Shareholders' Agreement - a Comprehensive Guide To What They Are & When to Use Them

A Shareholders' Agreement, in essence, describes how the shareholders will own and operate the company, along with their rights and obligations towards each other. As a result, this agreement is good at reducing the risk of future conflicts, helps cooperation, and increases the likelihood that the company will be successful long into the future.

Benefits of Shareholders' Agreements?

☑ Shareholders' agreements clearly outline the ownership stakes of each shareholder and their respective rights and responsibilities. Such clarity can then easily prevent misunderstandings and disputes over ownership and control from occurring.

☑ Without a shareholders' agreement, minority shareholders might be vulnerable to the decisions of the majority shareholders. For example, the agreement can include specific provisions to protect minority interests - such as requiring majority consensus for major decisions or providing Veto rights on particular issues, to name a few.

☑ A shareholders' agreement can set out the processes for making critical business decisions, including appointing and removing directors, approving budgets, and other significant operational matters.

☑ The agreement can stipulate conditions under which shares can be sold or transferred, such as Pre-emption rights - giving existing shareholders the first option to buy - Drag-along Rights - compelling minority shareholders to join in the sale of the company - and Tag-along Rights - allowing minority shareholders to join a sale initiated by majority shareholders, as some examples.

☑ In the event of disagreements among shareholders, the Shareholders’ agreement can provide for specific dispute resolution mechanisms - such as arbitration or mediation. Which in turn, can mean that these dispute resolution mechanisms can then help you avoid costly and time-consuming legal battles down the line, while ensuring that disputes are settled as efficiently and amicably as possible as well.

Table of Contents

• Why Have a Shareholders Agreement in the First Place?

• How can you efficiently manage the storage of the Shareholders' Agreement?

• Who Needs a Shareholders' Agreement?

• What is Typically Included in a Shareholders' Agreement?

• How Does a Shareholders' Agreement Differ from the Articles of Association?

• Can a Shareholders' Agreement Override the Articles of Association?

• How Does a Shareholders' Agreement Differ from a Stockholder Agreement?

• How Does a Shareholders' Agreement Differ from a Founder's Agreement?

• Contents of a Founders Agreement

• How Does a Shareholders' Agreement Differ from a Shareholder Rights Agreement?

• How is a Shareholders' Agreement Enforced?

• What Happens if There is No Shareholders' Agreement?

• Can a Shareholders' Agreement be Amended?

• What are Drag-Along and Tag-Along Rights?

• Essential Provisions in Shareholders' Agreements

• Differences in Startup Shareholders' Agreements

• Corporate Shareholders' Agreements

• What Happens if There Are No Shareholders' Agreements

• Common Mistakes in Shareholders' Agreements

• Critical differences between Shareholders Agreement vs Articles of Incorporation

• Shareholders' Agreement vs Operating Agreement

Why Have a Shareholders Agreement in the First Place?

A Shareholders' Agreement is essential as it will set out how to handle future events, e.g. a sale of the company or what happens to an owner's shares if they pass away. 

In contrast to the Articles of Association, a UK Shareholders' Agreement does not have to be filed with the Companies Register. Consequently, it is not considered a public document.

Therefore, this agreement can include confidential provisions covering things such as the company's business plan or how profits will be shared

Another reason to have a Shareholders Agreement is that the terms setout can also be changed in the future, as long as all parties agree.

How can you efficiently manage the storage of the Shareholders' Agreement?

One way to manage the storage of your contracts is to print them out and hope they do not get lost. Another way is to keep it in your emails and wish it does not get deleted. Alternatively, you can use the Pocketlaw platform to securely store your Shareholders' Agreement Templates and use the platform for designates, which can then be logged and tracked.

Then, these agreements can be easily shared with other team members when required and needed and will avoid getting lost.

As these are just one type of legal document that we can create more efficiently for you, this enables you to easily create and adapt many templates and streamline your whole legal document & contract process.

Who Needs a Shareholders’ Agreement?

Any company with more than one shareholder can benefit from a Shareholders' Agreement, and it is vital for private companies, primarily - where shares are not publicly traded.

What is Typically Included in a Shareholders' Agreement?

Common elements typically include share ownership and valuation, dividend policies, procedures for transferring shares, dispute resolution mechanisms, and provisions for appointing and removing directors.

