In company law, the profits of a company (i.e. what is left after overheads and salaries have been paid) can be distributed between the shareholders in proportion to the shares that they hold. This is called “dividends”.
The Shareholder Agreement can specify how the dividends are to be paid in certain scenarios – for example, if the directors cannot otherwise agree on whether to pay out or to invest.
There is no automatic duty on the directors to issue dividends to the shareholders. By the same token, there is no duty to keep anything back to re-invest in the business. While a degree of flexibility is essential to the success of a business, dithering is of no use to anyone, so having a settled accounting basis in the Shareholder Agreement can help resolve any hesitations. One such point of indecision could stem from something as simple as defining what the net profit is, in order to work out what is distributable.
A common scenario is that a Shareholder Agreement will be used to ensure that a percentage of net profits (e.g. 25%) will always be distributed, regardless of what else is happening within the business. This is most relevant in companies where there is a 50/50 split and where disagreement will lead to deadlock and the default position that nothing is decided and no course of action taken. A clause to ensure that at least some of the profit is distributed will ensure that the most solvent party does not force the other into accepting a lower exit settlement by preventing money from leaving the company during the negotiation period as a hard-ball negotiating tactic.
If you’re looking for more flexibility in issuing dividends, you may again turn to alphabet shares, where different categories of shareholders may receive different amounts in different circumstances. This may be useful in a situation where remuneration is linked to the amount of fees earned by the director-shareholders – in a recruitment consultancy or other ‘individual sales’ type business.
Another useful clause could be that if shareholders have made loans to the company then no dividends will be paid until all loans have been paid in full. This ensures that the shareholders who bankrolled the company in the early days are repaid in full before the profits are shared amongst the other shareholders, who perhaps didn’t contribute when the risk of non-repayment was greatest.
Remember, of course, that corporation tax needs to be paid on company profits before the dividends are dished out. The Shareholder Agreement should include a note that provision will be made for corporation tax before dividends are paid.