Introduction

Who is this guide written for?

This guide is written for founders who want to run a business through a company. It focuses on the legal procedures and protections that you should consider putting in place to ensure that your company’s growth is not hampered by unexpected life events.

Was this guide written by AI?

No. I am an experienced UK corporate lawyer and I wrote everything in this guide based on my experience advising hundreds of startups over the last 15 years.

What is a shareholders’ agreement?

A shareholders’ agreement is a private contract between the shareholders of a company. It provides clarity about how everyone involved should behave. It is not a legal requirement for a company to have a shareholders’ agreement, but it is very common for shareholders who take their business seriously to put one together.

PEDANTIC POINT

We are really considering an agreement between shareholders rather than the shareholders’ agreement itself; this is because the agreement between the shareholders is implemented in many documents, not just the shareholders’ agreement document.

Why do you need a shareholders’ agreement?

If your company has (or will have) more than one shareholder, and you are concerned about:

• a shareholder losing interest in the business and leaving, but holding onto their shares; or
• the company being unable to proceed with a deal because there is a deadlock and the deal can’t be authorised; or
• minority shareholders being overruled by the majority; or
• anything else that can prevent your company’s success,

then that is why you need (or will need) a shareholders’ agreement.

What law applies if there is no shareholders’ agreement?

In the absence of a shareholders’ agreement, default company law applies.

Default company law comes from the Companies Act 2006. This is a comprehensive framework that governs every aspect of how companies operate. For example:

• what has to be done for a company to exist,
• how directors are appointed and removed, and
• how shareholders are involved and make decisions.

Part of these rules exist under the company’s articles of association. The default articles for most UK companies are the model articles. Making changes to the model articles gives the owners of the company flexibility in how it is to be run.

When do you need a shareholders’ agreement and/or new articles?

A shareholders’ agreement (and new articles) are most commonly used where the owners of a company want to deviate from default company law.

They don’t usually think “let’s deviate from company law”.

In reality, people who start businesses together end up discussing the details of how the business - and those involved - should operate.

Most of the time, these discussions will require changes to be made to default company law.

In order to implement those changes, the owners will need a shareholders’ agreement (and probably new articles of association).

Who can help you put together a shareholders’ agreement?

You can do it yourself, if you read this guide in full and use Robolawyer to implement the deal. It is not that difficult.

You can also approach a corporate lawyer or law firm with experience drafting shareholders’ agreements for startups. Lawyers will help you figure out what needs to be dealt with, prepare and explain the documents to you and assist with the formal procedures required to implement it. However, this comes at significant expense: lawyers typically charge £1,500 plus for this type of work. You should also ensure that any lawyer you choose has experience advising startups, because the considerations will be different.

What are the risks of not having a shareholders’ agreement?

Without a shareholders’ agreement in place, default company law applies. The default rules may not be suitable for your situation; especially if you are working in a startup.

Common problems startups might face without a shareholders’ agreement include:

• being unable to claw back shares if a shareholder stops contributing to the business,
• no protection from shareholders setting up or helping competing businesses,
• limited ability to resolve disputes between directors and/or shareholders,
• majority shareholders doing things that treat minority shareholders unfairly,
• shares might be transferred to another person without any restrictions, and
• the company is not investment-ready.

The list could go on - but the basic point is that a shareholders’ agreement reduces risks of disagreement and unpleasantness by having everyone lay out their cards from day one. You can think of it as a prenup for your business - cringe to discuss, but you’ll be so glad it is there when things go wrong.

What steps are required to implement a shareholders’ agreement?

Building the term sheet

The first step is for the founders to discuss the most important terms and agree them in principle.

These are typically recorded on a term sheet.

Preparing a term sheet can be difficult if you do not know what a term is, or which terms are relevant.

I will cover what terms are below. There’s also an example term sheet which will make a lot more sense if you read this guide in order.

Preparing the documents

The term sheet is used to determine which legal documents are required and what goes into them.

There is no legal requirement to have a lawyer prepare the documents.

Most lawyers who do this type of work are known as corporate or business lawyers.

Some corporate lawyers further specialise in advising startups.

If you pay someone to prepare the docs, make sure they have this specialised experience.

You can also prepare them yourself using Robolawyer.

Circulating the documents

The person preparing the drafts needs to be happy with them first.

Once the documents reflect the terms of deal, you (or your lawyer) should:

• prepare instructions for each person involved,
• ensure they are only sent documents relevant to them, and
• give them an opportunity to come back with comments or questions.

Negotiating the wording

Certain things in (or not being in) documents can lead to protracted negotiations. Typical issues include:

• the documents generally not reflecting the intention of a term that was agreed in principle,
• the wording containing some additional right or obligation which one of the parties is unhappy about,
• exact procedures for certain topics requiring further clarity,
• ambiguous or vague language that leaves things open to interpretation, potentially causing disputes later,
• inconsistencies between related documents, potentially causing confusion about which is right, or
• omissions of things that are assumed to be included as standard and not explicitly required by the term sheet.

The key is that seemingly minor wording differences can have major practical or legal consequences, which is why this phase often takes longer than expected. The solution is to reduce deviation from standard and established practice as much as possible, so that everyone involves knows and understands that what is in front of them is ‘the right way’.

Closing and formalising

Once everyone has agreed, you will need to obtain properly signed copies of the documents from each party. These are then assembled into a single final document, which is then dated. Giving the signed documents a date means they formally take effect. After this, several administrative procedures need to be followed (such as making filings to Companies House if new shares were issued or new articles were adopted).

How long does it take to complete a shareholders’ agreement?

The longest part is agreeing the initial terms.

This is because they are often foreign concepts for people that require some time to digest and understand.

The simpler you can make it for each person involved to understand what is going on, the quicker you can come to an initial agreement.

Once the initial terms are agreed, the rest is procedure.

How long the procedure takes depends on:

• whether you do it yourself or appoint someone else to do it for you,
• how experienced you are (or the person you appointed is), and
• how many people are involved and need to sign off on the drafts.

We are planning to raise money in the future. Do we need a shareholders’ agreement in the interim?

You are asking this because you’ve heard that raising money means all existing shareholders’ agreements are binned and a new one is adopted when the investment takes place. This is true. However, whether you need a shareholders’ agreement in the interim depends:

• have shares actually been issued to the shareholders, and if so are you comfortable with how default company law applies?
• do you unwaveringly trust your fellow shareholders not to do anything that might jeopardise the business before investment?
• will your future investors expect any existing shares to have been subject to vesting?

Yes, there is a cost to putting together a shareholders’ agreement, and yes, that cost is harder to stomach when you know that work will be ripped up sooner or later. But a shareholders’ agreement is more than just a document: the discussions required to put one in place ensure that founders have the difficult conversations up front, when they matter.

Ask yourself what you’d be happier with - peace of mind or saving a few pounds under the mistaken belief that it’s a waste of money?

What happens after implementing a shareholders’ agreement?

Once a shareholders’ agreement and new articles are adopted by a company and its shareholders, the way the company operates will change. For example:

1. Decision making becomes more structured, with certain matters requiring approval from minority shareholders before they can go ahead.
2. The composition of the board may be formalised, with a chair person being appointed who has the casting vote if there is a disagreement.
3. Any rights to information will take effect, meaning that shareholders will expect to be sent reports monthly, quarterly or as regularly as you agree.
4. Share vesting and leaver rules take effect, meaning that if someone leaves the company or stops contributing, their shares can be clawed back.
5. Transfer restrictions come into force, meaning that a shareholder cannot just transfer ownership of their shares to a third party.

Terms of shareholders’ agreements

What is a term in the context of a shareholders’ agreement?

In the context of agreements between shareholders, a term encompasses a particular subject. For example:

what will the equity split be?

Terms do not correspond directly to documents.

For example, if the founders agree to split equity 70/30, implementing this would require certain wording to appear in several different documents.

What are heads of terms / what is a term sheet?

Heads of terms and term sheet are used interchangeably. They refer to a short, non-binding document which outlines the most important terms that the founders have already agreed in principle.

I have included an example term sheet below. But before you can make sense of a term sheet, you need to know what the most important terms are.

What are the most important terms in a shareholders’ agreement?

The most important terms in a shareholders’ agreement are the ones that can directly affect the founders.

These include:

what will the equity split be?

what happens if someone who has shares leaves the company?

how will disagreements be handled and resolved?

how can a founder be protected against unfair dilution?

is it possible to get rid of someone who has shares?

Opening discussions might bring other things to light. That’s why it’s important to have these conversations as soon as possible.

How do we start discussing terms and putting together a term sheet? It’s awkward.

It can be tough. It’s best to set aside a specific session to discuss things in person. Here are a few ideas that have worked for some of my past clients:

• The future scenario. Invite each co-founder to describe a few hypothetical futures: fast growth, slow growth, someone stepping back, someone not contributing enough. Then ask each person: “what would fair treatment look like?” in each case.

• Focus on shared principles. Start by agreeing 3 to 5 principles: everyone should be treated the same, decisions should not be made without consent, the board member with the deciding vote will rotate every 3 months.

• Work on blind spots. Frame the exercise as risk management: “let’s list everything that could hurt the company or any one of us”. The same topics will come up: founders departing or being diluted, whether the company is investor ready - and what needs to be done to make it so.

• Use Robolawyer. Use Robolawyer to put together your shareholders’ agreement. The first step is to build out the term sheet, which Robolawyer helps you get done without overwhelming you. You can do this alone and lead negotiations offline, or invite your co-founders onto the platform and build them out together. Because the structure comes from a third party, it reduces personal tension and introduces topics without you or your co-founders having to explicitly raise them.

Whatever method you use, getting started is the hardest part. Remember, everyone involved wants to know things are being done right.

Term: equity splits and the cap table

What is an equity split?

The equity split refers to the percentage of a company that a person owns. For example: a company has 2 co-founders with an equity split of 50/50.

What is a cap table?

A cap table is a visualisation of the company’s ownership. It should show the details of all shares that currently exist, as well as contain details of any future shares that may be issued. Here is an example of a simple cap table for a company that has ordinary shares with a value of 1p each:

How is the cap table kept?

Cap tables are kept using spreadsheets or other software built to keep them.

One person should take responsibility for ensuring the cap table remains up to date.

The cap table should only be updated when things actually change. For example:

• where shares are actually issued to someone, or
• where a promise of equity is made to someone that you intend to fulfil.

The purpose of the cap table is to make it easy to quickly see who owns what.

Is an equity split different to the cap table?

Yes. The equity split simply describes who owns what percentage. A cap table is a visual representation of the company’s ownership. Looking at a company’s cap table will tell you what the equity split is. In the example above, reading the cap table tells me that the equity split between Natasha and Kerry is 50/50.

Why does equity split matter?

A larger percentage means more money. It also means more control, although that additional control is only under default company law.

The split also matters when it comes to making decisions. Take the above example: if decisions can only be passed by a majority, what happens if either Natasha or Kerry does not agree?

How does having more equity give someone more control?

Under default company law, decisions are made by shareholders passing resolutions. A resolution is an official decision of the shareholders, and a resolution can be either:

• an ordinary resolution, which requires a majority of the shareholders to agree in order to pass, and
• a special resolution, which requires 75% of the shareholders to agree in order to pass.

For example, this means that:

• if a shareholder holds over 50%, they can pass ordinary resolutions, or
• if two or more shareholders together hold over 50%, they too would be able to pass ordinary resolutions, or
• if 3 shareholders own 26% together, this would allow them to block the other shareholders from passing a special resolution.

