How Do Articles of Association or Shareholders’ Agreements Impact Valuation?
Articles of Association are an often overlooked fundamental pillar of any company.
A company’s articles expressly set out key aspects of its governance, such as how it must be managed and run, who makes decisions and when.
A company’s articles of association are publicly available via Companies House, and having these in place is a mandatory requirement for forming (or incorporating) a company in England and Wales.
Shareholders’ Agreements are voluntary binding contracts between owners (shareholders) of a company.
These typically provide a more nuanced, detailed agreement between the shareholders and cover a range of factors, including how, when and for what price shares can be transferred or sold and what happens in case of a dispute.
Shareholders’ Agreements are essentially a business pre-nup.
Our specialist litigation team does not draft Shareholders’ Agreements or Articles of Association, but we frequently and routinely litigate for shareholders and companies in disputes across the country.
Should a dispute arise, having well-drafted Shareholders’ Agreements or Articles of Association in place can significantly impact the outcomes.
In this context, we address below how both Articles of Association and Shareholders’ Agreements can impact valuation.
What’s the Difference Between Articles of Association and Shareholders’ Agreements?
What Are Articles of Association?
Articles of Association (AOA) are a statutory requirement for all limited companies incorporated in England and Wales.
A company can have unique Articles of Association, but specific provisions must be included by law.
Companies of all sizes often use standard Articles of Association known as ‘model’ articles.
The government provides these to make it as easy as possible to satisfy the legal requirements for establishing a limited company:
- Model articles for private companies limited by shares
- Model articles for private companies limited by guarantee
- Model articles for public companies
The Articles must be registered at Companies House as part of the company’s constitution, along with a Memorandum of Association.
Essentially, a company’s Articles of Association sets out the regulations company officers and shareholders must follow when operating the business.
Some of the crucial aspects of company operations laid out by the Articles include:
- Details regarding meetings and minutes
- Decision-making rights and responsibilities regarding company matters;
- Shareholder rights and liability;
- How conflicts of interest can/should be managed;
- Arrangements concerning the number and types of shares;
- How the administration and issuance of new shares should take place;
- How shares can be sold or otherwise change hands;
- Processes concerning the payment of dividends;
- Governance in relation to the appointment and removal of company directors;
- Director roles and responsibilities; and
- How decisions by shareholders are made.
Although model Articles of Association are frequently used, it can be of considerable benefit to consider whether amendments are needed and might be more appropriate, especially before any dispute arises.
Afterwards, it’s usually too late.
Amendments to the model articles are very common with well-advised companies and investor shareholders and are found regularly in larger businesses.
What Are Shareholders’ Agreements?
A Shareholders’ Agreement (SHA) is a legally binding private contract between some or all shareholders of a private company that outlines how the business is run and defines the relationship between stakeholders.
Unlike the Articles of Association, a Shareholders’ Agreement (SHA) is not a legal requirement for limited companies in England and Wales, but it is extremely sensible to obtain one.
A well-drafted Shareholders’ Agreement:
- Helps protect the rights of minority and majority stakeholders
- Defines director and shareholder responsibilities
- Lays out a mechanism for dispute resolution should disagreements occur.
Depending on what side of the dispute our client falls on, a shareholders agreement can be very helpful to us as litigation specialists.
Having a direct contract between shareholders enables us to consider claims based on breach of contract.
If no Shareholders’ Agreement is in place, shareholders are left to rely on one or more of the following.
- Companies Act 2006 regulations
- Allegations of unfair prejudice in breach of Sections 994-996 Companies Act 2006
- Breach of Director duties
- Is the company a quasi-partnership?
Obviously, care should be taken to ensure that the voluntary Shareholders’ Agreement and mandatory Articles of Association work in tandem and don’t contradict each other.
Another advantage of a Shareholders’ Agreement is that it is a private contract between some or all shareholders.
It does not have to be made public, whereas the Articles are publicly available at Companies House.
Which Takes Precedence?
Every effort should be made to ensure that the Articles of Association do not conflict with the provisions of a Shareholders’ Agreement.
Many companies adopt new Articles of Association upon establishing a Shareholders’ Agreement to help avoid potential conflicts and contradicting content between the documents.
In cases where there is a conflict between the Articles of Association and a Shareholders’ Agreement, the Articles will likely take precedence.
A recent High Court decision in Lord v Maven Wealth Group Ltd [2021] EWHC 2544 confirmed that the Articles of Association superseded the mechanism for determining the fair value of shares in the shareholders’ agreement.
However, this decision is not as definitive as it may appear.