Shareholders' Agreement Vs. Articles of Association - How do they Differ?

Are you wondering how the shareholder's agreement compares to the Articles of Association?

Well, the Articles of Association is a public document that sets out the company's structure and governance.

Whereas, a Shareholders' Agreement, on the other hand, is a private contract between shareholders that offers additional, more detailed governance provisions within it.

Can a Shareholders' Agreement Override the Articles of Association?

Generally, a Shareholders' Agreement cannot override the Articles of Association.

Both documents should be consistent with each other, and in case of any conflict, the Articles often take precedence.

Shareholders' Agreement Vs. Stockholder Agreement - How do they Differ?

Stockholders' Agreements and Shareholders' Agreements are essentially the same thing and are often used interchangeably. This is because both refer to a contract among the shareholders - or stockholders - of a company that describes how the company should be operated and outlines the rights and obligations of the shareholders.

For example, people in the United States usually call this document a "stockholder agreement," but in Europe, the United Kingdom and other Commonwealth countries, they often use the term "shareholder agreement."

Despite this regional difference in terminology, the function and purpose of these agreements remain the same.

How Does a Shareholders' Agreement Differ from a Founder's Agreement?

A Founders' Agreement and a Shareholders' Agreement are both essential documents in the context of a business. Still, they serve very different purposes and are used at various stages of a company's lifecycle. We have covered a Shareholders Agreement in-depth above.

However, a Founder’s agreement can differ in several critical areas. These can consist of:

Purpose

A Founder’s agreement is typically used in the early stages of a business. Consequently, it is an agreement between the founders of a company and outlines the critical aspects of their relationship, the initial ownership and contributions, and the overall vision for the company moving forward.

Contents of a Founders Agreement

A Founders Agreement usually covers topics such as:

• The roles and responsibilities of each founder

• Equity ownership and distribution

• Decision-making processes

• Provisions for what happens if a founder leaves the company

• Initial funding

• How to handle Intellectual Property

• Division of labour among founders

The Founders' Agreement is crucial for startups and new businesses where the founders are the primary stakeholders.

As a result, a Founders' Agreement sets the foundational relationship and agreement among the company's creators - focusing on their roles, responsibilities, and initial ownership. 

In contrast, a Shareholders' Agreement is more about the ongoing operation and governance of the company - involving all shareholders and addressing broader issues like management, finance, and transfer of shares.

How Does a Shareholders' Agreement Differ from a Shareholder Rights Agreement?

The difference between a Shareholders' Agreement and a shareholders' rights agreement lies in their specific purposes and contents. Although they are both legal documents involving the shareholders of a company, the Shareholders' Rights Agreement differs in several ways.

Shareholders' Agreement

This is a contract between all or some of the shareholders of a company. It governs the shareholders' relationships to each other and to the company.

Shareholders' Rights Agreement

Also known as a "Stockholders' Rights Agreement" or "Poison Pill", is a type of defensive strategy document used by a company's board of directors to prevent - or discourage hostile takeovers. 

Consequently, a Shareholders' Rights Agreement gives existing shareholders certain rights. One such right, is the right to buy additional shares at a discount if a single shareholder buys a significant percentage of the company's shares.

This dilutes the new - potentially hostile party's ownership interest, making a takeover less attractive or more difficult. 

These agreements are designed to protect the company and its shareholders from takeover tactics that they deem unfavourable or predatory.

Consequently, while a Shareholders' Agreement is a broad document detailing the general governance and relationships among company shareholders, a Shareholders' Rights Agreement is a specific document used primarily to defend against hostile company takeovers.

How is a Shareholders' Agreement Enforced?

As a legal contract, it is enforceable through the legal systems and primarily via courts. This is because Shareholders can take legal action if parts of the agreement - or contract - are breached.

What Happens if There is No Shareholders' Agreement?

With an agreement, disputes may be more complex to resolve, and standard corporate laws will govern how the company is run - which may only sometimes align with the shareholders' intentions.

Can a Shareholders' Agreement be Amended?

Yes, but amendments usually require consent from all parties involved, depending on the provisions for amendments outlined in the agreement itself.

What are Drag-Along and Tag-Along Rights?

Drag-along rights allow majority shareholders to force minority shareholders to join in the sale of the company if it is decided upon.

Tag-along rights allow minority shareholders to join a sale initiated by the majority of shareholders - ensuring they receive the same terms and conditions.