Remember, this is under the default company law. Adopting a shareholders’ agreement can mitigate this level of control.

How does a shareholders’ agreement help reduce the power of holding more equity?

Shareholders’ agreements introduce an additional layer of security by requiring written consent from all (or a certain percentage of) the shareholders before certain reserved matters are carried out. For example, reserved matters include:

• issuing additional new shares (requires only an ordinary resolution; could dilute other shareholders out of existence), or
• adopting new articles (requires a special resolution; could introduce provisions that favour one shareholder).

By having a shareholders’ agreement that requires consent before a reserved matter is carried out, the threshold increases from 50% (or 75%) to 100% (or whatever other percentage of shareholders you decide need to agree).

What mistakes do founders typically make when it comes to determining the equity split?

• Defaulting to an equal split when contributions are not equal (whether contributing money or effort).
• Deciding on and implementing the split too early (before co-founders are able to truly assess each others’ contributions).
• Issuing new shares at different times without proper planning (creating unexpected and unfair dilution for existing shareholders).
• Failing to apply vesting (so that equity is given rather than earned).
• Giving too much weight to ideas (often worth what they’re written on).
• Not stress-testing scenarios like illness, underperformance, relocation or shifted life priorities.

How do we determine a fair equity split?

• Start with roles and commitments over the next 1-2 years. Quantify how long you expect things to take, who has responsibility for what and who is accountable to who. Remember that ownership should mirror forward-looking contributions and not just founder origin stories.

• Consider the risk taken by a founder. If someone has quit their job to do this full time, they’re taking a greater risk than a founder who’s doing it on Sunday mornings. 50/50 doesn’t seem right.

• Separate negotiation of percentage from negotiation of vesting. You may all agree that someone owns 30%, but only if it’s fully earned over 3 years.

• Ensure shareholders with critical capabilities are adequately incentivised. A founder with domain expertise or highly relevant previous experience building your product might justify a higher slice because substituting them would be difficult or slow.

• Have someone sanity check your decisions. A neutral third party can spot emotional bias, overconfidence or any perceived unfairness that may not be obvious to you.

Splits are fair when everyone involved can explain why the chosen split accurately reflects the contributions made and risks being taken.

When should we incorporate a company? Before or after agreeing the equity split?

Founders typically approach when to incorporate in one of two ways:

1. One founder takes responsibility for the legal stuff and incorporates a company as the single shareholder in order to grab the name.
2. The founders incorporate the company with the equity split in place from day one.

Each approach has upsides and downsides.

One founder has already incorporated. How do we fulfil the equity split?

The company will issue new shares to the other founders in the proportions required to fulfil the agreed split.

This means:

• The original founder keeps all the original shares (let’s say 100 shares of 1p each).

• If there are 2 shareholders and the agreed split is 50/50, you simply issue an equal number of shares to the other founder - a further 100 shares of 1p each.

• If there are 3 shareholders and the agreed split is 60/30/10, you work out the total number of shares needed for the original founder to end up with 60%. So:

  • 100 shares divided by 0.6 = 167 shares needed in total

  • 60% of 167 = 100 shares for founder 1 (already held)

  • 30% of 167 = 50 shares for founder 2 (to be issued)

  • 10% of 167 = 17 shares for founder 3 (to be issued)

  PEDANTIC POINT

  The maths often produces fractions (100 ÷ 0.6 = 166.666, and 40% of 167 = 66.8). Because you can’t issue a fraction of a share, you round to whole numbers — here, up — so the final cap table is as close as possible to the intended percentages. The tiny differences this creates don’t matter for most early-stage companies; they only become important if you need increased precision.

  For situations where increased precision is required, you would split each share into smaller values. So a share of 1p would become 10 shares of £0.01, or 100 shares of £0.0001. Splitting the shares this way allows percentages to be calculated cleanly without rounding.

Why issue new shares rather than transfer existing shares to fulfil an equity split?

You should not transfer shares from one founder to another. Issuing new shares is cleaner and makes it easier to follow the company’s legal history. Transfers are more complicated with significant tax consequences. They also muddy the corporate history (since selling shares is an action by the shareholder, not the company).

We have not incorporated yet. Should we do it with the initial equity split in place?

You could incorporate a company with the equity split already in place.

Imagine this: a company is incorporated with shares that have a minimum value of £0.01 each. It issues 6,000, 3,000 and 1,000 shares to each founder. There would be 10,000 shares in total; no need to worry about rounding up or down on fractions of shares.

However, once incorporated, note that default company law will apply until you override it by implementing a shareholders’ agreement. This might be fine for you, but reconsider the question above: what are the risks of not having a shareholders’ agreement?

We want to allocate shares for staff in the future. Is this relevant now?

Startups tend to allocate shares for staff by establishing share option pools. Option pools work by hypothetically increasing the number of shares that currently exist by a certain percentage (usually 10%). Doing this usually dilutes the other shareholders equally. We can visualise it like this:

Crucially, the option pool shares are not actually issued to staff until they have a value that can be converted to cash (this is typically when an exit event takes place, such as a funding round or acquisition).

So is it relevant now? Not really, as it is unlikely that you’ll be adopting a formal share option pool (a fairly complex legal task) when your primary concern is putting together a shareholders’ agreement. However, being aware of how a share option pool works is important, as even discussing a percentage to set aside for staff now provides clarity over what each shareholder’s eventual ownership might be.

What should we keep in mind when discussing how to split equity?

• There’s no single formula to determine a fair split.
• Consider actual contributions (money and effort) and risk each co-founder is taking.
• Default company law applies in the absence of a shareholders’ agreement.
• You should be able to put together a cap table that demonstrates the target equity split.

Term: vesting

What is vesting?

Vesting is a mechanism that protects the company. It is a way to claw back shares from a shareholder if they stop contributing to the business.

How does vesting work in UK companies?

The best and most common way to implement vesting in a UK company is to use reverse vesting.

The easiest way to understand how reverse vesting works is with an example:

• A new company will have 3 shareholders: Amber, Bruce and Haley.
• They agree that their shares will reverse vest over 4 years with a 1 year cliff (what’s a cliff?).
• On 1 January 2026, ordinary shares of 1p each are issued and the shareholders’ agreement takes effect.
• The cap table looks like this:

  Shareholder	Shares	Invested	Owns
  Amber	10,000	£100	33.3%
  Bruce	10,000	£100	33.3%
  Haley	10,000	£100	33.3%
  TOTAL	30,000	£300	100%

What is reverse vesting?

Reverse vesting means the shares are actually issued to the shareholders on 1 January 2026, but a proportion of them can become worthless if the shareholder leaves the company before 1 January 2030.

If it was forward vesting instead:

• no shares would be issued on the day the agreement is signed (1 January 2026),
• the first 25% of their shares (2,500) would be issued on 1 January 2027,
• the second 25% of their shares (2,500) would be issued on 1 January 2028,
• the third 25% of their shares (2,500) would be issued on 1 January 2029, and
• the final 25% of their shares (2,500) would be issued on 1 January 2030.

Why is reverse vesting better than forward vesting?

• For shareholders: they get ordinary shares up front, allowing them to vote as normal; they own something real now.
• For investors: it’s easier to see who owns what; hard to understand ownership that slowly increases over years.
• For the company: conversion to deferred shares has specific triggers; using company law share class system is a clean way to differentiate between vested and unvested shares.
• For tax reasons: the capital gains base cost is tied to the initial (low) value of the company; if shares are issued slowly over time, market value would be higher (= more tax due eventually) each time new shares are issued.
• For everyone: less paperwork and admin.

What does ‘over 4 years with a 1 year cliff’ mean?

This is the vesting schedule. It means that for the next 4 years (from 1 January 2026), each shareholder will unlock a proportion of their shares each month, which they can keep even if they leave the company. But if they leave within the first year (the cliff period), they get to keep nothing.

What does ‘unlock a proportion of their shares’ mean?

• Take the vesting period in months (4 years = 48 months) and turn it into a percentage: 1/48 * 100 = 2.0833% . This is the proportion of their shares they unlock after each full month passes.

• After 2 years, 24 months will have passed, and so: 24 * 2.0833 = 50% . This is the percentage of their shares that will be considered vested.

• After 4 years, 48 months will have passed: 48 * 2.0833 = 100% of their shares are vested.

What happens if someone leaves during the cliff period?

• On 1 July 2026, Amber leaves.

• Since this is within the 1 year cliff, all of her shares become worthless.

• Worthless shares are named deferred shares.

• They differ from ordinary shares because people who hold deferred shares can’t vote and don’t receive payments.

• We can visualise it like this:

  Shareholder	Class	Shares	Of class	Voting
  Amber	deferred	10,000	100%	0%
  Bruce	ordinary	10,000	50%	50%
  Haley	ordinary	10,000	50%	50%
  TOTAL	2 classes	30,000	-	100%

What happens if someone leaves after the cliff period?

• On 30 September 2027, Bruce leaves.

• 21 full calendar months have passed.

• 21 * 2.0833 = 43.75% of Bruce’s shares have vested; 56.25% have not.

• Applied to his shares: 4,375 have vested and 5,625 have not.

• We can visualise it like this:

  Shareholder	Class	Shares	Of class	Voting
  Amber	deferred	10,000	64%	0%
  Bruce	deferred	5,625	36%	0%
  Bruce	ordinary	4,375	30.43%	30.43%
  Haley	ordinary	10,000	69.57%	69.57%
  TOTAL	2 classes	30,000	-	100%

What happens if someone leaves after the vesting period ends?

They get to keep all of their ordinary shares and they don’t need to worry about deferred shares at all.

Does an outgoing shareholder need to consent to their ordinary shares converting to deferred shares?

If the shareholders’ agreement is put together properly, no. The agreement should be clear about:

• what triggers the conversion,
• how to calculate the number of vested shares, and
• how deferred shares are different from ordinary shares.

What can trigger the conversion of ordinary shares to deferred shares?

Something has to happen for a shareholder’s ordinary shares to become deferred. This is the trigger.

The trigger is usually tied to a shareholder’s employment with the company. For example:

• Bruce is an employee with an employment contract.
• The employment contract says he can be validly fired in certain situations.
• Bruce is validly fired under the employment contract.
• Being fired is the trigger.

If the person is not an employee (for example, a consultant) then their consultancy agreement should contain something similar.

If the person is not an employee or a consultant, the trigger is unclear.

How does vesting get triggered if there is no employment contract or consultancy agreement?

It doesn’t - unless the shareholders’ agreement says otherwise.

A well drafted shareholders’ agreement should work like this:

• if there is an employment contract or consultancy agreement in place:
  • being terminated under that is the trigger,
• but if there isn’t one:
  • failure to meet certain key performance indicators by a certain date is the trigger,
• and if for some reason the indicators or date aren’t present:
  • at least 75% of the other shareholders will together decide what the trigger is.

Should we always include key performance indicators in a shareholders’ agreement?

If you already have or will immediately put employment contracts and consultancy agreements in place with each shareholder, then including milestones in a shareholders’ agreement is unnecessary.

If not, then you should include them - otherwise vesting might not be triggered.

How do we list what each shareholders’ actual tasks and responsibilities are?

Ask yourselves, in respect of each shareholder:

What should this person be doing and how can that be evidenced?

These should help you form their milestones. For example:

• Haley is responsible for building the minimum viable product.
• Haley says she will be working on this full time.
• Haley says the MVP should be ready for first user within 6 months.
• Haley will make the code accessible to the team.
• Haley will will maintain a test deployment for the team to use.

