Overview of a Shareholders’ Agreement

What is a Shareholders’ Agreement?

A Shareholders’ Agreement is a contract among founders of a company to regulate their rights as shareholders of the company.

In a Shareholders’ Agreement, the founders agree on a set of rules for the future transfer of shares and the level of consent required for making major decisions.

A Shareholders’ Agreement protects founders of a business by imposing restrictions on the transfer of issued shares so that when one founder leaves, the sale of his shares is subject to other founders’ consent or the remaining founders have the chance to buy his shares before someone outside the company does.

Does a Shareholders’ Agreement override articles?

A Shareholders’ Agreement is a document that is drafted to regulate the relationship between shareholders and protect their rights. Whereas an article is more like a constitution of a company that regulates the overall management structure of a company. There might be situations when a shareholder agreement and articles can collide. To avoid such a situation, a shareholder agreement has a “supremacy clause” that means in such case a shareholder agreement will be given priority.

What should a Shareholders’ Agreement include?

A Shareholders’ Agreement provides measures to regulate the shares between each shareholder. It also defines the right and obligations of each shareholder towards the company. Some of the important things to include in a Shareholders’ Agreement are:

Name, address, and shareholding of each investor: Name, address, and details of the shares that each shareholder has should be clearly written in a Shareholder’s Agreement.

Restrictions on share transfer: if any shareholder wants to leave the company then a Shareholders’ Agreement provides measures to deal with share transfer provision and restriction. Generally, there is two option:

  • The tag-along option is where a shareholder intends to sell his shares to a third-party buyer, a tag-along option will allow fellow shareholders to “tag-along” with the sale, i.e., to sell their own shares along to the same third-party buyer on the same terms.
  • The drag-along option is where a majority shareholder (or a group of shareholders) intends to sell his shares to a third-party buyer, the drag-along provision gives him a right to force remaining shareholders (typically minority shareholders) to sell their shares to the same buyer on the same terms.

Confidentiality obligation: It is the implied terms or obligation for each shareholder to not disclose the company’s internal affairs with any outsiders. Providing information regarding finance, sales and future plans of the company might have serious negative consequences towards the growth of an organization.

Founder vesting: This is the concept that a founder’s total ownership in a company is agreed to in the present and earned over time, not that much unlike a salary or other time-based compensation. If a founder leaves a company, the unearned portion of their ownership is canceled or returned to the company.

Shareholder death clause: A mandatory offer of shares upon death or liquidation of a shareholder ensures that the shares of the company will remain in the hands of the remaining shareholders.

Deadlock: A deadlock is a situation where two shareholders or two groups of shareholders are unable to agree on certain key matters. Deadlock arises when shareholders’ meetings are repeatedly inquorate because one group of shareholders refuses to attend, or when one group of shareholders votes down or abstains on a resolution proposed by the other group.

What is the purpose of a Shareholders’ Agreement?

A Shareholders’ Agreement is a contract signed by company shareholders to govern the relationship between shareholders and the company’s management. The basic purpose of any Shareholders’ Agreement is

Dispute resolution mechanism: When disputes do arise, there is often little in general law that is of assistance; sometimes the only solution may be to dissolve the company, even if the company itself is successful. A Shareholders’ Agreement can be a very useful tool in avoiding and managing such disputes and can include provisions setting out a mechanism for the parties to resolve disputes without needing draconian measures such as dissolving the company.

Investor protection: Investors are taking a risk in their investment as they may not recover the monies which they invested into the company. So they often require the shareholders to agree to certain provisions designed to protect their position. For example, they might require performance targets for the company to meet within a given time and if those targets are not met, the investor has the ability to require certain actions to be taken or has the opportunity to take control of the company. These provisions are often found in a Shareholders’ Agreement.

Confidentiality: The shareholders are likely to have access to valuable confidential information about the company by reason of their involvement in the business. While the general law provides that a person who has received information in confidence cannot take unfair advantage of it, most shareholders are not prepared to rely on this alone. A Shareholders’ Agreement containing confidentiality provisions is the best way for a company to ensure that the shareholders will keep information about the agreement and about the company confidential during the life of the agreement and following its termination.

Conclusion

Business keeps changing with the external environment it dealt with. There might be changes in the business product line or the way the business is providing its services or changes to share capital. The most important thing that keeps the business operations running is the mutual understanding between each shareholder to grow and adapt according to the external business environment. A well-drafted Shareholder’s Agreement can help any business to grow and thrive to its full potential.

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