a contract between the shareholders themselves. As a result, the two documents serve different functions and need to be consistent with each other.

Crucially, the shareholders’ agreement can do things that the articles cannot. Specifically, it can impose personal obligations on the shareholders that go beyond what the articles can require. Likewise, it can address matters that the parties want to keep private. By contrast, certain types of provision are better placed in the articles, because the articles are easier to enforce against new shareholders who join the company.

Importantly, the standard practice is to have both. Specifically, the articles set the constitutional framework, and the shareholders’ agreement sits alongside, dealing with the specific matters that the shareholders have agreed between themselves. Crucially, the two documents need to be drafted together so that they are consistent and complementary. As a result, a family business that has articles drafted at one time and a shareholders’ agreement drafted years later, with no review of the articles in light of the agreement, may have inconsistent documents.

The drafting process

By contrast, the drafting process for a family business shareholders’ agreement is often as valuable as the agreement itself. Specifically, the process of agreeing the provisions forces the family to confront the questions that would otherwise be avoided. For example, what happens when the founder retires? How will dividends be paid? What happens on divorce? Crucially, the conversations the family has during the drafting process often surface assumptions that no one had previously articulated. As a result, the drafting process is itself a form of family business governance.

Importantly, the best practice is to involve all the relevant family members in the drafting process. Specifically, the agreement will only be effective if everyone feels they have had a fair voice in shaping it. By contrast, an agreement that is drafted by the founder and presented to the next generation as a fait accompli is unlikely to survive contact with reality. As a result, the drafting process needs to be inclusive even if it is slower as a consequence.

Updating an existing agreement

Importantly, an existing shareholders’ agreement that has not been updated in years may be doing more harm than good. Specifically, the agreement may reflect arrangements that have long since been overtaken by changes in the family or the business. As a result, the agreement may bind the family to provisions that no one would now agree to. Crucially, the result is sometimes that the family ignores the agreement entirely, which then undermines its enforceability when it becomes relevant.

In practice, the most common reasons to update a shareholders’ agreement are these. First, a generational transition. Second, a significant change in the family, such as a divorce, a death, or the addition of new family members. Third, a significant change in the business, such as a major acquisition, a refinancing, or entry into new markets. Fourth, a change in the law, such as the introduction of new tax rules or changes to the Companies Act. Fifth, the discovery that the existing agreement does not work in practice.

Importantly, the review of the existing agreement should be holistic. Specifically, it is rarely sufficient to update one or two provisions. By contrast, the entire agreement should be re-examined in the light of the current family and the current business. As a result, the review may produce a new agreement rather than an amended one.

What happens if there is no agreement

Crucially, where there is no shareholders’ agreement, the relationship between the shareholders is governed by the articles of association, the Companies Act, and the common law. Specifically, this means that the parties’ rights are limited to those set out in the articles and the statutes. Importantly, the articles of most family companies are based on the standard model articles, which provide very little protection for minority shareholders. As a result, the absence of a shareholders’ agreement leaves the family business heavily exposed to the unfair prejudice route as the only realistic remedy.

Specifically, the consequences include the following. First, the working family members can take decisions without consultation, subject only to the directors’ duties. Second, the non-working family members have limited rights to information beyond the statutory minimum. Third, dividends can be declared or withheld at the directors’ discretion. Fourth, there is no agreed exit mechanism for shareholders who want to leave. Fifth, there is no agreed valuation methodology. Sixth, there is no dispute resolution clause requiring mediation. As a result, every dispute becomes a question of how unfairly prejudicial the conduct is, with all the cost and time that involves. For more on this, see unfair prejudice petitions in family business disputes.

Frequently asked questions

What is a shareholders’ agreement?

In short, a shareholders’ agreement is a contract between the shareholders of a company that governs the relationship between them as shareholders. Specifically, it sits alongside the articles of association of the company. Importantly, the agreement is private, where the articles are public. As a result, the agreement can address matters that the parties would not want to set out publicly. The agreement is enforceable as a contract.

Does every family business need a shareholders’ agreement?

Generally, yes. Specifically, every family business that has more than one shareholder should have a shareholders’ agreement. Importantly, the great majority of family businesses do not have one, or have one that is out of date. As a result, this is one of the most common and most expensive omissions in family businesses. Crucially, putting an agreement in place while the family is functioning well is one of the highest-return investments a family business can make.

What should a family business shareholders’ agreement contain?

Typically, a family business shareholders’ agreement should contain provisions on decision-making, director appointments, share transfer restrictions, dividend policy, remuneration of working family members, exit mechanisms, share valuation, dispute resolution and confidentiality. Specifically, family business agreements should also address issues such as divorce, succession, the founder’s retirement, in-laws, non-family executives and disengaged family members. As a result, the agreement is considerably more detailed than a standard commercial shareholders’ agreement.

How much does a family business shareholders’ agreement cost?

Generally, a well-drafted family business shareholders’ agreement costs between £5,000 and £25,000 in legal fees, depending on the complexity of the family and the business. Importantly, the cost is a small fraction of the cost of a single family business dispute. As a result, the agreement is one of the highest-return investments a family business can make. By contrast, families who choose not to have an agreement on cost grounds typically save the agreement cost only to spend many times more on dispute resolution later.

When should we update our existing shareholders’ agreement?

Typically, a family business shareholders’ agreement should be reviewed every five years and at every generational transition. Importantly, the agreement should also be reviewed after any significant change in the family or the business, including a divorce, a death, a major acquisition, or a refinancing. As a result, the agreement remains current rather than gradually losing relevance. Crucially, an out-of-date agreement is sometimes worse than no agreement at all.

Further reading on this site

• Family Business Disputes (main page)
• The Legal Framework for Family Business Disputes
• Unfair Prejudice Petitions
• Quasi-Partnership in Family Companies
• Family Business Valuation
• The Have and Have-Not Pattern
• The Founder Problem
• Succession Planning
• Family Constitutions and Family Forums
• Preventing Family Business Disputes
• Why Mediation Is Usually the Right Starting Point
• The Cost of Family Business Litigation

Get advice on your situation

A well-drafted shareholders’ agreement is one of the most powerful protections a family business can put in place. Specifically, it addresses most of the issues that would otherwise become disputes later. As a result, early specialist advice on drafting or updating a shareholders’ agreement is one of the most valuable investments you can make. I act as a direct access barrister, commercial mediator and mediation advocate in family business disputes throughout England and Wales.

Call 020 4538 0246, use the contact form, or book a call directly. In addition, my book Winning in Family Business Disputes (forthcoming) covers shareholders’ agreements for family businesses in detail, alongside my published works on shareholder disputes and commercial mediation. Organisations like Family Business United also publish useful guidance for family business owners.

Important disclaimer: This page is provided for general information purposes only and does not constitute legal advice. The content may not be legally accurate for your situation or at all. You must not rely on anything on this page in respect of your legal rights. Before taking or refraining from taking any legal action, you should seek advice from a qualified lawyer. I disclaim any and all liability for any loss, damage or expense howsoever caused by reliance on the contents of this page. If you would like advice on your specific situation, contact me here.