These are concrete requirements that can be evidenced. Ask yourselves:

If Haley fails to deliver, should that trigger vesting?

This will help you put together a fair and fact based list, making it clear if milestones have been met or not.

What does conversion to deferred shares involve?

The first step is understanding that converting someone’s shares to worthless shares is a big thing. It usually happens when the relationship has broken down to the point where you can’t imagine working with them again.

The process should be outlined in the shareholders’ agreement and articles. Generally, where there are no disagreements:

1. The directors of the company will calculate the number of shares that are to be treated as unvested.
2. The unvested proportion of ordinary shares will be converted to deferred shares by:
   • updating the company’s cap table and registers to show the change, and
   • filing the appropriate forms with Companies House.

What happens to the share certificate for the original ordinary shares?

When a person becomes a shareholder, they usually receive a single certificate for all of their shares. For example: “Tia holds 1000 ordinary shares of £1 each”.

If some of those shares then become deferred, that share certificate needs to be returned and then cancelled.

A new share certificate is then issued for the updated shareholding. For example, one that says “Tia holds 500 ordinary shares of £1 each” and another that says “Tia holds 500 deferred shares of £1 each”.

If the share certificates were never sent (for whatever reason) then you don’t need to do anything other than issue the updated ones.

If the share certificate was sent, but that person now says they can’t find it, that person needs to provide an ‘indemnity for a lost share certificate’. This is a promise from that person that it’s truly lost, but if someone uses it for something naughty and the company suffers as a result, that person will take financial responsibility for putting things right.

What happens to deferred shares?

Nothing. The deferred shareholder continues to hold them indefinitely.

However, the articles should say that the deferred shareholder has no rights (such as the right to be notified of a meeting, or the right to vote at one). This means the deferred shareholder does not participate in the company’s operation at all.

Doesn’t the existence of deferred shares make my cap table messy?

Having deferred shares visible on the cap table makes it clear who left the company and when. You should not automatically consider this as messy, since it provides some important information about the company’s history.

However, it is possible to clean up the cap table by having the company purchase and cancel the deferred shares. Whether this is worth the expense at an early stage is debatable. These things usually get cleared up as part of a larger round in the future.

Why is vesting important?

• Vesting ensures that everyone has skin in the game.
• Vesting prevents people unfairly holding onto or getting hold of shares in your company.
• Vesting rewards long term commitment to your company.
• Vesting is expected by investors. If it hasn’t already started, investors will make you start it. So it’s best to start early.

What is a ‘normal’ vesting schedule?

Market standard is 4 years with a 1 year cliff, from the date they receive the shares.

Whether this is appropriate for you, and for every shareholder, is ultimately up to you to agree amongst yourselves.

It is possible to have different vesting schedules per founder, but I don’t recommend it - feelings will get hurt.

How is vesting implemented in legal documents?

This is the legal framework:

1. When a person becomes a shareholder, they agree to abide by the company’s articles.
   PEDANTIC POINT

   • The contract a person automatically enters into to abide by the articles is different to the shareholders’ agreement.
   • The automatic contract is created by section 33 of the Companies Act 2006.
   • When you implement a shareholders’ agreement, this is in addition to the section 33 contract.
   • Does this matter in real life? No.
2. The company’s articles are governed by company law. Company law makes things black or white: “was this process followed properly? No? Sorry, not valid.”
3. When an agreement between shareholders is formalised, the articles are usually replaced. The new articles make the vesting schedule legally enforceable and provide procedural guidance. The shareholders’ agreement document will contain sensitive information and rules, such as details of an individual’s vesting schedule.
4. For conversion to worthless shares to happen, something needs to trigger it. The usual trigger is resigning as a director, or the termination of an employment, consultancy agreement, or failing to meet clear milestones or key performance indicators.

Why is vesting implemented this way?

This is why vesting is implemented in the way described above:

• company law forces compliance with the articles; you need new articles,
• the articles are public, so you need a private agreement; you need a shareholders’ agreement,
• each shareholder’s responsibilities and deliverables are listed somewhere; you need employment/consultancy agreements or milestones.

Why is vesting so complicated?

It seems like a vesting schedule should be simple enough to fit on a single page, so why does it need to be sewn across 3 documents? It’s because each of these documents is governed and enforced slightly differently:

• The shareholders’ agreement is a private agreement that is governed by contract law. If someone breaches a contract, another person needs to sue that person, quantifying what loss they suffered as a result of the breach.

• The articles are a public document that is governed by company law. If someone does not act in accordance with company law, the action that was taken is seen to be invalid - and everything else that flows from that action.

• The employment agreement is another private agreement, this time governed by employment law. If an employer doesn’t act in line with this, the employment tribunal can get involved.

What key things should we consider when discussing vesting?

• You should agree that all shares are issued up front to keep things clean and simple. This is normal market practice.
• You should agree that if someone doesn’t follow the rules, the directors can determine a proportion of their shares as unvested in accordance with the articles, and convert them to deferred shares. This is how vesting works.
• You should agree that deferred shares do not have votes or other useful rights. So even though they remain visible on the cap table, they are taken out of the equation when it comes to calculating true ownership.
• You should all understand that this ‘give then take away’ approach is called reverse vesting and is the right way to do it with a UK company.
• You should all see vesting as an incentive that works equally for everyone - don’t spend too long discussing this term or trying to deviate from what’s standard.

Term: good leavers and bad leavers

What is a leaver?

A leaver is someone who has left the company.

Now we want to classify them as good or bad leavers, so we can determine what happens to their shares.

What is a good leaver and what is a bad leaver?

Good leavers typically leave under fair circumstances: giving normal notice, redundancy, death or after the vesting period ends.

Bad leavers and those who leave as a result of termination of their contract for cause, or gross misconduct, or failure to do something under the shareholders’ agreement, or breaching a restrictive covenant (like a non-compete) even after they have left the company.

Why does it matter if you are a good leaver or a bad leaver?

It matters because it determines what happens to your shares.

If you’re a good leaver, you keep your vested shares; only the unvested shares become deferred.

If you’re a bad leaver, you lose all your shares (vested or not),

Some founders negotiate always keeping vested shares, whether a bad leaver or a good leaver.

How is someone classified as a good leaver or bad leaver?

The shareholders’ agreement should contain precise wording that makes it clear.

It’s quite common to explicitly define what a ‘bad leaver’ is; for example:

• someone dismissed for gross misconduct, or
• someone who reveals company secrets to a competitor a week after leaving.

A ‘good leaver’ would then be everyone else; for example:

• someone who changes jobs, or
• someone who is made redundant.

What is there to negotiate when it comes to being a leaver?

There is a fairly standard list of what constitutes good and bad. But you may want to supplement it by discussing it this way:

• Which departure scenarios should be treated leniently?
• Which should be treated harshly?
• What happens to shares in each case?

I have seen plenty of shareholders’ agreements which tie being a leaver to the termination of that person’s contract. But what if there was never any agreement made? Your shareholders’ agreement should deal with this. Here’s something to consider:

• First:
  • agree that where a shareholder has an employment contract or consultancy agreement with the company, the procedures in that document will determine whether someone’s employment or appointment is terminated
• Else:
  • prepare a schedule of duties / responsibilities for that shareholder and attach it to the shareholders’ agreement, stating in the agreement that failure to deliver on that schedule could result in being classified as a leaver, but
  • if an employment contract / consultancy agreement is put in place, that takes priority
• Otherwise (nightmare scenario):
  • there is no schedule of duties or employment contract, so
  • give the other shareholders the ultimate discretion as to whether someone is a good or bad leaver.

Term: resolving deadlocks

What is a deadlock?

A deadlock is a situation where shareholders and/or directors cannot reach agreement on an official decision, preventing the company from moving forward.

What is the difference between a deadlock between directors and a deadlock between shareholders?

A deadlock between directors usually relates to daily management of the company, such as whether to accept a quote for some work to be done.

A deadlock between shareholders usually relates to more significant decisions, such as whether to allow new shares to be issued.

What does deadlock between directors look like?

The directors are in charge of day to day decision-making. Formal decisions require board resolutions to be passed. Board resolutions are passed by a majority of directors. For example:

• The directors get quotes from 3 software developers to build a product. They vote on which one to go with.
• If there are 3 directors, 2 of them need to agree for a board resolution to be passed.
• If there are 2 directors, and 1 of them does not agree, the board resolution cannot be passed.

Deadlock between directors does not definitively mean that the entire company is stuck from moving forward. It might cause a delay while a further quote for work is obtained. The dissenting director might change their mind after speaking to one of the developers. In every business, discussion and communication can help convince directors to change their stance.

What methods exist to resolve deadlocks between directors?

You should start with practical steps such as reframing the proposal or pushing for consensus through further discussion.

If a genuine legal deadlock remains, a shareholders’ agreement typically resolves it by giving the chair a casting vote, allowing shareholders to intervene by reconstituting the board or issuing directions, or sending the issue to an independent third party (such as an expert or mediator) for a final binding decision.

What does a deadlock between shareholders look like?

Shareholders must always decide on major matters such as issuing new shares and altering articles. For these matters, there will be a voting threshold prescribed by company law. If enough votes are not obtained, the proposal simply doesn’t pass. This is not a deadlock!

A genuine deadlock arises when equal numbers of shareholders are in favour of and against a particular action being taken. This generally only happens when:

• there are 2 shareholders (or 2 distinct groups of shareholders) with equal voting power (50/50),
• the issue is one that needs to be decided by shareholders (whether under company or contract law),
• neither shareholder (or group) can unilaterally force a decision, and
• the company cannot continue without that decision being made.

This kind of deadlock is uncommon under company law alone (although there is a brief list of things that require 100% shareholder consent, such as increasing shareholders’ liability or varying class rights). It becomes most significant where a shareholders’ agreement creates matters requiring unanimous consent.

What methods exist to resolve deadlocks between shareholders?

Again, start with practical efforts like revisiting the proposal, adjusting its scope or trying to negotiate a compromise. If a genuine deadlock persists, the shareholders’ agreement should provide formal mechanisms to resolve. For example:

• Mediation or other third party input; a neutral person helps negotiate a settlement or a specialist is appointed to make a binding decision.
• Buy-sell mechanisms such as:
  • Russian Roulette or a Texas Shoot-out; where one shareholder offers to buy the other’s shares at a set price and the recipient must accept the offer or buy the offeror out at the same price, or
  • one shareholder buying out the other at a fair value.
• Forced sale of the company to a third party.

When should deadlock provisions be triggered?

As a last resort. If something is contentious the best approach is to discuss, negotiate, reframe, reconsider and settle. The legal route should never be your first option.

How do we negotiate the best approach to resolve deadlocks?

Consider each shareholders’ bargaining power, financial capacity and the dynamics of the relationship between them. Now is the best time to discuss these matters - you will not agree on how to resolve matters when there is an actual deadlock.

For 50/50 owners, the best solution is often mutual buy-sell mechanisms. This allows one founder to totally exit the company at a fair price.

Most importantly, you need to match the chosen mechanism to each shareholders’ ability to execute: there is no point introducing Russian Roulette if only one can finance the buyout.

Term: protecting minority shareholders

What is a minority shareholder?

A minority shareholder is usually someone with less than 50% - and is therefore subject to the will of the majority.

Why do minority shareholders need protection?

Imagine this scenario. You put £100k into a company with a mate in exchange for 20%. Your friend and his wife are the majority shareholders and also the only directors - you’re happy to take a back seat. You’re a minority shareholder. There’s no shareholders’ agreement.