Many Shareholders’ Agreements contain a ‘supremacy clause’ that seeks to ensure that the SHA overrides the Articles.
It is best practice to ensure there is no conflict between the AoA and SHA in the first place.
Judgments in such matters are very case-specific.
Absent any relevant express clauses, the last agreed document would likely take supremacy in any litigation.
Valuing Private Company Shares
The Articles of Agreement and the Shareholders’ Agreement — if there is one — can determine how shares in a private company are valued and how, if, and when they can be sold.
Determining value is essential for share transactions to take place and is fundamentally important in the shareholder litigation we are instructed to deal with.
For example, growth potential will likely be emphasised if the shares are valued for outside investment.
Conversely, if the shares are being transferred internally within the company, the focus will likely be more on present-day value than future growth.
There are several accepted private company share valuation approaches, the most common being:
An AOA or SHA may specify which valuation method is to be used in the event of internal and external transactions or disputes.
Private company share valuations are typically undertaken by third parties, such as experienced forensic accountants or other business valuation experts. A valuation expert may be retained by the company, a shareholder, or an outside investor or lender seeking to determine the business’s worth.
The courts may also appoint valuation experts to aid in resolving a shareholder dispute.
Our preference is always to ensure we obtain an expert report — not least so that we are in control of that instruction and the resulting report/evidence.
Valuation is crucial in litigation as it significantly impacts the shareholder’s realisation of value.
Additionally, valuing shares at “X” rather than “Y” date can drastically change the resulting valuation.
Articles of Association and Shareholders’ Agreements: Valuation Implications
Shareholders’ Agreements and/or expertly drafted Articles of Association often set out express terms for how shares are valued in internal and external transactions and cases of dispute.
In theory, setting out a valuation mechanism in a binding contract like a Shareholders’ Agreement reduces uncertainty about the worth of individual shares, the conditions under which they can be sold or transferred, and the possibility of costly litigation if there’s a dispute.
In reality, a valuation formula agreed upon at the outset of a commercial venture when value is yet to be created may not reflect everything that comes later in terms of a fair market value after a business has evolved and time has elapsed.
For that reason and others, disagreements over company valuation are often a central aspect of shareholder disputes.
Clauses regarding valuation in the Articles of Association or SHA inevitably impact the value of individual shares — for better or worse.
Classes of Shares
Small private companies typically start by issuing ‘ordinary’ or common shares.
Ordinary shares are simple.
Each share represents a percentage of company ownership based on the total number of shares issued.
For example, if a company issues 100 shares and you own 10, you own 10% of the company.
The minimum number of shares a limited company can issue is one — this structure is frequently used for companies with a sole owner and director.
No upward limit exists on the total number of shares a company can issue.
However, the value of individual shares is diluted each time the company issues additional shares.
Generally, ordinary shares entitle shareholders to dividends (where payable), voting rights, and participation in surplus asset distribution if the company winds up.
Ordinary shares are commonplace, but many other classes of shares exist.
Often, a company issues ordinary shares when first established and then establishes different classes of stock as the business grows and evolves.
The most common share classes include:
- Ordinary shares
- Deferred ordinary shares
- Preference shares
- Non-voting shares
- Redeemable shares
Additionally, many companies subdivide ordinary shares by alphabetical Class, such as:
- Class A
- Class B
- Class C
Each class designates the shareholder a different percentage of specific rights, such as voting, dividends, and capital rights.
Unless prohibited by the Articles of Association or Shareholders’ Agreement, a company is free to issue additional shares at any time after formation.
Any share structure or allotment amendments must be reported to Companies House using Form SH01.
Frequently Asked Questions
What Is the Relationship Between Articles of Association and a Shareholders’ Agreement?
Articles of Association are mandatory for incorporating a limited company in the UK. A Shareholders’ Agreement is a voluntary but legally binding private contract between some or all shareholders in a company that sets out the relationship between stakeholders in a business, share structure and valuation, decision-making, and how the business is run.
Need Advice? Contact Helix Law.
If you’re involved in a shareholder or boardroom dispute, it’s essential to consider and understand the content of the Articles of Association and Shareholders’ Agreement in detail.
Otherwise, you’ll be ill-equipped to assess your overall position and the potential value you can hope or expect to achieve out of the dispute and your shares or Directorship.
Helix Law is a firm of specialist litigation solicitors.
Our commercial litigation team is instructed in shareholder disputes across the country, usually when something’s gone wrong or there has been wrongdoing.
Whatever your situation, we’d be happy to speak with you.
Contact Helix Law today. We aim to respond to all queries within an hour.
