This agreement lays the groundwork for how the company’s control will be distributed among shareholders.
People often set up a new company and wonder what they will have to do next. This is where many people bring up things like company bylaws or shareholders agreement. For those who don’t know, a company shareholder agreement is vital for setting up an organization. However, similar to several business owners and founders, you might have some confusion about how a shareholder agreement works and what makes it different from a company articles of association.
Whenever a company has multiple shareholders, having a shareholder agreement becomes a necessity for protecting every individual’s rights. This agreement lays the groundwork for how the company’s control will be distributed among shareholders.
- Procedures for disputes
- Transferring and holding shares
- The company’s rules and regulations
- Responsibilities and rights of the directors and shareholders
People who set up a business for the first time often believe that things can stay clear cut without a shareholder agreement, but as time passes, shareholders and other members of the organization encounter confusion and a barrage of difficulties, which is why you should always have a company shareholder agreement in place.
What is a Shareholders Agreement?
As mentioned earlier, a shareholder agreement acts as an arrangement for a company’s shareholders. It consists of provisions about how the company will operate and what its relationship with the shareholders will be. Also referred to as “stockholders agreement”, a shareholder agreement protects the shareholder’s and company’s investments.
It also makes sure that the shareholders don’t have to encounter unfair treatment. Minority shareholders benefit from this agreement too, as they have very little control over how the business operates. A company shareholder agreement outlines the shareholder’s obligations and rights and lays out a blueprint for equal distribution of the shares.
As mentioned, drafting a stockholder’s agreement when issuing shares for the first time or setting up a company is a must. Why? Because it assists investors or entrepreneurs find common ground for what they can expect when it comes to receiving and providing to the business. If any investor faces difficulty settling a conflict and reaching an agreement, they may have to reconsider their alliance.
What’s more, investors can also draft a shareholder agreement later on’; however, doing so is not advisable as people’s expectations tend to diverge as time passes and reaching a harmonious consensus could become difficult.
Why is a Shareholder Agreement Important?
Resolution of conflict is a recurring theme whenever someone discusses a company shareholder agreement. A properly drafted shareholder’s agreement can solve a dispute among shareholders, allowing a company to run seamlessly. Mentioned below are several benefits that highlight why a shareholder agreement is so important.
- As you would expect, shareholders have to address a variety of scenarios and provisions, like what would happen if someone decides to sell or transfer their shares or gets severely injured. A shareholder agreement key terms and clauses helps address complicated questions like these, providing members of a company with practical and effective solution for almost every scenario.
- This agreement also provides solutions for what would happen when consent for certain things require permission from multiple parties. Consequently, the inaction could have an adverse impact on the organization’s business, creating massive conflicts among different roles.
- A shareholder agreement can detail provisions regarding the company’s management at the directorial level. This helps provide consistency and clarity for the organization’s day to day affairs. For instance, info for matters that require the shareholder’s or director’s consent.
- A shareholder agreement also protects minority shareholders by helping them stay in the loop about any share sale made by majority shareholders.
- It also imposes restrictive contracts on shareholders, regulating their freedom to get involved in competing companies or anything that could affect the organization as a whole.
- This agreement also ensures that the company’s information remains confidential and details what would happen if a shareholder or director leaks the company’s info or data to a competitor.
When Should a Share Agreement be put in Place?
In most cases, utilizing a shareholder’s agreement is a wise idea, especially when forming a company or issuing its initial shares. Some would even say that it is an excellent exercise for making sure that shareholders have a common understanding about what they can expect from the company. In case a shareholder has different opinions about their shares and role in the company, a company shareholder agreement can address this issue, making sure it doesn’t unsettle the company moving forward.
In some cases, investors tend to steer clear from discussing agreements to focus on other aspects of running the business. While this may seem like an effective strategy in the beginning, it rarely works, if at all. Sure, the investors may be planning to return to the share agreement later on, but it never works out. This is why investors and shareholders should ensure that they prioritize the shareholder agreement first, and focus on other aspects later.
Without a solid foundation, running a company can be very difficult and give birth to a variety of disputes. Company owners can easily avoid these problems from taking place by signing off on the share agreement at the very beginning.
Key Terms and Clauses in Shareholder Agreement
A shareholder agreement contains plenty of key terms and clauses, and knowing them is vital for understanding how this agreement works. From non-competition clauses to issuing and selling shares, there are different terminologies present in these agreements, and knowing their meanings can help you draft a compelling shareholder agreement that addresses important elements of your organization. The following is a list of terms used quite frequently in shareholder’s agreements:
- Selling and Issuing Shares – The terms selling and issuing share mean exactly what their names suggest. Issuing shares simply means the date when an organization provided its employer with shares. Selling shares, on the other hand, refers to selling a share for liquidating cash. Recipients often do this when their stock or options’ value increases.
