Over a series of articles Oliver King examines some of the traps and pitfalls of operating within a private limited company structure without the protection of either a shareholders’ agreement or bespoke articles of association. Poor preparation of a company’s constitutional documents can lead to disputes and ultimately the business failing.
The two most common ways in which a person can become a shareholder are by the transfer of existing shares, or the issue of fresh shares.
The latter results in an increase in the total share capital, and so, in order to avoid a minority shareholder being diluted without having any say in the matter, legislation in the form of the Companies Act 2006 provides that those shares must first be offered to all existing shareholders on the same, or more favourable terms, than those offered by the prospective new shareholder.
For example, where a company has 100 ordinary shares in issue (which is very common), 90 held by one party, and 10 by one other, if the company wished to issue a further 100 shares to a third party, or even to an existing shareholder, those shares would first have to be offered as to 90 to the 90% shareholder, and 10 to the 10% shareholder, at the same price, and on the same terms, as those offered by the relevant prospective purchaser.
‘Well, that’s all fine and dandy then’, I hear you cry…
If the parties rely solely on the provisions of the Companies Act 2006 and the model articles, this can lead to problems. For example, if the majority shareholder is in a better financial position than the minority shareholder, they could manufacture a situation where they offer to subscribe for 100,000 shares in the capital of the company for £100,000.
If the minority shareholder does not have £10,000 to subscribe for their proportionate entitlement, the result would be that the minority shareholder goes from having 10 out of 100 shares (10%), to 10 out of 100,100 shares, or 0.001%. This will of course impact upon voting rights, the right to require meetings to be held, the right to receive dividends and distributions, the ability to block a sale of the company, and many other issues besides.
This is a further example of a provision that can be included within the shareholders’ agreement, potentially as a unanimous reserved matter, meaning that all shareholders would have to agree to the issue of shares in the capital of the company in order for it to take place.