{"id":29149,"date":"2019-07-24T13:04:03","date_gmt":"2019-07-24T05:04:03","guid":{"rendered":"https:\/\/zegal.com\/?p=29149"},"modified":"2023-06-29T15:37:50","modified_gmt":"2023-06-29T07:37:50","slug":"five-clauses-every-shareholders-agreement-should-include-does-yours","status":"publish","type":"post","link":"https:\/\/zegal.com\/en-gb\/blog\/post\/five-clauses-every-shareholders-agreement-should-include-does-yours\/","title":{"rendered":"Five Clauses Every Shareholders\u2019 Agreement Should Include"},"content":{"rendered":"\n
\"shareholders<\/figure>\n\n\n\n

Your company may be right on track; internal relationships are building, external networks are expanding and net profits are growing.<\/span> That\u2019s all good to hear, but has it ever crossed your mind that something unpredictable might mess up what\u2019s seemingly perfect right now? <\/span><\/p>\n\n\n\n

It could be a a breakdown in the shareholders\u2019 relationship or in a shareholder\u2019s unfortunate bankruptcy or even death. Numerous businesses fall into vulnerable situations because shareholders hadn\u2019t given enough thought to what may possibly go wrong. <\/span><\/p>\n\n\n\n

Remember back in 2005 when Mark Zuckerberg diluted Facebook co-founder <\/span>Eduardo <\/span>Saverin\u2019s stake in Facebook and kicked him out of the company? You never know when an amicable relationship can turn sour. That\u2019s why it\u2019s always wise, for any practice with multiple shareholders, to sign a shareholders\u2019 agreement<\/a> to safeguard your interest down the road.<\/span><\/span><\/p>\n\n\n\n

<\/span>What is a Shareholders\u2019 Agreement?<\/strong><\/span><\/span><\/h2>\n\n\n\n

A shareholders\u2019 agreement is a binding contract concluded between the shareholders of a company, to define their respective rights and entitlements and to organise the management of the company. <\/span><\/p>\n\n\n\n

It is in place to supplement the company\u2019s articles of association<\/a>. Some mandatory provisions must be included in the agreement but the rest is for the company\u2019s shareholders to decide based on their personal goals and industry-specific objectives.<\/span><\/p>\n\n\n\n

From mapping out management strategies, to governing loans or debt arrangements, to setting out the impact of capital raising on voting power, a shareholders\u2019 agreement is there to provide clear guidance at times of change and uncertainty.<\/span><\/p>\n\n\n\n

<\/span>Five Important Clauses to Include in Your Shareholders\u2019 Agreement<\/strong><\/span><\/span><\/h2>\n\n\n\n

<\/span>1.Share Vesting Clause<\/span><\/strong><\/span><\/h3>\n\n\n\n

You may often hear vested shares as part of the reward for shareholders, particularly for startups. Share vesting<\/a> for shareholders basically means that founders do not own the shares until some conditions are fulfilled. This benefits the company in multiple ways, including encouraging retention and postponing the pay out of cash. The conditions and details of how shares are vested are known as the Terms of Vesting<\/a>, which should be stated in the Shareholders\u2019 agreement to avoid disputes. Some Terms of Vesting include<\/span> remaining with the business for a minimum period of time or hitting specific company targets. The company has an automatic right to purchase any unvested shares either at the original purchase price or at fair value, depending on how the shareholders\u2019 agreement stipulates. A common vesting schedule is to vest shares over a period of 4 years on a monthly basis, subject to a cliff period (i.e. a minimum period of time has to pass before the allotment of shares). To illustrate this with an example, let\u2019s say the cliff period is 12 months, then 25% of the shares would have been vested after a year, with the remaining 75% to be vested proportionally in the next 36 months.<\/strong><\/span><\/p>\n\n\n\n

<\/span>2.Pre-emptive Rights and Right Of First Refusal Clause<\/span><\/strong><\/span><\/span><\/h3>\n\n\n\n
\"\"<\/figure>\n\n\n\n

<\/span>3. Special Rights to Appoint Directors and Super-Majority Clause<\/span><\/strong><\/span><\/h3>\n\n\n\n

These clauses are introduced to securing the interest of minority shareholders. In general, minority shareholders cannot block the passing of ordinary resolutions, such as the appointment and removal of board directors<\/a>. In other words, a minority shareholder can have 49% of shareholding but still have no power to influence the composition of the board of directors. To mitigate such rigidity, the shareholders\u2019 agreement can provide for a clause that enables a minority shareholder, with a minimum percentage of share, to appoint or remove a director. Alternatively, shareholders may opt for a supermajority clause, which requires that certain major decisions can only be passed with the consent of more shareholders, say 75%. This prevents minority shareholders\u2019 voices from being buried and affords them with more bargaining power in the company.<\/strong><\/span><\/p>\n\n\n\n

