Your Company’s Constitution

It is likely that you, as the founder, will wish to grow your business by involving others as investors, partners, consultants or employees.  Any one individual may fulfil more than one of these roles.  Investors and partners will wish to hold shares in your business, and you may also want to reward and incentivise consultants and employees by issuing shares – or share options – to them, especially at the outset when cash will be scarce.  Before issuing shares to others it is advisable to establish a constitution to regulate your relationship with the investors, to protect your business, and to set out an orderly exit route.

Most businesses are initially launched as a Private Company Limited by Shares.  A company’s formal constitution will be contained in its Articles of Association which is a public document, but it is likely that the shareholders will also enter into a separate Shareholder’s Agreement.

Other possible legal structures include a Sole Trader, a traditional Partnership, and a Limited Liability Partnership.

The following factors are worth bearing in mind:

  • An experienced investor may propose his own set of documents, which should be carefully vetted.  A sensible investor will not wish to disincentivise you by imposing onerous terms, but depending upon your bargaining strength, you should aim to optimise your control both as shareholder and director.
  • An investor will normally want to prevent dilution by ensuring that you may not issue further shares without giving him or her the right to maintain his percentage of the share capital by purchasing a proportion of the new shares.  The Companies Act 2006 includes this protection but also gives you the right to exclude it.   The experienced investor may insist that it is included – but if it is excluded you will have the freedom to issue shares whenever and to whomever you wish.
  • An investor may wish to influence the management of the company by having the right to appoint a director, or by including in the Shareholder’s Agreement a list of key business decisions which the directors may not undertake without the approval of the investor.
  • You will normally want to ensure that if any shareholder wishes to sell his shares, then you will have the first right of refusal.  Such “pre-emption rights” are sometimes contained in the Shareholder’s Agreement, but generally we advise that they are in the Articles (being a public document) so that potential buyers are aware of them.
  • The documents may include provisions which require that in certain circumstances you have the right to buy out a shareholder – for instance in the event of a shareholder’s death, or if you have issued shares to an employee and he or she stops working for the Company.  If you include such provisions then you should also specify how the sale price should be fixed.
  • You may wish to include “tag along” and “drag along” rights which provide obligations of share sale on minority and majority shareholders in the event of a takeover.
  • If you have an equal partner, then the Shareholders’ Agreement can include procedures for addressing disagreements and the mechanics for an orderly exit from the Company by one of you in the event of a falling out.
  • You may protect your business by including confidentiality and non-competition clauses in the Shareholders’ Agreement.   These are especially helpful where your shareholders are involved in the running of the business as employees or consultants.  Employment contracts often contain similar clauses but the courts have held that non-compete clauses are easier to enforce if contained in a Shareholders’ Agreement or Share Sale Agreement.

Our Business Law Team is here to help you in modelling your constitution to fit your needs and to meet the reasonable requirements of your investors.