Over time, your buddy:

• Doesn’t provision for / refuses to declare dividends - they get a fat salary; you get nothing.
• Awards themselves bonuses and benefits - company car, pension contributions, health insurance.
• Dilutes your shareholding - issues new shares to his kids without telling you.
• Excludes you - you have no idea how the company operates day to day.
• Blocks your exit - telling a buyer that you’re a happy silent partner and leaving you behind.

How are minority shareholders protected under default company law?

There is limited protection; they all require going to court after the event:

• claiming that the minority have been treated unfairly,
• making a claim against the directors on behalf of the company, or
• asking for the company to be wound up.

Nobody wants to do this - it’s stressful, expensive and unpleasant.

What additional rights could minority shareholders have under a shareholders’ agreement?

• The right to be asked for consent before anything that affects them takes place.
• The right to be bought out on favourable terms.
• The right to have a director appointed on their behalf.
• The right to additional information beyond the bare minimum required under default company law.

How do we agree on which minority shareholder protections to include?

Here is a sensible list of actions that should require consent:

• changing the company’s core identity or the type of business it does,
• changing how many shares there are or what rights shares have,
• changing the company’s articles,
• closing the company down,
• appointing, removing and paying directors,
• doing anything that’s outside normal business practice,
• doing business with connected people, and
• shares being bought, sold or transferred,

When it comes to implementing this, you will also need to consider “what percentage of shareholders will need to give consent?” for the action to take place. Unanimous (100%) is the fairest, but there may be reasons to go for less - someone may truly want to be a silent partner with no input or expectations at all. And don’t forget: unanimous consent can lead to deadlock if there are even numbers of people voting.

How can a shareholders’ agreement help a minority shareholder in an exit scenario?

An exit scenario is where someone wants to buy the majority of the company’s shares.

Tag-along rights are helpful where a percentage (often 51%) of the shareholders agree to sell to the buyer. Tag-along rights enable the minority to ‘tag along’ with the other shareholders, on the same terms they agree with the buyer.

Drag-along rights, while often included, actually help the majority (often 75%) by allowing them to ‘drag’ the minority along with them in a sale.

Other less commonly included protections are:

• a minimum valuation for the company when it comes to selling shares,
• enhanced information rights during a sale process, or
• super majority consent for specific situations, such as exits.

Term: defining the business

What does defining the business mean?

It means coming up with a terse, accurate description of the work that the company carries out.

For example:

the design, development and commercialisation of cloud based project management software for the construction industry in the United Kingdom

or:

the provision of corporate tax advisory services to mid-market companies operating in the manufacturing and retail sectors in England and Wales

or

the manufacture and wholesale distribution of organic skincare products to retailers and spas throughout the UK

Why is it important to define the business when putting together a shareholders’ agreement?

A singular definition should be used throughout all legal documents that rely on this meaning. For example:

• if intellectual property (IP) is being developed for the company by contractors, you’d use the definition to encompass all of the work that contractor does for the company, or
• if non-competes or other restrictions (restrictive covenants) are being put in place for the shareholders, you’d use the definition to scope the restrictions enough to make them enforceable, or
• if the company wants to share some confidential information with a third party (with an NDA), you’d use the definition to scope what is considered confidential.

What makes a business definition effective?

Take the examples above. You should note that:

• they are specific without being rigid - detailed enough to be meaningful without being obsolete if the company does something slightly different,
• there are geographic limitations - each is territorially scoped, which is essential to make some agreements enforceable,
• they are functionally clear - they describe what the company does, not what industry it’s in,
• the scope is reasonable overall - courts tend not to look too favourably upon overly broad definitions as this can be considered anti-competitive.

What are some examples of unhelpful business definitions?

the provision of technology services

• too vague - what type of technology? What services? Provided how? This could include anything from IT support to AI integration to erecting telephone poles. A restrictive covenant based on this would be unreasonable and it provides no meaningful guidance for IP assignment or NDA scope.

the development and sale of the SuperAwesome26 software app using NextJS framework to construction companies with 50-200 employees in Greater London

• so specific that it is immediately out of date. What happens when you release version 27? What if you decide to use a different tech stack, target a larger company or expand to Manchester?

the manufacture and distribution of consumer electronic products worldwide and online

• no realistic geographic restriction makes this unenforceable when used as the basis for a non-compete.

operating as a disruptive innovator in the fintech space, leveraging cutting-edge solutions to help revolutionise financial services for British companies and business people

• sounds like marketing jargon, doesn’t tell you what the company actually does.

carrying on the business of the company as currently conducted from time to time

• sounds fancy but defines nothing and is completely useless.

a company operating in the renewable energy sector in the United Kingdom

• describes the industry but not what the company does within it. Manufacture solar panels? Provide consultancy? The lack of a functional description makes it impossible to apply to IP assignments, NDAs or non-competes.

How do we come up with a decent business definition?

Here is a practical approach that past clients have found helpful:

1. Note that a good definition contains 3 elements:

   • the activity or function - what your company does (“the design, development and provision of”)
   • the product or service - what you sell and to who (“AI assistant software to GPs”)
   • the location - where you sell it (“in the UK”)

2. Appreciate the importance of this task. This is where I have seen many shareholders’ agreements crash. The definition used is often weak, something to fill out quickly before you get to the real meaty stuff.

   The truth is, the definition of the business is just as important. It determines what a departing shareholder can and cannot do, what IP everyone must hand over, and what constitutes a breach of confidentiality (which could even be grounds to dismiss someone with cause).

   You should spend adequate time on this task, even if you engage a lawyer to help you draft the agreement. As a shareholder you should be insisting on this definition being right.

3. Start jotting down your own variations on the theme:

   our company [activity] [product or service] [customer] [location]

4. Test your drafts against the requirements:

   • for IP assignment: does your wording capture all IP the company needs to own? If a person creates something that falls outside of this definition, you may struggle to argue that the company should own it.

   • for restrictive covenants: is it narrow enough to be enforceable but broad enough to protect your legitimate business interests? Would a court see this as reasonable?

   • for NDAs: does the wording appropriately scope what information relates to the business? Information that falls outside of this definition would not qualify as confidential business information.

5. Test your drafts against hypothetical scenarios. Ask yourself:

   if we launched product X, would that fall within this definition?

   if a founder left and started doing Y, would that breach their non-compete?

   if we shared Z info, would that be good enough to ensure the info we want to share qualifies as confidential?

6. Refine it until everyone agrees that it “feels right”.

Term: intellectual property

What is intellectual property and how is it created?

Intellectual property: intangible creations that have commercial value and can be legally protected.

The main categories are:

• copyright: protects original creative work (software, business plans, illustrations, photos, video). The easiest to create - simply exists in new work, does not require registration.

• trade secrets: protect valuable confidential information. Legal protection in the form of confidentiality agreements and NDAs.

• trade marks: protect reputation, brand names, logos and distinctive signatures. Lengthy process and considerable cost.

• patents: protect inventions and technical innovation. Complicated and time consuming application process. Becomes public knowledge.

A company typically relies on a significant amount of IP: software, branding, proprietary processes, customer lists and even know-how that gives them a competitive advantage.

Why is intellectual property relevant when putting together a shareholders’ agreement?

The company needs to own the IP that relates to its business.

There is probably no existing assignment of IP from the shareholders, so doing it at this time makes sense.

By including an assignment of the IP that relates to the business (which you already defined so clearly) from the shareholders to the company, you can take care of this in one place - for the shareholders, at least.

How do we know what intellectual property exists?

If you don’t already know you will need to conduct an IP audit. This involves:

• Reviewing what’s been created and is relied on by the company: code, designs, notes, sketches, customer contact details.
• Identify who created it: will this person be a shareholder?
• Determine current ownership: did the creator already transfer it to someone else?

What do we need to do to ensure the company owns the right intellectual property?

IP that is protected by copyright, trade mark and patent law requires assignment from one owner to another, in writing.

Individual things do not need to be assigned separately. A single assignment can include an entire body of work.

Trade secrets and know-how do not transfer well through assignment alone; they require two things:

1. an agreement that confidential information belongs to the company, and
2. operational controls that maintain secrecy (access policies etc).

What about open-source software or other third-party dependencies that we have?

It’s difficult to run a business without being dependant on third-party IP. The most important thing is to ensure that those dependencies are understood, properly licensed and compatible with your company’s commercial plans. For example:

• software libraries are often used under permissive open-source licences,
• cloud services are essential for making software products available to the world, or
• proprietary data or LLM tooling might be something you pay a licence fee to access.

Do we need separate assignments of intellectual property for each shareholder?

For most early stage startups, probably not. Provided that your business definition is wide enough and the IP that is assigned under the shareholders’ agreement captures existing and future IP that relates to the business, this is probably sufficient.

What should our position be on intellectual property when it comes to putting together the shareholders’ agreement?

You should agree a unified stance:

• the company should own all relevant IP that relates to the business,
• every person involved (shareholder or not) will assign existing and future IP that relates to the business to the company,
• this should happen as part of the shareholders’ agreement where possible, and
• it should be clear what third-party dependencies exist, and you should agree that depending on any without an appropriate licence should be avoided.

It might make sense for one person to take (unofficial) responsibility for managing IP - which includes keeping any necessary registrations up to date, taking charge of trade secret policies and having overall awareness about new IP which is developed for the business and ensuring that it is assigned properly to the company.

Term: non-competes and other restrictions

What is a non-compete? What other types of restrictions exist?

A non-compete is a type of restrictive covenant. It is where a person agrees not to do something that competes with the company while they are employed. Other types of restrictive covenants relating to companies include:

• non-poaching: where a person agrees not to poach (steal) the company’s workers or advisors,

• non-solicitation: where a person agrees not to solicit (get business from) the company’s customers or clients, and

• non-dealing: where a person agrees not to solicit (deal with) with the company’s suppliers.

What is a restrictive covenant?

A restrictive covenant is a clause in a contract which is designed to protect business interests.

They can only be enforced if they are considered reasonable and go no further than is needed to protect legitimate business interests.

This means a restriction that is too broad (“you cannot work for another tech company”) may have no legal effect.

On the other hand, a reasonable restriction (“you cannot work for any direct competitor in the UK for the next 6 months”) is likely to be enforceable, and so the person on the other end of it is more likely to respect it.

PEDANTIC POINT

• There is another type of restrictive covenant which relates to land and is not relevant in the context of putting together a shareholders’ agreement.

Are restrictive covenants essential in a shareholders’ agreement?

Yes. Ultimately the shareholders’ agreement exists to protect the company, and restrictive covenants are one of the many tools used to do this. For example:

• 3 shareholders start a company developing legal tech software for law firms.
• The company is successful and has 5 large firms as clients.
• One shareholder leaves, taking half the staff and 3 clients with him to set up a similar business.
• The remaining 2 shareholders cannot stop him and eventually, the company fails.

Without restrictive covenants in place, this is an all too common occurrence.

Do restrictive covenants only appear in shareholders’ agreements?

No. Restrictive covenants also commonly appear in employment contracts and less commonly in consultancy agreements (and other contracts for services rather than employment).

How do restrictive covenants work?

They work in a few ways:

• when a document containing one is signed: creates the restriction immediately; the shareholder will be aware of it and plan accordingly around it,

• when someone leaves: some companies remind shareholders of their restrictions and what the consequences of breaching them might be,

• when someone breaches: the practical power a company has is the threat of litigation (“you have breached our non-compete and we need you to stop doing what you’re doing NOW”); the more reasonable the restriction is the more seriously the threat is likely to be taken, and

• when someone is setting up on their own: their own lenders or investors often ask about compliance; ignoring covenants can jeopardise funding.

