Corporate governance often involves dealing with three essential legal documents: Shareholders’ Agreements, Director's Service Agreements, and Employment Agreements.
When dealing with start-ups, I see a lot of confusion in relation to founders who occupy overlapping roles – founders may be, or believe themselves to be shareholders, directors and/or employees, sometimes without any documentation to support their belief, sometimes with documentation that undermines their purported role.
In this article, we aim to provide a clear understanding of these roles and agreements, highlighting their specific purposes whilst also drawing comparisons and distinctions.
A Shareholders’ Agreement (SA) is a legally binding contract signed between a company and its shareholders, so both the company and each of its shareholders are parties to the agreement, hence the apostrophe is usually after the s. Shareholders are the owners of a company, usually registered as such with Companies House. SA’s outline each shareholder's rights, responsibilities, and obligations. They are tailored to meet the needs of the parties, including the company itself.
Shareholder Agreements primarily focus on how the company is governed and managed, dividing power and responsibility between the board, major shareholders and minority shareholders. They define decision-making processes, director appointments, and voting rights. They ought to aim to safeguard the interests of shareholders, particularly minority shareholders, by providing dispute resolution mechanisms, share transfer restrictions, and exit strategies. Unless an SA is properly drafted, the company is unlikely to receive serious investments because investors will usually know that their interests will be properly protected. Thus, there may be tension between Founders and Investors in the drafting of an SA if a good agreement has not been drafted before the arrival of serious investors. SA’s must adhere to UK laws and regulations, including the Companies Act 2006.
Director's Service Agreements
A Director's Service Agreement (DSA) is a legally binding contract between a company and one of its directors. A director in this context is a member of the company’s board of directors. Usually, a director is duly appointed by the board or shareholders and registered as such with Companies House, but (confusingly) a person can be a shadow director (a role that involves legal liability) without being appointed or even called a director. Perhaps worse, a person who has ‘Director’ in their job title, for example an HR Director, is not necessarily a member of the company’s board (or registered with Companies House) but can still be deemed to be a shadow director.
A DSA outlines the terms and conditions governing the director's role, responsibilities, and rights. Sometimes a director will be an employee of the company, other times not.
DSA’s sometimes serve as employment contracts for directors, detailing their remuneration, duties, and employment terms, together with clarity on their roles and responsibilities as directors within the organization, including their authority and obligations.
Other times, a DSA might include provisions related to confidentiality, non-competition, and intellectual property rights, similar to those that usually bind employees, but may not actually give the director the rights of an employee, instead being tailored to the different roles and remuneration arrangements of non-executive directors. A non-executive director is a member of the board who is not employed by the company in a decision-making (executive) role.
In either case, DSA’s ought to comply with both UK employment and company law, although employment law will be less relevant for a non-executive director.
An Employment Agreement (EA) is a legally binding contract between an employer and an employee, covering terms and conditions of employment, including job responsibilities, compensation, benefits, and termination provisions.
Employment Agreements are designed for all employees, encompassing employment terms for non-directors and non-shareholders. Whether an employee is also a director and/or shareholder is a separate matter that ought to be covered by the relevant DSA and/or SA.
Employment Agreements must ensure compliance with UK employment laws, regulations, and standards. They apply to all employees within the organization, irrespective of their role or ownership stake.
Shareholder Agreements concentrate on governance and shareholder rights, DSAs on director’s duties and obligations, and Employment Agreements on employees’ rights and responsibilities.
All three types of agreement bind the company: Shareholder Agreements also bind shareholders, DSA’s bind directors, and Employment Agreements bind all employees.
It is not uncommon for a Founder who is also a director and an employee to be asked to execute and be bound by all three agreements. Similarly, an investor (shareholder) who is also on the board, might be asked to execute and be bound by the SA and a DSA. An employee who has executed an Employment Agreement might be asked to execute a Shareholders’ Agreement when issued with employee shares, or to sign a DSA if elevated to the Board.
All three agreements are therefore designed to protect the company, and each protects the party to whom it relates.
Shareholder Agreements are more difficult to change as time goes on, because each and every party must usually agree to a change in the agreement, subject to what the agreement says about its ability to be amended. DSA’s are often tailored to specific directors and may be negotiated accordingly. Employment Agreements can be standardized or customized, usually depending on the nature of the role.