- Removing or Appointing Directors – This term is also quite self-explanatory, as it refers to when a company owner decides to designate a director or remove him or her from their respective decision. Both decisions require the approval of the company’s shareholders.
- Special Rights to Appoint Directors and Super-Majority clause – Clauses like these are often implemented for securing the minority shareholder’s interest. Traditionally, minority shareholders do not have the power to block the approvals of regular resolutions like the appointment or removal of board directors. To simplify things, minority shareholders may even get 49 percent of shares but not get any influence over the board of directors.
- Share Vesting – Most of you may have heard about vested shares for the shareholder’s reward, especially for startups. The term share vesting means that company founders cannot become the owners of shares until fulfilling certain conditions. Companies benefit from this in several ways, which includes the postponement of cash payouts and increasing employee retention.
- Dividend Payments – Dividend payments are essentially a division of profits offered by a company to the shareholders. Whenever an organization obtains a surplus or profit, it can pay a part of the profit to shareholders, and the term used for it is “dividend payment”. What’s more, the dividend a shareholder receives is their income and could become liable for income tax.
- Right of First Refusal/Pre-emptive Rights – Pre-emptive rights or rights of first refusal are high value mechanisms. What makes them so great is that they come in quite handy for shareholders, especially because they incorporate it in their agreements. The main purpose of this clause is to safeguard the current shareholders from their stake’s dilution.
- Non-Competition Clauses – Non-compete clauses are present in almost every shareholder agreement. By making clear how and when a shareholder can carry out activities after and during their time as the company’s shareholder, this clause helps eliminate any vagueness or ambiguity regarding restrictions and rules. Non-compete clauses also ensure that shareholders don’t disclose the company’s info to competing parties.
How a Shareholder Agreement Helps Minority Shareholders?
Since most organizations abide by majority decisions, there are very few cases where minority shareholders get control over how their business operates. Sure, there are laws to protect the minority shareholder’s interest, but their protection is quite minimal and could be costly and challenging to enforce.
That said, this agreement does offer some level of protection to minority shareholders. For example, these shareholders have to provide approval for some decisions, without which the company can’t proceed with a certain deal or plan.
Things to Consider While Drafting Shareholder Agreement
It must be clear by now that shareholder agreements should be drafted with great attention to detail. Leaving out even the tiniest bit of information could make it vague and create problems down the line. The following is a list of things to consider drafting a compelling shareholder agreement:
- Determine the amount of stock that can be transferred or sold
- Making changes to the initial shareholder agreement
- Naming the company’s shareholders
- Each party’s particular legal obligations
- A well-formulated exit strategy
- Dividend distribution
Shareholder Agreement Sample
Every company’s sample shareholder agreement is different. However, if you are new to it, knowing what is present in a traditional shareholder agreement sample will give you a decent starting point. In most cases, the document starts with an agreement between the company’s various shareholders and their specific obligations and duties.
Generally, the first article of the agreement sample contains the purpose of the shareholder agreement. The second article details the organization’s management, along with details regarding the board of directors, limitations, and expenses.
Finally, the third article discusses the distribution of losses and profits among the shareholders. Sure, you may find several other details in a company’s shareholder agreement but these elements are present in almost all of them.
Recording Company Shareholders agreement on Eqvista
With the importance of shareholder’s agreement for a company, its better to keep these recorded in your company’s Cap Table. This is where the Eqvista platform can help. Our captable software will help store all your company documents and share access to these with your shareholder and other company founders, with a click of a button. Let’s see how it works:
Here is how a company’s Cap Table would look on the Eqvista platform.
In this scenario we have 4 company founders and various option holders. Whereas before you would need to send countless emails to each shareholder and company admin for record keeping, on Eqvista, you can simply upload the documents to the platform and share with your interested parties.
From the Documents section, you can upload the shareholder agreement and share access to each party after typing in their name. You can even edit the name of the document, edit the title or type, and download it for later.
Start Using Shareholders’ Agreement for your Company
When it comes to high level companies, it’s vital to ensure that shareholders are aware of what they can and cannot do. It eliminates poor decision making and negative impact on the company’s business. This is why creating a well-written, detailed company shareholder agreement is important, as it can safeguard the company while keeping the shareholders in harmony. It’s equally important to record these documents in an organized Cap Table.
Eqvista is an advanced captable to fit your company documents need. With the platform, companies can easily issue shares, create stock option plans, and store and share documents to the shareholders and company admin. Read about our entire list of support articles here.