The point is, if the restriction exists (and is reasonable), it helps stop behaviour that can damage the company’s business - even if it’s never going to be enforced.

What are reasonable terms for restrictive covenants in shareholders’ agreements?

What is reasonable ultimately depends on your company’s industry and the people involved. Here are some absurd examples, which I’ll explain in more depth below.

• Arnold is an ex-lawyer in a company selling legal software, with connections to the legal industry. His restrictive covenants are:

  • non-compete: can’t compete with the business, while he holds shares, and 12 months after he stops,
  • non-poaching: for 18 months after he leaves, he can’t poach anyone who was employed during his last 12 months at the company,
  • non-solicitation: for 18 months after he leaves, he can’t do competing business with any person who was a customer of the company during his last 12 months there, and
  • non-dealing: for 6 months after he leaves, he can’t work with anyone who was a supplier to the company during his last 18 months there.

• Sylvester is a former salesperson at a niche AI startup. His restrictive covenants are:

  • non-compete: for 5 years after he leaves, he “can’t engage in any business involving software, hardware, data or tech of any kind, anywhere in the world”,
  • non-poaching: indefinitely restricted from “hiring any person who has ever worked for the company”,
  • non-solicitation: global, unlimited in duration and applies to “any actual or potential customer”, and
  • non-dealing: covers every supplier the company has ever used.

• Bruce is a hairdresser in a new hair salon startup. His restrictive covenants are:

  • non-compete: for 12 months after he leaves, he “can’t work for another hairdressing salon in London”,
  • non-poaching: he can’t recruit stylists who worked with him in his final 6 months,
  • non-solicitation: he can’t approach clients he personally worked for in his final 12 months, and
  • non-dealing: he can’t work for a specific list of named high value clients for 6 months after he leaves.

What makes a restrictive covenant enforceable (or unenforceable)?

Courts look for two things:

• a legitimate business interest to protect, and
• a restriction that is not wider than necessary.

Let’s consider the above examples:

• Arnold’s restrictive covenants target concrete interests such as client relationships and trade secrets. The durations for each are modest and they seem to be in line with his actual influence at the company. Likely to be enforceable.
• Sylvester’s restrictive covenants are far wider than the interests at stake: global restrictions lasting for years on end, encompassing entire industries. They go too far. Unenforceable.
• Bruce’s restrictive covenants are more difficult. Two of them (non-solicitation and non-dealing) are tied to clients he actually worked with and are time limited, which makes them seem more reasonable. The London-wide 12 month non-compete seems more absurd - is it really necessary to protect a single salon? Could be argued either way.

How do we determine what restrictive covenants to include in a shareholders’ agreement?

You should probably start with the 4 most common ones: non-competes, non-poaching, non-solicitation and non-dealing.

As for the terms of each:

1. Start by mapping key business interests - list clients, suppliers, staff, IP and know-how that is critical to the company.
2. Identify shareholder influence - who has direct relationships or strategic knowledge?
3. Set realistic scope - define how long each one should last and where it should apply.
4. Tie it all to the business - everything should be scoped to the business the company carries out.
5. Benchmark against industry - find out what similar sized companies in your industry do.

What are the risks of agreeing overly restrictive terms?

There are a two major risks:

1. the person agreeing to them knows they are overly restrictive and they take the action you are trying to prevent, knowing that they cannot be enforced, and
2. it goes to court and the court decides that the restriction is unenforceable - money and effort wasted.

What happens if only one of the restrictions is unreasonable?

Contracts that include restrictive covenants typically also include another boilerplate clause titled ‘severance’.

The rule of severance says that where a clause in a contract is found to be unenforceable, that clause can be cut off (severed) without the rest of the contract being affected.

This means that a single restrictive covenant being unenforceable does not affect any other restrictive covenants that might exist.

How difficult is it to enforce a restrictive covenant?

They are typically enforced like this:

• the company gets wind of someone having breached the restriction,
• the company sends a letter before action to that person formally notifying them they may be breaching and demanding they comply,
• the company gathers evidence needed to prove breach,
• the company instructs lawyers to assess how enforceable the covenant is and prepare court documents if needed,
• the company applies to the court to obtain an interim injunction against the person doing whatever they’re doing,
• throughout all of this, the company and the person negotiate and come to a settlement, or
• the court makes a decision and directs what a suitable outcome is.

Most of the time, the letter before action step will prompt the shareholder to stop doing whatever they are doing - provided that the restrictive covenant is enforceable - and both parties know it.

Is it common to have different restrictive covenants for different people in a shareholders’ agreement?

No. In a shareholders’ agreement it is often sensible for everyone to have the same terms.

This makes drafting and administration easier. It also ensures everyone is on the same page.

However, it is entirely possible to have different restrictions in place for different people.

I hear non-competes might be banned in 2026. What is this about?

As part of the November 2025 budget, the UK government released a working paper on options for reform of non-completes.

According to this paper, non-competes “play a part in restricting employee movement, limiting knowledge spillovers and can undermine incentives for innovation”. It goes on to reiterate what we’ve talked about above; that restrictive covenants need to be reasonable in order to be enforceable. Interestingly, it also says that even if unlikely to be enforceable, workers may “perceive the clause as binding and comply with it for fear of legal repercussions”.

To deal with this, they’ve proposed:

• a limit on how long a non-compete can last (3 months is the figure being thrown around), perhaps taking into account company size,
• an outright ban on non-competes (and maybe on the other types of clause too, if they also restrain a person’s ability to work),
• banning them below a certain salary threshold (although this seems to apply to employment contracts rather than shareholders’ agreements).

What can you do with this knowledge?

• keep an eye on what the Department for Business & Trade are up to; if this becomes law, it will be big news;
• consider a 3 month restriction - would it work for your company?

Term: right to appoint a director

Why would a shareholder need the right to appoint a director?

A shareholder is someone who holds shares in a company.

A director is a person who is responsible for the daily management of a company.

The two roles are separate, with shareholders generally only involved when very important decisions need to be made.

Being a shareholder does not give a person the automatic right to also be a director.

But having the right to appoint a director is often important, because it gives a shareholder:

• protection of their investment,
• access to information only available to directors, and
• significant influence over how the company operates.

What are the risks of giving shareholders the right to appoint a director?

There are 3 risks:

1. decision making risks:

   • an appointee might push the appointing shareholder’s agenda over the company’s interests
   • increased chance of disagreements that could lead to deadlock situations

2. risk of confidential information leaking

   • sensitive financial or commercial data might get back to a shareholder who has a bigger interest in a competing business

3. operational risks

   • misalignment between general management and an appointee
   • an inexperienced or unengaged appointee can reduce board’s effectiveness

Don’t default to ‘everyone should have the right to appoint a director’.

What needs to be discussed when considering giving shareholders this right?

Each shareholder needs to understand the importance of being a director:

• directors are responsible for the day to day operations of the company,
• directors have duties under law to act in the best interests of the shareholders generally, and
• directors are under legal obligations about how to behave and present information about the company.

And they should also discuss:

• the fact that appointed directors’ duties are owed to the company, not to the person who appointed them,
• how sensitive information will be handled and whether any safeguards should be put in place, and
• how the right to appoint a director might affect board balance and the company’s decision making abilities.

What should the default position be when it comes to having the right to appoint a director?

By default, no shareholder should have the right to appoint a director. Instead:

• directors are elected by shareholders collectively, not individually
• individual appointment rights should only be given where the shareholder’s contribution justifies it - e.g. a major strategic investor or an original founder

But if one shareholder requires it, then consider if the fairest solution is to give the same right to all shareholders.

OK, we each understand the main terms. What’s next?

Once everyone is aligned, put them in writing. You can do this in any format you like - the point is to keep a record of what everyone has agreed is the best route to take. The heads of terms / term sheet document is a sensible way to do it. Example next.

Example term sheet for a shareholders’ agreement in a UK company

This example combines several of the terms discussed above into more naturally grouped topics that you can use as conversation starting points.

If you find the way this term sheet is laid out to be useful, you’re in luck - Robolawyer’s unique term building system helps you complete your term sheet progressively, alone or with your co-founders.

Once filled out, all of the documents you need will be put together automatically - without any irrelevant wording or square brackets for you to comb through. Learn more →

Documents required for shareholders’ agreements

How do terms agreed in principle between founders translate to documents?

Ultimately, this is about formalising an agreement between shareholders; making it legal and enforceable. Term sheets are typically not binding; the agreement still needs to be implemented to have legal effect. The documents implement the agreement in several ways:

• by creating new contracts between people,
• by creating new shares and issuing them to people (where required),
• by creating new rules that the company must abide by, and
• by keeping proper records that the right procedures were followed.

The key thing to understand is that a term does not translate directly to a document; the documents should together reflect the terms you have agreed while ensuring that the correct legal procedures are followed.

How do we get the documents prepared?

You have a few options:

1. Use Robolawyer to prepare, update and amend your documents automatically - all you have to do is provide the information that appears in the example term sheet. Once happy, Robolawyer will help with the entire remainder of the process - all for a fixed fee.

2. Engage a lawyer. But make sure they have done this kind of stuff before. Question what value they are adding, considering that most of the work (understanding and agreeing the key terms) will be done by you and your co-founders.

3. Download templates. Not recommended unless you really know what you’re doing - in which case you probably wouldn’t be reading this.

4. Ask AI. Not recommended unless you have legal training and experience. Even then, AI will only spit out some text - it’s up to you to translate that text into a legally binding transaction.

It’s really difficult to know how to prepare these documents in the best way. My knowledge of this comes from:

• understanding how the various types of law relating to shareholders (company, contract, employment, tax) work and interact with each other
• knowing what standard practice is; the accepted way of doing things, and
• advising many people in similar but unique situations.

That’s why I built Robolawyer - to put all of that knowledge into a framework that non-lawyers can understand.

Why is it important to read the documents?

Since you are responsible for what you sign, “you must read the documents” is an understatement!

Not doing so can lead to:

• total omission of crucial terms or parties,
• terms agreed in principle not accurately reflected in the final implementation,
• procedural requirements that someone might not agree with,
• unnecessary mistakes and errors that can be costly and take time to fix, or
• incorrect calculations and other secondary data in schedules or appendices.

You must read the documents! We’ll continue with an overview of what each one is.

Shareholders’ agreement

What are we talking about?

An actual document, titled “Shareholders’ Agreement”.

Every person who holds shares in the company needs to be a party to (sign) this document.

The company is also usually a party to the document.

It is a private document, with only the parties keeping copies.

If someone breaks a rule in the document, one or more of the other parties has to take the rule breaker to court to enforce it.

Why would the company be a party to an agreement between its shareholders?

The company is a party because:

• many of the things covered by the shareholders’ agreement document require it to act in a certain way,
• it would only be obliged to do those things if it signed the document, and
• it lets shareholders take action directly against the company if the rules are breached.

What does the shareholders’ agreement document do?

It creates legally enforceable rights and obligations for each party.

If a party breaks the rules of the document, the other documents can follow the procedures to fix the problem.

If all else fails, they can take the rule-breaker to court to enforce it.

How is a shareholders’ agreement document different from the term sheet/heads of terms?

Term sheets are non-binding indications of what each party is prepared to agree to, when the deal is formalised.

