What to include in a shareholders' agreement
Kirsty Ranger
Business and Investment Coach - I help early-stage business leaders shift their mindset, grow their business, and/or find investors.
Partnerships and collaborations are common in all businesses, but it’s crucial to have clear rules for how the entity operates and make sure the interests of everybody are protected. No surprise then why shareholders’ agreements are so important.
Whether starting a small corporation or a limited liability company, it's key to establish clear guidelines for shareholders to protect their interests. This is where a shareholders' agreement is required.
Agreements can be complex, but this article outlines the key elements you need to understand about shareholders' agreements, why they are necessary, and the key points that must be included to avoid future arguments and help a business operate smoothly.
What is a shareholders agreement?
Shareholders' agreements are legal documents that set out the entitlements, obligations, and accountabilities expected of shareholders of a business. They serve as a framework for how a business is operated and managed and the process for how decisions that impact it are made. Also known as a stockholders' agreement, it protects the business and its shareholders, safeguarding their investments and ensuring fair treatment.
Purposes of a shareholders' agreement
Shareholders' agreements serve various purposes, dealing with various subjects and scenarios. Below are some key reasons for putting a shareholders' agreement in place:
A principal part of a shareholders’ agreement sets out the rules regarding who can be a shareholder in the business and who must remain as one. By setting clear criteria, it regulates the composition of your shareholder base and preserves stability within the company.
A shareholders' agreement can establish mechanisms to preserve shareholders' proportionate interests to maintain a fair distribution of ownership. For example, suppose one shareholder wants to exit the business. In that case, the agreement can allow the other shareholders to buy the stake in the business in proportion to their current holdings.
Shareholders' agreements can include stipulations that curb how shares can be sold or transferred to others. These restrictions ensure that shares are not transferred to undesirable or incompatible parties, which means the stability and vision of the business are protected.
Shareholders' agreements can outline which shareholders have the right to vote and define the rules for how major decisions are made in the business. This can include needing a higher majority for certain actions, such as borrowing money or making significant investments, ensuring that important decisions are made collectively.
Shareholders' agreements often address events that may trigger the need for action, such as the death, disability, divorce, or termination of employment of a shareholder. They can institute buy-sell arrangements that restrict the transfer of shares in such circumstances, ensuring a smooth transition and protecting the interests of all parties involved.
Shareholders' agreements can outline management and governance arrangements, including allocating authority between the board and shareholders. It can also address succession planning, ensuring a clear path for transferring ownership and management responsibilities when the current shareholders exit the business.
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To prevent costly litigation and maintain a harmonious relationship among shareholders, a shareholders' agreement can include mechanisms for dispute resolution, such as mediation or arbitration. These provisions help to resolve conflicts in a timely and efficient manner, saving time and resources.
Shareholders' agreements can establish guidelines for the distribution of earnings, including the payment of dividends. These agreements provide transparency and avoid potential disputes by clearly defining how profits will be distributed.
Tag-along and drag-along rights are important provisions to protect minority shareholders in a business. A tag-along provision ensures that if a majority shareholder wants to offload their shareholding, the minority shareholders can participate in the sale on the same basis. Conversely, a drag-along provision allows majority shareholders to force minority shareholders to participate in a sale, ensuring a unified approach to selling the business.
To prevent partners from competing with the company or disclosing trade secrets, shareholders' agreements often include non-competition and non-solicitation provisions. These provisions protect the company's intellectual property and help to maintain its competitive advantage.
When drafting a shareholders' agreement, it is essential to consider your business's unique circumstances and goals. Here are some key considerations to keep in mind:
Every business is unique, and shareholders' agreements should reflect that. Tailor the agreement to the business's specific requirements, considering factors such as the entity's nature, the class of shares, the number of shareholders involved, and its size and potential for future growth.
To avoid uncertainty in valuing shareholders' interests, consider including provisions that establish the value of shares in the event of a shareholder's death or withdrawal from the business. Valuation methods can range from fixed prices that are periodically reviewed to formulas based on various factors or external expert appraisals.
Drafting a shareholders' agreement can be complex, so it is recommended that business owners seek legal advice to ensure compliance with relevant laws and regulations. Consulting with an experienced business lawyer will help you navigate the intricacies of drafting an agreement that protects the interests of all shareholders involved and ensures that there are no potential loopholes that may cause problems later.
Conclusion
A shareholders' agreement is a vital tool for establishing clear guidelines, protecting investments, and ensuring the smooth operation of a business. By addressing key issues and potential conflicts in advance, shareholders' agreements provide a solid foundation for successful partnerships and collaborations. Whether starting a new venture or looking to strengthen an existing one, a well-drafted shareholders' agreement is essential to your business's long-term success.
All businesses are different, and the shareholders’ agreement should reflect that and be tailored to its specific requirements – and it is something that should be drafted with expert legal advice.
With a comprehensive shareholders' agreement, you can confidently navigate the complexities of business partnerships, safeguarding your interests, focusing on growing your business, and creating value for shareholders.
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