<\/span>4. Non-competition Clause<\/span><\/strong><\/span><\/h3>\n\n\n\n

Non-competition clauses<\/a> are commonly found in shareholders\u2019 agreements. By clarifying when and how a shareholder may carry out rival activities during and after his time as a shareholder of the company, it eliminates any ambiguity that may arise due to the want of explicit restrictions. The rationale behind controlling shareholders\u2019 external pursuits is that prime knowledge about the company\u2019s intellectual property or management system, which are crucial elements to keeping the company\u2019s edge, shall stay confidential notwithstanding the come and go of shareholders. The shareholders\u2019 agreement should state loud and clear the dos and don\u2019ts, including the scope and the period of these restrictions. It\u2019s imperative that the shareholders\u2019 agreement includes a non-competition clause, or there\u2019d be no use crying over spilt milk if a shareholder takes advantage of the loophole and exposes the company\u2019s trade secrets. However, bear in mind that non-competition clauses have to be reasonable in order to ensure their enforceability.<\/strong> If they are inordinately restrictive or drafted in an excessively broad manner, the court may rule that such a clause has no effect on the shareholder.<\/p>\n\n\n\n

<\/span>5. Deadlock Resolution Clause<\/span><\/strong><\/span><\/h3>\n\n\n\n

A pre-agreed dispute resolution mechanism is constructive towards overcoming deadlocks in both 50:50 owned companies and companies with disproportionate shareholding. When shareholders with equal standing are unwilling to budge from their stance or when a super-majority or unanimous consent is required but cannot be attained, the company enters a deadlock. This would force an otherwise completely functional business into a standstill if the shareholders cannot compromise and move forward as one.<\/strong> The shareholders\u2019 agreement should define, ahead of time, what constitutes a deadlock (eg. the failure to pass a resolution after two or more attempts) and the panacea for such an occurrence. There are various formulations of deadlock resolution clauses, each bearing different implications. A \u201cRussian Roulette Provision<\/strong>\u201d, generally more favourable to shareholders with deep pockets, allows a shareholder to issue a notice indicating the intention to buy out the other shareholders at a specified price. On the other hand, a \u201cPut Option<\/strong>\u201d is more beneficial to shareholders with weaker financial abilities as he is entitled to sell his shares<\/a> to another shareholder at a predetermined, fair price. A \u201cSealed Auction Provision<\/strong>\u201d enables the shareholder with the highest bid to purchase the others\u2019 shares at the stated price. There isn\u2019t an absolute answer to which provision is the best, it all hinges on the shareholders\u2019 preferences and course of negotiations.<\/span><\/p>\n\n\n\n

The above does not summarise all<\/em> the important clauses that a shareholders agreement should include. Some other widely recognised clauses pertain to drag-along rights, liquidation preferences<\/strong> and debt and equity capital arrangements<\/strong>. It’s necessary for shareholders to sit down and discuss their expectations and commitments to the company before a water-tight shareholders\u2019 agreement can be drafted.<\/span><\/p>\n\n\n\n

You may still have second thoughts about entering into a shareholders\u2019 agreement, thinking \u201cIt sounds goods, but maybe my company doesn\u2019t need one<\/em>\u201d. The truth is every working relationship starts off with the best of intentions, but you just can\u2019t guarantee how things will roll out.<\/p>\n\n\n\n

So for all that\u2019s ahead, you should have a signed a shareholders\u2019 agreement.<\/p>\n\n\n\n

This article does not constitute legal advice.<\/i><\/b><\/p>\n\n\n\n

The opinions expressed in the column above represent the author\u2019s own.<\/i><\/p>\n\n\n\n

Start managing your legal needs with Zegal today<\/b><\/a><\/span><\/p>\n\n\n\n

 <\/p>\n\n\n\n

READ MORE: Business Documents You Need As A Business Partnership<\/a><\/p>\n\n\n\n

DOCUMENT: Share Subscription Letter<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Your company may be right on track; internal relationships are building, external networks are expanding and net profits are growing. That\u2019s all good to hear, but has it ever crossed your mind that something unpredictable might mess up what\u2019s seemingly perfect right now? It could be a a breakdown in the shareholders\u2019 relationship or in […]<\/p>\n","protected":false},"author":51,"featured_media":127369,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_editorskit_title_hidden":false,"_editorskit_reading_time":5,"_editorskit_is_block_options_detached":false,"_editorskit_block_options_position":"{}","inline_featured_image":false,"footnotes":""},"categories":[14278,133],"tags":[8104,10307],"usecases":[13751,13716],"businesstypes":[],"country":[],"class_list":["post-29149","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-business-management","category-startup","tag-non-competition-clause","tag-z-syndicate","usecases-communicate-with-shareholders","usecases-set-up-a-shareholders-agreement"],"acf":[],"yoast_head":"\nFive Clauses Every Shareholders\u2019 Agreement Should Include<\/title>\n<meta name=\"description\" content=\"You may 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These are some highly-valued mechanisms sought by shareholders and are usually incorporated in most shareholders\u2019 agreements. These clauses serve to protect existing shareholders from the involuntary dilution of their stake in the company. Any new issuance of shares (pre-emptive right<\/a><\/strong>) or outgoing shareholder\u2019s shares (right of first refusal<\/a><\/strong>) must first be offered to existing shareholders before they can be sold to a third party. Such rights are usually on pro-rata basis, although in some cases, the parties may agree to a \u201csuper pre-emption\u201d which means some shareholders may be entitled to invest more than pro-rata. Without these important safeguards, existing shareholders will end up with a smaller piece to a larger pie eventually.<\/strong> This is clearly unfavorable to the founders, which is why we strongly recommend that these rights be put in writing.<\/span><\/p>\n\n\n\n