The shareholders’ agreement document is one of many documents that are required to actually formalise the deal.

It is common for terms to change between signing a term sheet and preparing the draft agreement.

Who needs to review and sign a shareholders’ agreement?

Each shareholder who owns shares in a company will need to review and sign the document.

The company’s directors will need to review and sign it on the company’s behalf.

PEDANTIC POINT

If new shares need to be issued (for example, to fulfil equity splits to co-founders) those new shareholders will also need to sign it.

Who has access to a shareholders’ agreement?

It is a private document. Only the parties to it (the shareholders, and each director of the company) should have access to it - especially the final signed copy.

In practice, advisors and countless others will have had access to it - the fact that it is ‘private’ only means it does not have to be publicly filed anywhere.

What should a shareholders’ agreement contain?

There is no standard form of a shareholders’ agreement.

Every shareholders’ agreement document will look different depending on who drafts it. As a minimum, it should create a legally binding, enforceable contract between the shareholders which:

• names the parties explicitly,
• clarifies how this private document interacts with the public articles,
• states who owns how many shares with information about any vesting schedules,
• lists what things should require consent before being done, and how consent is to be obtained, and
• creates obligations of confidentiality and restrictive covenants that relate to the company’s business.

What happens if a party breaches the terms of a shareholders’ agreement?

The other parties can sue for damages or specific performance (where the court forces them to do something).

Some provisions in a shareholders’ agreement might trigger automatic consequences, such as converting a person’s proportion of ordinary shares into deferred shares.

Does a copy of the shareholders’ agreement need to be filed or sent to anyone?

No.

How long does a shareholders’ agreement last?

They last indefinitely; until terminated by all the parties to it. In practice, a shareholders’ agreement evolves in two ways:

1. The shareholders’ agreement continues to be relied on. As the company has new shareholders come on board, they sign up to the existing agreement (using a document called a deed of adherence). This requires new shareholders to be happy with the existing document.

2. Powerful shareholders (usually investors or acquirers) come on board and require the existing shareholders’ agreement to be ripped up and replaced with a new one which better serves their interests. This is fairly common.

If the shareholders’ agreement is going to be ripped up why do we need it?

Operating a company under default company law is risky.

Consider how long it might take you to actually close a deal that would require a new shareholders’ agreement with investors to be put in place: 6 months? 12? What would you do if a 33% shareholder went quiet 5 months into the process?

Having a shareholders’ agreement in place that deals with the company as it exists today provides the reassurance you need.

What ongoing obligations typically exist under a shareholders’ agreement?

Ongoing obligations are obligations that each party needs to be aware of before signing the document. This is because they can arise at any time and in most cases require some action from the party. For example:

• getting permission before any reserved matters are carried out,
• keeping things confidential, and
• restrictive covenants for each individual.

What happens if someone breaches an ongoing obligation?

Ongoing obligations should be sufficiently detailed, providing a full and clear process to follow.

Ultimately, the upset shareholders (or company) can enforce the obligation in the same way as any other breach - by going to court.

Can a shareholders’ agreement be amended after signing?

Yes, but only if everyone who originally signed it agrees to this.

PEDANTIC POINT

Some shareholders’ agreements allow the document to be varied if a certain percentage of shareholders agree.

This can be appropriate where there are a lot of shareholders involved (for example, multiple angel investors) who are low-touch and often take a while to respond to queries. A lower threshold (such as 90%) can help avoid delays. But this can be risky for the minority, who lose a significant amount of power by allowing this.

New articles of association

What are articles of association?

A company’s articles of association (rules) are contained in a document titled “Articles of Association” or similar.

Every UK company has to have articles of association.

Companies are incorporated with the default articles of association, commonly known as the model articles.

What are the model articles?

The model articles are the default articles of association that a UK company has when it is incorporated.

You can read the model articles for private companies here. They were last updated in 2013.

The model articles were written to apply to as many small companies as possible, and so are fairly limited. For example:

• they give directors very broad powers,
• they have minimal protections in place for shareholders, and
• the rules governing how shares are transferred are very basic.

They are not really made for startups.

How do I know if my company is using the model articles?

If you don’t know, and your company was incorporated recently, then it most likely is using the model articles.

You can verify this by going to the Companies House website and searching for your company. Type in your company’s name and hit search, then select it from the results. Click on the ‘filing history’ tab. The oldest chronological entry (at the bottom) will probably say ‘Model articles adopted’ in its description.

Do new articles override the model articles completely?

Yes. Each time new articles are sent to Companies House, those are the definitive articles for that company that are in force.

PEDANTIC POINT

If you actually read a set of new articles, you’ll commonly see wording along these lines:

The model articles shall apply to the company, except where they are varied or excluded by or are inconsistent with the articles contained in this document

If the articles are completely overridden, what is going on here? Why are we referring to them applying?

Well, the model articles are actually quite well written and cover a wide range of basic situations fairly well. In most situations, it does not make sense to override those already established procedures. So when new articles are drafted, it’s common to conceptually take the model articles as the base document, then have the new articles override the parts that are inconsistent.

This results in a significantly shorter individual document, but it does mean that when you read it, you also need to refer to the original document - and understand which parts of it are no longer applicable!

In any case: this still results in the previous articles being completely overridden by the new ones.

Is this pedantic enough for you?

Why do we need new articles of association when putting together a shareholders’ agreement?

There is no legal requirement to adopt new articles of association when putting together a shareholders’ agreement. But it is very common to do it. Why?

• We know the shareholders’ agreement can create rights and obligations, but these are only contractual and can be hard to enforce.
• The articles are different. Since they are governed by company law, failure to adhere to them does not usually require going to court.
• Instead, if someone does not behave in line with the company’s articles, the action they took is invalid.

This means it makes sense to include certain things in the articles (such as procedures to be followed if someone’s shares are being transferred) and other things in the shareholders’ agreement (what an individual’s vesting schedule is).

Are new articles a legal requirement when adopting a shareholders’ agreement?

No. A shareholders’ agreement can be effective without modifying the articles. But doing this can lead to conflicts between the existing (usually model) articles and the adopted shareholders’ agreement - especially where there is an overlap between procedural rules that appear in both.

Who needs to review and sign the new articles of association?

Everyone who is involved in the company (directors and shareholders) needs to review the articles.

Nobody needs to sign them.

How are new articles actually adopted if nobody has to sign them?

Articles are adopted by the shareholders passing a special resolution to adopt new articles.

The (condensed) process is:

• the directors have new articles prepared,
• the directors propose a special resolution to adopt the new articles,
• the directors circulate the special resolution along with the new articles,
• if 75% of the shareholders agree, the resolution is passed and the articles are adopted.

PEDANTIC POINT

The process above is what applies under default company law. If your company already has a shareholders’ agreement in place, you may need to obtain further contractual consent to adopt the new articles, which is typically one of the reserved matters.

What is the typical structure of new articles of association when putting together a shareholders’ agreement?

Most custom articles will take the model articles as a ‘base document’.

The new articles will list each provision in the model articles that is inconsistent, disapplying or varying them as required.

What happens if there is a conflict between the shareholders’ agreement and the new articles?

The shareholders’ agreement usually takes priority. But this has to be written in the shareholders’ agreement or articles for it to be true.

Why do some things go into the articles? Where does this requirement arise?

The Companies Act 2006 requires every company to have a set of public articles of association.

The articles are intended to contain formal rules that are legally effective and bind everyone involved in the company.

Certain things have to go in the articles. For example:

• the rights that shares have (can the holder vote?),
• restrictions on selling or transferring shares, or
• rules for appointing and removing directors and how they make decisions.

Everything that doesn’t need to go in the articles usually goes in the shareholders’ agreement.

The only exception is where something that normally goes into the articles is commercially sensitive - but this is not common for early stage startups.

What happens if something appears in the articles when it should be in the shareholders’ agreement and vice versa?

The question is “can you enforce it?” If it’s ineffective or unenforceable in the way you intend it, this can lead to disputes and a failure to bind everyone it needs to bind.

What happens if someone does not follow the articles?

Invalid decisions taken by the company, possible litigation, possibly personal liability for directors.

Can the new articles be changed going forward?

Yes, but changing the articles requires a special resolution (where 75% of the current shareholders agree to change them). Most shareholders’ agreements will also explicitly list changing the articles as one of the reserved matters that requires further consent beforehand.

At what point do the new articles take effect?

They take effect at the moment the special resolution proposing their adoption is passed. They do not need to be sent to anyone for them to have legal effect.

Who do the new articles need to be sent to and by when?

To Companies House, within 15 days, including a copy of the special resolution that authorised them being adopted.

Companies House allows articles and special resolutions to be submitted using the generic upload a document to Companies House service.

Who is responsible for filing the new articles?

Ultimately it is the company’s responsibility. But this means it is the directors (or secretary - if there is one) who need to actually do it.

What are the consequences of not filing new articles with Companies House?

Legally, this is a breach of the Companies Act 2006 and is a criminal offence - the typical penalty is a fine.

Commercially, failure to file important documents on time can be a red flag for anyone looking at your company’s history - banks, investors, acquirers. It can also delay transactions until the problem is remedied.

In reality, Companies House usually allows articles to be filed late and fines are rarely issued.

Subscription letter / agreement

What is subscription?

In company law, subscription is the process of creating new shares in a company.

A person who subscribes for new shares is usually referred to as a subscriber.

Technically:

• the subscriber applies to the company for X shares at £Y per share, and
• the company accepts the application and issues new shares to the subscriber.

PEDANTIC POINT

Even more technically, the company first allots the new shares before they are issued to the person:

• Allotting is the company’s decision to give this person shares (creating an implicit contract to issue them).
• Issuing is actually giving them to them (entering them in the register of member, issuing shareholders).

Why not transfer shares rather than issue new ones?

Issuing new ones keeps the cap table clean and allows you to trace the history of ownership with relative ease.

Consider this example:

• Odette holds 100 shares in a company.
• She wants to give Mandeep 20 shares, so she has 80%.
• She transfers 20 shares to Mandeep and retains 80.

All seems fine. But note:

• The company’s statutory books (in particular, its register of members) need to record a chain of title. Transferring shares requires a significant amount of paperwork. Over time, multiple transfers create a long and messy history.
• Transferring shares might trigger something unexpected in the existing articles.
• Any change in the value of the shares since Odette was first issued them and the date they are transferred might trigger tax issues for both of them.
• The cap table becomes messy and details reallocations rather than a clean trail of newly created shares.

Contrast this with issuing new shares instead:

• When the total number of shares is 125:

  • Odette still holds 100 shares (80%), and
  • Mandeep holds 25 shares (20%).

• There are no unavoidable tax issues and the cap table stays clean.

  PEDANTIC POINT

  What does unavoidable tax issues mean?

  There is a potential tax issue that relates to ‘restricted securities’ in UK companies. If a shareholder holds restricted securities, they might end up paying more tax than they should.

  This is an issue that can be avoided by completing a section 431 election.

What is a subscription letter?

It is a contract (disguised as a letter) from a subscriber to a company, where the subscriber applies for new shares and the company accepts the application. It is signed by both parties. It looks like letter because this is the simplest way to document a simple subscription.

What makes a subscription simple or complicated?

Subscriptions are simple when nobody has any extra demands before the subscriber pays for the shares and they are issued.

A subscription can be complicated when:

• there are multiple people subscribing at the same time (everyone has to be in sync),
• the subscribers are actually investors who have extensive requirements before subscribing (due diligence), or
• the company (or its shareholders) are expected to provide warranties about the company (guarantees against being ripped off).