Important Provisions in Shareholders' Agreements

A shareholders' agreement can include governance provisions around how directors are appointed (for example, whether certain shareholders should be able to nominate a director) and what decisions cannot be taken without the approval of all of the shareholders.

• Ensure the shareholders' agreement sets out what happens when a shareholder wants to sell their shares in the company. Consider whether the shareholder should be free to sell their shares to anyone or whether the non-selling shareholders should have a right to purchase the shares before they are sold to a third party.
  
  

• If a shareholder is vital to the company's business, you should ensure the shareholders' agreement includes protections that will stop the shareholder from joining a competitor.
  
  

• A shareholders' agreement can include provisions around what happens when the company is sold. For example, should a purchaser be required to make an offer to all of the company's shareholders?

Differences in Startup Shareholders' Agreements

The difference between a Shareholders' Agreement for a startup and that for an established company lies primarily in the nature of the business and the stage of its development over anything else. For instance, some essential differences that may need to be included in a startup agreement to consider could consist of:

Flexibility for Growth and Change

Startups, for instance, often undergo rapid and significant changes, including growth, pivots in business strategy, and funding rounds.

Shareholders' Agreements for startups typically will include provisions that accommodate these changes - such as clauses that address future investment rounds, dilution, and the entrance of new shareholders that wouldn’t tend to occur in more established companies.

Focus on Founder Control and Roles

In startups, founder involvement and control are critical. Shareholders' Agreements in this context include specific provisions about the roles and rights of founders - including how decision-making is handled and what happens if a founder leaves or is no longer active in the business.

Vesting Schedules for Shares

Unlike established companies, where shareholders often fully own their shares outright, startup Shareholders' Agreements frequently include vesting schedules. 

This means that founders - and early employees - earn their shares over time, which incentivises long-term commitment. Consequently, a share agreement for a startup can tend to have clauses that cover these that wouldn’t be included for an established company.

Consideration of Future Financing

Startups often anticipate raising capital through various financing rounds, whereas established companies would not.

Shareholders' Agreements may, therefore, include pre-emption rights, anti-dilution provisions, and terms relating to convertible notes or preferred stock - which are more common in startup financing.

Valuation Challenges

Establishing the value of a startup can be more challenging than valuing a based company due to the need for historical financial data.

Therefore, Shareholders' Agreements in startups often include mechanisms for valuation that are revisited during each funding round or significant event that an established company wouldn’t tend to have to include or go through.

Exit Strategies and Liquidity Events

Startups often focus more on potential exit strategies, such as acquisition or IPO. 

Consequently, their Shareholders' Agreements may outline processes and rights related to these events, including Drag-along and Tag-along rights that larger, more market-established companies would not need to include.

Protecting Intellectual Property

For startups, intellectual property (IP) can be a crucial asset. Consequently, their agreements often include clauses ensuring that IP created by founders and employees is owned solely by the company.

Risk and Reward Considerations

Startups inherently come with higher risk and the potential for high reward. 

As a result, Startup Shareholders' Agreements may reflect this balance with terms that address risk-sharing among shareholders accordingly.

Corporate Shareholders' Agreements

A corporate Shareholders' Agreement, particularly for more extensive and established corporations, might include specific elements that are not typically necessary or relevant for smaller companies, startups, or different business entities like LLCs.

For instance, some key aspects to consider in a corporate Shareholders' Agreement might uniquely include:

Detailed Governance Structures

Larger corporations often have more complex governance structures. The agreement might detail the roles and powers of the board of directors, committees, and officers and how they interact with shareholders.

More Complex Share Structures

Corporations, mainly publicly traded ones, may have multiple classes of shares with different voting rights and dividend policies. For instance, the agreement might specify the rights and obligations associated with each class.

Market Fluctuations and Share Pricing

For publicly traded companies, the agreement might include mechanisms for dealing with share price volatility and procedures for valuation in the event of share transfers or buybacks.

Regulatory Compliance

Larger corporations are subject to more regulatory oversight than smaller ones are, which in turn can mean that their Shareholders' Agreement may need include provisions related more to compliance with securities laws, disclosure requirements, and other regulatory obligations as a result.

Anti-takeover Provisions

These can include measures to prevent hostile takeovers, such as poison pills, golden parachutes for executives, and restrictions on share transfers that could change control.

