Shareholders agreement

The basics

A shareholders agreement is a legally binding arrangement entered into between each of the shareholders in a company by which they agree how their relationship as shareholders will be regulated. It is designed to deal with the issues that may arise during the life of a business, by determining in advance, how such issues should be dealt with.

Previously…

In a previous post, ‘What are the top 5 growing pains for start-ups?’ we cautioned against not having a shareholders agreement in the early stages in order to avoid or mitigate disagreements by owners.

Why is it important?

There are two very good reasons why shareholders should consider entering into a shareholders agreement:

1. The process of negotiating such an agreement may be a useful way of bringing out into the open many of the contentious issues which can become real problems in the future for the company; and

2. The agreement will provide a mechanism for resolving any disputes which might arise in the future.

The purpose of a shareholders agreement

Some of the key areas dealt with in a well-drafted agreement will normally deal with the following areas:

1. Management

The agreement will contain provisions setting out the rights of shareholders, including minority shareholders, to be involved in the management of the company. Shareholders may be granted the right to become a director or to appoint nominee directors to represent their interest on the board

2. Funding

The agreement can set out what the requirements are for further funding in particular whether or not existing shareholders can be required to provide further share capital or lend the money to the company and if so upon what terms. Further, where shareholder contribution is required, the agreement may dictate a dilution process for those shareholders who do not contribute funding (when required).

3. Exit routes

The agreement will specify what is to happen if one or more shareholders wish to sell their shares or if a third party acquisition offer is received. If one or more of the shareholders wish to sell their shares the usual mechanisms in a shareholders agreement will include:

Pre-emption provisions

A shareholder wanting to sell must first offer his/her shares to the other existing shareholders who may acquire them at a fair price and if several of them want to take up the offered shares will do so in proportion to their existing shareholdings.

Drag along provisions

If a significant majority, say at least 75% of the company shareholders, wish to accept a bone fide third party offer for their shares they can force any other minority shareholders to sell and thereby facilitate the sale of the entire company.

4. Restraint of trade

The agreement will seek to protect the competitive interests of the company which may include restrictions on a shareholder’s ability to be involved in a competing business and restrictions on a shareholder’s ability to poach key employees of the company.

A vital consideration

A shareholders agreement will be useful for most types of company. Such agreements will anticipate problems and help to resolve any that do arise with the minimum of disruption and cost. Indeed, it is best prepared at the start of a business when all parties are enthusiastic and there have been no disputes or disagreements over the running of the business.

What are the top 5 growing pains for start-ups?