What is a subscription agreement?

A subscription agreement is a more comprehensive contract that usually deals with multiple people investing at the same time.

When would you use a subscription letter versus a subscription agreement?

Subscription agreements are commonly used during investment rounds (the investors are the subscribers). They:

• are much more detailed and significantly longer than a subscription letter,
• legally oblige the company to follow the correct processes,
• contain extensive warranties about every aspect of the company, and
• should be clear about what the cap table looks like after the shares are issued.

Do we always need a subscription letter / agreement?

You only need a subscription letter or agreement if new shares need to be issued.

For the type of shareholders’ agreement we are discussing in this guide (one without investors), this would only be in order to fulfil an equity split.

Who needs to review and sign a subscription letter or agreement?

• Subscription letters are signed by the subscriber and the company (individual documents).
• A subscription agreement is signed by all subscribers (a single document).

Are subscription agreements only necessary when investors are involved?

No. Subscription agreements are useful when you need more detail about the process of issuing shares, or where any of the shareholders (whether they are investors or not) requires something to be done before, during or after the process of subscribing.

What should a subscription letter contain?

At a minimum, a subscription letter should contain wording like this:

I, Peppa Pig, hereby apply for the allotment and issue of 100 new ordinary shares in the capital of the company.

and

Please indicate the company’s acceptance of this application by signing and returning a copy of this letter to me.

What should a subscription agreement contain?

A subscription agreement usually has 3 main components:

1. the subscription process - mirroring the wording that would appear in a letter,
2. how and when the shares should be issued - the actual steps to be taken by each party to complete the deal, and
3. having the existing shareholders warrant that a list of things is true - the warranties.

What are the most heavily negotiated terms that appear in subscription agreements?

Assuming the draft is fair and in line with the term sheet, the most heavily negotiated parts will be to do with warranties.

What is a warranty?

A warranty is a promise made under a contract. If the promise is not kept, the person on the other end might be entitled to damages.

What does a warranty look like?

A warranty should be a statement which the reader either agrees with, does not agree with, or needs to provide further detail about.

For example:

the company is not engaged in any litigation

What is a warranty in the context of a subscription agreement?

Imagine this:

• you are a celebrity,
• you’re interested in taking 30% of a startup that’s already got some traction,
• the founders are offering you shares at the base price, knowing you’ll add serious value.

You want to do it, but you need to be sure that the traction is real - you don’t want to put your face on something bogus.

You ensure that the subscription agreement contains appropriate warranties (promises) from the founders about the business, just in case you are being hoodwinked.

What type of warranties are expected to be given and by whom when putting together a shareholders’ agreement?

Any warranties asked for should reflect the reality of the company and its founders. For example:

• If the company sells software, the founders should promise that the company owns all intellectual property in the software.
• If the company sells a celebrity branded product, the founders might promise they have appropriate experience doing this type of work before.
• If the company sells professional services, the shareholders will probably promise that they have the appropriate qualifications to do so.

This level of detail is usually only needed when investors are involved. When putting together a shareholders’ agreement, only minimal warranties are necessary. For example:

• that the company has been properly incorporated,
• that the information given to the shareholder about the company’s ownership since then is accurate,
• that all taxes have been paid,
• that there isn’t any ongoing litigation, and
• that the software it relies on has been properly acquired and licensed.

These warranties are typically given by the company itself.

Sometimes, incoming shareholders will ask for the existing shareholders to also give the same warranties in a personal capacity.

What happens if you need to provide further details about a warranty?

Whenever you give warranties, you should be reading each one in detail. Remember, each one is a statement that you either agree with, do not agree with, or need to provide further details about. This is how I approach each one:

• Agree with: no action needed, you will agree to it when the document is signed
• Do not agree with: inform the person who drafted the agreement and ask for it to be removed
• Further detail needed: put it in a disclosure letter.

A disclosure letter refers to the warranty in question and provides the further detail needed. This is then considered as ‘disclosed’ to the new shareholders and can’t be a reason for breach of that warranty.

Do we need a disclosure letter when putting together a shareholders’ agreement?

If:

• new shares need to be issued, and
• you use a subscription agreement which contains warranties,
• and you think any warranty needs further details to be accurate. then you do.

PEDANTIC POINT

You could also amend the warranties to suit your custom situation. This often takes more effort to negotiate than it would to just have disclosed against it.

Does a subscription letter or agreement need to be filed or submitted anywhere?

No. Each one is a private document and should only be retained by its parties.

What has to be done after a subscription?

When new shares are issued:

• the company updates its register of members/cap table,
• the directors send share certificates to the new shareholders, and
• Companies House is informed using form SH01 within a month of the issue date.

Section 431 election

What is a section 431 election?

A tax form that helps you pay less tax if you’re an employee that has shares. It is actually called a section 431 joint election because it requires both the shareholder and the company to sign it.

Why is a section 431 election relevant in the context of putting together a shareholders’ agreement?

Section 431 elections are relevant because restricted securities are likely to be involved:

• where new shares are being issued to an employee, if shares are subject to vesting they will be restricted securities
• when restrictions are applied to shares that already exist, those shares also become restricted securities from that date

Restricted securities are taxed when they are acquired on the basis of their restricted market value. The unrestricted market value is likely to be higher - this difference remains as an untaxed percentage. You want to avoid having an untaxed percentage when there’s more money to be taxed (in other words, later).

This can be avoided by signing a section 431 joint election which shows that you both and the company agree there should be no untaxed percentage remaining.

How do we know if section 431 elections are needed?

Imagine this:

• An employee gets shares worth £10k (the unrestricted market value), but the vesting schedule (4 years, 1 year cliff) makes the market value only £8k (the restricted market value).
• Tax is calculated and paid on the restricted market value of £8k.
• The £2k difference becomes an untaxed percentage of 20%.
• Years later, the company is sold and those shares are now worth £100k.

Without a section 431 election:

• The law says that any untaxed percentage must be taxed at the higher income tax/national insurance rate.
• The 20% untaxed percentage is applied to the full sale value of £100k.
• This means £20k of the employee’s gain is subject to the higher income tax/national insurance rate.
• Only the remaining £80k is taxed at the lower capital gains rate.
• Result: employee pays more tax.

If a section 431 election had been made:

• The company and employee agreed when the shares were issued that tax should be paid on the entire £10k up front.
• There is no untaxed amount.
• The entire gain above the initial £10k value (£90k) is taxed at the lower CGT rate.
• Result: employee pays less tax.

A section 431 election is the form that the company and employee both sign that confirms they agree there should be no untaxed percentage. This form needs to be signed within 14 days of the shares being acquired by the employee.

Do I need an accountant to prepare a section 431 election?

No. HMRC makes the wording freely available.

What are the disadvantages of entering into a section 431 election?

If the value of the shares reduces after the election, the employee will have paid more tax up front that would have otherwise been due.

Why might someone choose not to sign a section 431 election?

An employee might choose not to make a section 431 election if their shares are subject to vesting.

For example:

• Emily is a minor founder in a startup (she holds 10%, the others hold 45% each).
• She is not sure if it’s going to work out, but she is willing to give it a shot.
• All of the founders’ shares will vest over 4 years.
• Let’s say the restricted market value of her shares is £1k (unrestricted value being £5k).
• If she signs the section 431 election, she pays tax on the full £5k.
• If she doesn’t sign it, she pays tax on the £1k restricted value only.

Since Emily is unsure whether she’s going to stick it out for the full years, she is probably better off not signing the election.

But if there is a chance that it all works out, and the company eventually sells for millions, she will have an untaxed percentage of 80%.

It’s up to Emily to decide what’s best for her.

Who has to sign a section 431 election?

The subscriber and the company both sign it.

Are section 431 elections only relevant for employees/directors receiving shares, or for all shareholders?

Section 431 elections are only relevant for shares that fall under the broader ‘employment related securities’ laws.

This means it is only relevant to shareholders who are employees or directors of the company.

What are the implications of entering into a section 431 election?

There are long lasting tax implications.

The biggest impact is that it transforms a future higher income tax and national insurance liability into a capital gains tax liability.

Capital gains are taxed at lower rates than income tax and national insurance.

There are 3 main implications of signing one:

1. your immediate income tax charge might be higher,
2. your future income tax risk is eliminated, and
3. all future growth is taxed as a capital gain.

It’s an immediate small tax cost paid now to avoid a potentially massive bill later.

What does a section 431 election look like?

They are usually simple 1 or 2 page documents. They can look like a form or be in letter format. They can also be integrated into other documents.

Here is HMRC’s example.

When must a section 431 election be made?

It has to be made within 14 days of the restricted shares being ‘acquired’ by the shareholder.

What does acquired mean in this context?

I haven’t seen any clear guidance about this, so my own interpretation is that ‘acquired’ doesn’t necessarily equate to ‘issued’.

I think this is important because:

• new restricted shares are obviously acquired (issued) to co-founders when equity splits are being fulfilled
• but where an existing shareholder has already incorporated a company:
  • those shares were already issued before any restrictions came about, and
  • the restrictions only have effect from the date of the new shareholders’ agreement, then
  • HMRC could argue that the restricted securities were acquired only on this date.

Essentially a person now has restricted securities when they didn’t before - I think that fits into the meaning of acquired

What are the risks of not signing a section 431 election at the right time?

Paying tax at a higher rate, on an untaxed percentage.

In other words, paying more tax than was needed.

Do we need to send a copy of the section 431 election to anyone?

No, the individual copy doesn’t need to be sent to anyone.

However, the company does need to report the fact that any shares were issued and section 431 elections were made in its annual employment related securities return.

How long should we retain copies of section 431 elections?

The company and the shareholder should each keep a copy for at least 6 years.

HMRC may need to see it if they carry out an audit or compliance check.

If no copy of the election is available, it won’t be valid.

Can a section 431 election be combined into a subscription letter or agreement?

Yes. HMRC has confirmed that ‘other formats’ are acceptable:

HMRC does not require the approved election forms to be used or agreed as part of a single or dual-part document so long as it can be shown that the relevant employee and employer have agreed whether by email, in a share subscription agreement or otherwise the key terms of an election in no less detail than the written form of election supplied by HMRC.

Why do this?

• one less document per person,
• the election is made on the date of the letter or agreement,
• the shares the election relates to are clear,
• the letter or agreement itself is the copy required to show HMRC.

Shareholders’ resolutions

What are shareholders’ resolutions in the context of shareholders’ agreements?

Shareholders’ resolutions document the formal permission of the company’s existing shareholders for the company to do something.

Remember, shareholders’ resolutions can either be ordinary (require > 50%) or special (require > 75%).

Putting together a shareholders’ agreement typically involves 3 actions that require permission:

1. issuing new shares (ordinary),
2. turning off pre-emption rights in relation to the new shares (ordinary), and
3. adopting new articles (special).

Shareholders’ resolutions are usually obtained as written resolutions.

What are written resolutions?

Shareholders can pass resolutions at meetings, or they can pass them in writing without holding a physical meeting.

For resolutions to be passed in writing:

• the proposed resolutions have to be sent to every shareholder on the same day,
• the required threshold needs to sign it (ordinary or special),
• signatures have to be back within 28 days, but
• if the required threshold comes back before then, you don’t need to wait the full 28 days.

Written resolutions make more sense nowadays.

When might we hold a meeting between shareholders rather than passing written resolutions?