Succession Planning

Provisions for the transition of leadership roles and how this affects shareholder rights and responsibilities may need to be included - which are especially relevant in family-owned or closely-held corporations.

Conflict of Interest Policies

Detailed policies on handling conflicts of interest must be included, particularly for board members and major shareholders who might have interests in other ventures.

Dividend Policies

Detailed terms regarding the declaration and payment of dividends can be more complex in larger corporations with different types of shareholders.

Shareholder Meetings and Voting Procedures

Additional procedures for calling, conducting, and voting at shareholder meetings can be more elaborate due to the more significant number of stakeholders and more complex issues to be addressed.

Rights of First Refusal or Co-sale

Provisions that require shareholders wishing to sell their shares to offer them first to existing shareholders or allow other shareholders to join in a sale - Tag-along rights - may need to be considered, for example.

Information Rights

Particularly in corporations where not all shareholders are involved in daily operations, there might be specific provisions about how company information is shared with shareholders.

Dispute Resolution

Then, you have more detailed mechanisms for resolving disputes among shareholders or between shareholders and the company - including arbitration or mediation clauses that will need to be included.

What Happens if There Are No Shareholders' Agreements

Not having a shareholders' agreement in place for a company can lead to several potential issues and complications. Here are some key points to consider:

• Disagreements Among Shareholders

• Lack of Protection for Minority Shareholders

• Issues with Share Transfer and Sale of Business

• Risks from Departing Shareholders

• Lack of Defined Responsibilities

• Difficulty in Bringing in New Investment

• Governance, Management, and Control

Common Mistakes in Shareholders' Agreements

Many founders feel that a Shareholders' Agreement is unnecessary when starting a company with a friend - let's face it, at the end of the day, you already know each other, so what can really go wrong?

Well, as in all types of relationships, even a friendship can end due to unforeseen events. 

For instance, one of you may want to withdraw from the collaboration and instead start working for a competitor where it is legally sound to do so. Alternatively, you can cash in on your success and sell the company.

As a result, agreeing on how you deal with these issues at the start of the venture will avoid a falling-out later on, benefiting all parties and the business on the whole.

Key differences between Shareholders Agreement vs Articles of Incorporation

Shareholders' agreements and Articles of Incorporation - also known as articles of association in some jurisdictions) are both crucial documents in the governance of a corporation, but they serve entirely different purposes and have distinct characteristics.

For Articles of Incorporation, for example, this formal legal document establishes the corporation's existence.

It outlines the company's basic structure, including its name, purpose, and the type and amount of stock it is authorised to issue, for example. Consequently, it is a public document filed with the state or relevant government body.

A Shareholders' Agreement is a private contract between the company's shareholders. 

As a result, it details the rights, responsibilities, and obligations of the shareholders concerning the company and each other. 

Consequently, it can cover many topics not typically included in the Articles of Incorporation.

Shareholders' Agreement vs Operating Agreement

A Shareholders' Agreement and an Operating Agreement differ in several ways. For instance:

Shareholders' Agreements Key Points

For instance Shareholders' Agreements are applicable specifically to corporations with multiple shareholders.

Their primary purpose is to govern the relationships between the shareholders of the corporation. This includes for instance:

• Outlining the rights and responsibilities of shareholders

• Detailing how the corporation will be managed

• How decisions are made

• Procedures for buying and selling shares.

Key elements of Shareholders' Agreements tend to include:

• Share transfer restrictions

• Buy-sell conditions for shares

• Decision-making processes for corporate governance

• Protection of minority shareholders

• Dispute resolution mechanisms.

Consequently, a Shareholders' Agreement is a contract between the shareholders of a corporation and is not a public document; it's a private agreement.

Operating Agreements Key Points

On the other hand, Operating Agreements are applicable to Limited Liability Companies (LLCs).

They govern the internal operations of the LLC in a way that suits the needs of its members - who are the owners. For instance, they outline both the financial and functional decision-making processes in an LLC.

Key elements to his document can include:

• The distribution of profits and losses

• Management structure

• Voting rights

• Rules for meetings and voting

• Procedures for admitting new members and handling departing members

• Member duties and responsibilities.

Similar to Shareholders' Agreements, an Operating Agreement is a contract among the LLC members and is also not a public document but a private agreement.

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