Shareholders Agreement

What is a shareholders agreement?

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

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

A Shareholders’ Agreement protects the 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.

What is the role of a Shareholders Agreement template?

A shareholder Agreement helps ensure that shareholders are treated fairly, and their rights are protected. It also helps in mitigating the risk of any conflicts that could occur in the future.

The Shareholders’ Agreement helps facilitate cooperation among the shareholders and ultimately aids in increasing the likelihood of a company becoming successful.

When creating an agreement, some of the essential provisions to include in a shareholders agreement template are:

Name, address, and shareholding of each investor

Personal and identifying details of the shareholders need to be mentioned along with their duties, responsibilities, and entitlements.

Detailed governance and management provisions

A shareholders’ agreement must have governance provisions about how the company will be managed. This can include details of how officers will be appointed, how official meetings such as board and shareholders meetings will operate, and how decision-making will occur among the shareholders.

Restrictions on share transfer

If any shareholder wants to leave the company or sell their shares, a Shareholders’ Agreement provides measures to deal with share transfer provisions and restrictions.

For instance, this can include clauses stating that the first right to purchase a shareholder’s share will be given to existing shareholders and only then to third parties.

Generally, there are two options:

Tag-along

The tag-along option is where a shareholder intends to sell their shares to a third-party buyer and will allow fellow shareholders to “tag along” with the sale, i.e., sell their own shares to the same third-party buyer on the same terms.

This ensures that where a good deal is made by a shareholder (typically a majority shareholder), remaining shareholders (typically minority shareholders) can exit on the same terms.

Drag-along

The drag-alone 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 them a right to force remaining shareholders (typically minority shareholders) to sell their shares to the same buyer on the same terms. This ensures that the third-party buyer can acquire the entire company, which could be crucial in negotiating the sale.

The drag-along mechanism is a drastic measure, and minority shareholders must understand its implications before agreeing.

Confidentiality obligations

This prevents the disclosure of information regarding finance, sales, and the company’s future plans, which might have serious negative consequences for an organisation’s growth.

Founder vesting

It is very common in venture-backed startups for the founder to be treated differently from investors.

A founder may agree to have ‘vested shares’, which means some or all of the founder’s shares are not fully ‘owned’ by the founder until they have earned them (by working for a set period or hitting specific milestones).

If a founder leaves a company, the unearned portion of their shares is either cancelled or returned to the company.

Deadlock clause

A deadlock is when two or more shareholders cannot agree on certain key matters.

Deadlock arises when shareholders’ meetings are repeatedly inquorate (unable to proceed) because one group refuses to attend, votes down, or abstains from a resolution proposed by the other group. There must be provisions on how a deadlock will be resolved so the company can move forward.

Restrictive covenants

Shareholders of a company are restricted from becoming a shareholder or competing or enticing away customers during the period they are shareholders and until a specified period after they cease to become one in a company by the restrictive covenant clause. 

Confidentiality/NDA clause

Shareholders are likely to have access to valuable confidential information about the company.

While the general law states that a person who has received information in confidence cannot use it to take an unfair advantage, most will not rely on this alone.

A Shareholders’ Agreement with confidentiality provisions, or an additional NDA, is best for a company to keep information confidential.

A dispute resolution mechanism

When disputes arise, a Shareholders’ Agreement can be a valuable tool to avoid and manage conflicts without reverting to extreme measures, like dissolving the company.

Investor protection

Investors often require the shareholders to agree to specific provisions designed to protect their position. For example, they might require performance targets or a board seat on the board of directors. These provisions are often found in a Shareholders’ Agreement.

Shareholder’s death or default

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

In a Shareholders’ Agreement, the fair value of the shares is determined by the company’s auditors, or if the auditors decline instruction, by an independent accounting firm appointed by the company.

Founder vesting

Founder vesting 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 cancelled or returned to the company.

Things to consider when you set up a Shareholder’s Agreement

• Disputes: When disputes arise, there is often little in the general law that is of assistance. Sometimes, the only solution may be to dissolve the company, even if the company itself is successful. A shareholder’s agreement can be a handy tool in avoiding and managing such disputes. It can include provisions setting out a mechanism for the parties to resolve disputes without needing draconian measures such as dissolving the company. Sometimes, to resolve a dispute, one or more shareholders may agree to sell their shares to the other shareholders. A shareholder’s agreement will often include valuation provisions to ensure a precise valuation mechanism for those shares and avoid a further dispute regarding the price to be paid.
• Investor protection: Investors are taking a risk on their investment as they may not recover the monies they invested into the company, so they often require the shareholders to agree on specific provisions designed to protect their position. For example, they might need performance targets for the company to meet within a given time. 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 shareholder’s agreement.
• Confidentiality: The shareholders are likely to have access to valuable confidential information about the company by reason of their involvement in the business. A shareholder’s 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.

Who needs a Shareholders’ Agreement?

Ideally, all companies which have more than one shareholder should have a Shareholders’ Agreement in place to regulate the business and have the responsibilities and rules for running the company pinned down in writing. Some benefits of having a shareholder’s agreement are:

• A dispute resolution mechanism

When disputes arise, a Shareholders’ Agreement can be a valuable tool to avoid and manage conflicts without reverting to extreme measures, like dissolving the company. It can be a tool to help treat sensitive topics with concrete pre-determined measurements.

• Investor protection

Investors often require the shareholders to agree to specific provisions designed to protect their position. For example, they might require performance targets or a board seat on the board of directors. These provisions are often found in a Shareholders’ Agreement.

Are Shareholders Agreements legally binding?

Shareholders’ agreements are contracts. However, they must fulfil certain contractual requirements to be legally valid and binding.

Can Shareholders’ Agreements be reviewed or changed?

Yes, while shareholder’s agreement provides a solid foundation for businesses to move ahead, their terms can be reviewed and changed in the future, if all the parties onboard agree on the changes.

The needs of companies, businesses and even investors are ever-changing, and it is only apt that the agreements are changed accordingly as well.

How is shareholders agreement different from Articles of Association?

While an article of association is a public document, a shareholders’ agreement is a private one that is signed between the shareholders of a company. Both are used to regulate the actions of a company and should be consistent with each other.

Conclusion

Shareholder agreements help to define the relationship of shareholders in a company.

A shareholder’s agreement is not a legal requirement or compulsory. However, having one in place can save you a lot of trouble and time.

It has clear guidelines in place for how the shareholders should conduct their roles in the company. It is also not a public document and can be a confidential contract.

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