Written resolutions do not:

• allow a shareholder to abstain from a vote - meaning the threshold is calculated based on the total shareholders and who actually responds,
• allow for open discussion of a particular resolution before asking for a show of hands - everyone considers written resolutions in isolation,
• allow for individual resolutions to pass or fail - they are all or nothing, and
• allow a director or auditor to be removed.

Meetings make more sense when there is actual discussion to be had.

They also make more sense where voting thresholds need to be taken into account. At a meeting, majority is calculated based on the votes actually cast (abstained are excluded). If you know certain shareholders may be hard to reach or unlikely to vote, it might be easier to pass a resolution at a meeting where their non-participation is not an issue.

Who needs to be sent copies of the resolutions and who needs to sign them?

They need to be sent to every eligible shareholder on one date (usually called the circulation date).

Each shareholder needs to sign and return the document within 28 days for it to count towards the decision.

Which resolutions are typically required when adopting a shareholders’ agreement?

If shares are being issued as part of the implementation, the directors will need the shareholders to approve:

• an ordinary resolution to issue the new shares, and
• any pre-emption rights (the right to also receive new shares in proportion to existing ownership) are disapplied.

PEDANTIC POINT

Section 550 of the Companies Act 2006 allows companies with a single class of shares (ordinary being the default) to allot new shares without getting shareholder authority (provided the articles allow this - which the default model articles do).

Similarly, section 569 allows companies with a single class of shares to allot new shares as if the pre-emption rules did not apply.

This means it is possible for a company with only ordinary shares, using the default articles, to validly issue new shares without obtaining the shareholder resolutions.

But in practice, most companies will obtain them anyway. This is because:

1. it future proofs the company in case a second class of shares comes into existence,
2. it provides certainty and clarity about what processes were followed - good for due diligence,
3. specific resolutions can be broader and be more flexible than this fallback law, and
4. it is the standard way of doing things.

If new articles are being adopted, they will also need a special resolution to be passed.

What should shareholders’ resolutions look like when putting together a shareholders’ agreement?

Shareholders’ resolutions appear in a single document.

The document should specify that these are resolutions of the eligible members of the shareholders.

It should clearly list each proposed resolution, noting whether it is ordinary or special.

It should be clear that the directors are proposing these resolutions to be passed, and that the shareholders’ signatures are now required.

It should provide instructions about how and when to return the resolutions.

What is the process for getting shareholders to approve the resolutions?

The proposed resolutions are usually sent out to the eligible shareholders along with all the other documents that relate to them.

This is the circulation date.

They then have 28 days to approve the proposed written resolution.

Even if you obtain 75% of the signatures by day 21, it might still good manners to wait the extra 7 days for the remaining shareholders to provide their responses. You don’t want them to feel excluded.

What are the implications of not passing the correct resolutions?

For new shares being issued:

• if authority is legally required, but knowingly not obtained, that is a criminal offence by the directors with personal liability,
• but the allotment itself is still valid - and the new shareholders are still valid owners.

For disapplying pre-emption rights:

• failure to do this creates a civil liability - which means the company is liable and each director is personally liable
• but the allotment itself still remains valid here too.

Where new articles are being adopted:

• the old articles remain in force, and
• there’s no criminal offence.

Do we need to send copies of the resolution to anyone? If so, by when?

Copies of written resolutions need to be sent to Companies House within 15 days of the date they are passed.

You do not need to send the signature pages - only the text of the actual resolutions needs to be sent to Companies House.

In practice, people often just send the whole thing anyway.

What happens if resolutions contain commercially sensitive information?

Section 29 of the Companies Act 2006 requires “a copy of the resolution” to be filed with Companies House, even if it contains commercial sensitive material.

This means:

• redacted parts are not permitted,
• you need to keep sensitive matter out of the resolution itself where possible,
• the resolution can cross reference other documents where sensitive information is contained, and
• if further detail about a resolution needs to be recorded, this can go in the board minutes (not filed).

Board resolutions

What are board resolutions in the context of a shareholders’ agreement?

Board resolutions formally record the decisions made by the company’s directors.

They also allow the board the carry out tasks on behalf of the company, such as those outlined in a subscription agreement.

Board resolutions can be passed at a meeting of the board with a show of hands, or they can also be passed as written resolutions.

Should directors hold a board meeting or pass board resolutions as written resolutions?

For transactions, written resolutions are quick - but they require unanimous consent. This means additional signatures may be required if there are multiple directors.

Board resolutions passed at a meeting only require a majority vote. These decisions are recorded in board minutes.

What are board minutes?

Board minutes are a record of a meeting of the board.

The board doesn’t actually have to meet in order to agree on the contents of board minutes. But they do serve as a detailed formal record.

Usually, only the chair of a company will sign the board minutes.

What is the difference between board minutes and board resolutions?

Board minutes record board resolutions within a wider narrative, providing context and explanation for the decisions taken.

Who needs to sign the board minutes or written resolutions when putting together a shareholders’ agreement?

If the board resolutions are to be passed as written resolutions, every director.

If the board resolutions are documented in board minutes, only the chair (or a single director).

Are non-director shareholders entitled to copies of the board minutes that relates to the shareholders’ agreement?

No, shareholders are not entitled to see board minutes (unless an existing shareholders’ agreement gives them this right).

However, incoming shareholders may ask for a copy to ensure that the company is following the correct processes.

Which board resolutions are typically passed when implementing a shareholders’ agreement?

Each document that the company needs to sign has to be considered and signing it needs to be approved.

If new shares are to be alloted issued, this needs to be approved and the directors are authorised to do what is required.

If new directors are being appointed or new service contracts are being put together for them, this also needs to be approved.

Resolutions are usually passed to make it clear what documents need to be filed by when and by whom.

How should we store and maintain copies of board minutes?

They should be stored in chronological order and kept private.

Nobody is entitled to see board minutes other than the board.

Copies will need to be shown to potential investors or acquirers.

What happens if there is a mistake in the board minutes? Can they be amended?

Board minutes record what happened at the meeting itself. So a mistake in the minutes does not invalidate any actual decision, provided that decision was actually made.

If amending them is necessary, this can be done at the next board meeting, or corrected by written resolution. You could even add supplementary minutes to the original ones.

The key thing is not to just rewrite and bin the originals.

What happens if a shareholders’ agreement is put together without proper board resolutions being passed?

The shareholders’ agreement document itself will probably still be valid. But if the company is a party to it:

• it may not have had the right approval to sign it (but this can be ratified later), but
• actions taken on the basis of the new agreement may be void.

The process to be followed

What are you trying to achieve?

The goal is for each person who should be a shareholder, to be a shareholder.

Once they are a shareholder, they need to be signed up to the shareholders’ agreement.

At the same time, the company needs to adopt the new articles.

You want this to be done as cleanly as possible.

One person needs to drive this job. Agree who that will be first.

What is the process?

We covered this above in depth above. In short:

1. The shareholders need to discuss and agree the main terms, recording them on a term sheet.

2. The term sheet is used as the basis of the documents. Use Robolawyer or instruct a real one to produce them.

3. Each shareholder will have specific instructions and need to be sent specific documents. For example:

   • a person being issued new shares might be sent:

     • the draft shareholders’ agreement,
     • the draft new articles, and
     • a combined subscription letter and section 431 election.

   • whereas, an existing shareholder who is not a director might only be sent:

     • the draft shareholders’ agreement,
     • the draft new articles, and
     • the draft shareholders’ resolutions (because their approval is needed).

   • or, a shareholder who is also a director who would be sent:

     • everything that relates to them as an individual, and
     • everything that relates to the company.

4. Each party is given the chance to review the documents, comment on them and propose any changes. This is the point at which delays can arise, especially if individual parties then appoint their own advisors.

5. At some point, everyone will align and be prepared to sign the documents. Once signed and dated, the deal is done.

What is the first thing that needs to be done?

The person in charge needs to lead discussions about the terms between shareholders. The shareholders then come to an agreement on how the company should be structured and run. The person in charge prepares a term sheet to document the initial agreement.

What do we do with the term sheet?

Use Robolawyer to run the rest of the deal. Or give it to a lawyer who has experience doing this type of work before. Don’t try and do it yourself by filling out a template or by using Chat. It won’t be fit for purpose.

What’s the best way to share documents with the shareholders?

Identify who needs to be sent what. For example: directors will need to review board minutes. Existing shareholders will need to sign shareholders’ resolutions. New shareholders will want to see a subscription letter or agreement. Everyone needs sight of the articles.

Prepare individual emails to each party, explaining what each document is and why it needs to be signed.

Should we engage a lawyer or other advisor to help us deal with this?

If you’ve managed to make it this far down this guide, and you’re thinking ‘it doesn’t seem too hard’, then you probably don’t need a lawyer to guide you any further.

If you would rather offload everything, then maybe a lawyer or other advisor will add some value.

But even if you engage a lawyer, you will be doing most of the heavy lifting. This is because:

• you will have an existing relationship with your fellow shareholders and are best placed to communicate with them directly rather than via a lawyer, which is impersonal,
• as a founding or majority shareholder, you may want to direct how things should be set up and structured, and
• lawyers will typically charge a great deal more to do this work on your behalf - and you probably don’t want to spend that cash.

Do documents need to be sent to everyone all at once?

When putting together a shareholders’ agreement, yes, it makes sense to share everything all at once. You want everyone to be on the same page and have an equal opportunity to see and review the drafts.

How long should I give people to review documents before following up?

A week between nudges is reasonable. But remember, shareholders resolutions expire after 28 days of the circulation date that appears on the draft shareholders’ resolutions that you sent out. If you left them undated, that’s one less thing to worry about.

What kind of response should I expect after sending out documents for review?

It depends who prepares your initial drafts and how accurately they represent the term sheet that was agreed in principle.

If you use Robolawyer to prepare your term sheet and drafts, the number of comments and proposed amendments is often zero. This is because our drafts accurately represent each term, spread across the entire suite of documents you need, drafted in the correct way, so that they are legally enforceable and actually useful.

If you use a law firm, your results may vary depending on how much you paid and how experienced your lawyer is, and whether they’re actually representing you (so you don’t do anything at all) or as is more commonly the case, advising you in the background.

If you are running it yourself, you will need to keep track of each party’s comments individually, deciding when is the best time to make any changes and re-share all of the documents with everyone again.

How long should it take to complete a shareholders’ agreement?

Discussing and agreeing terms can take some time - and I think this is the right approach. The terms contain the essence of the agreement between everyone. There usually comes a point where you just know that everyone is aligned. I don’t think there is any point engaging a lawyer until you are there.

The remainder of the process shouldn’t take as long. Could be days or weeks, is often months. How long it takes - totally up to you.

How should people sign the documents?

Most people use Docusign or similar services or insert digital signatures into pdf files and send those back.

Some people still print, sign and scan (or send a picture) of the signature page.

Ask people to attach the entire original document when sending you signed signature pages by email. This avoids confusion about which version of the document the signed page belongs to.

What do I do with all the separate signed copies of documents that each party has emailed me?

You will need to assemble a single, final dated copy of the document which contains the main text and each person’s signature.

This is usually done by dragging and dropping pages in and out of pdf files.

What date should be put on the documents?

Ideally this should be the date (or soon after) that the shareholders’ resolutions are passed.

In practice, lawyers ask for documents to be left undated. This gives the parties more time to consider the proposal ‘unofficially’.

The documents are then usually dated on a single date, known as the completion date or closing date.

Do we need to keep wet ink / hard copies of documents?

No legal obligation, but I would suggest keeping at least one as an offline backup.