A shareholder agreement acts as a guide for any interaction between the corporation and its shareholders. It outlines the responsibilities of the shareholder to the company and vice versa. It also states the privileges that the shareholders are to enjoy. By definition,
A shareholder agreement is a legal contract that defines the relationship between a corporation and its shareholders.
The information in a shareholder agreement is privileged and not made accessible to individuals who are not stakeholders.
A shareholder agreement leaves no ambiguity as to how the corporation is going to run. It covers details about both the daily operation of the corporation and the procedure for handling any emergency. Apart from operations, it also determines and provides ease in making future amendments to the company articles.
A shareholder agreement needs to be thorough. It should cover all possible scenarios to prevent any party from taking advantage of loopholes in the document.
A shareholder agreement is also regularly called:
- Company shareholder agreement
- Agreement for a corporation’s shareholders
- Agreement for corporate shareholders
- Agreement for shareholders
- Stockholder’s agreement
- Agreement of corporation shareholders
A company’s shareholder agreement and articles of association are both legally binding documents. They regulate the day-to-day operations of the company.
The only difference between them is that while the articles are public documents, only shareholders can access the company’s shareholders agreement.
Benefits of a Shareholder Agreement
A shareholders agreement is vital for both the company and all its stakeholders. The document has different implications for all types of shareholders, majority, minority, and equal.
Both large and smaller corporations make use of shareholder agreements in guiding their decision-making. This document protects the interests of both the company and its shareholders. A shareholder agreement helps to keep all parties accountable. It limits the number of disputes and legal cases that could occur due to conflict or diverging interests. A shareholder agreement has several use cases. Examples include:
Company decision making
The shareholder’s agreement allows companies to have a separate document for shareholder entitlements and company policy. Unlike an article of association, it allows some information to be kept private. Corporations may need shareholder agreements to make decisions and implement future changes without amending their articles of association.
In most companies, disputes usually arise when it comes to deciding direction and policies. Usually, the unilateral decision-making power belongs to the majority shareholder. However, stakeholders in a company can modify this rule using this agreement.
The level of influence a minority shareholder has in a company depends on the shareholder agreement. Some companies allow their shareholders to have a say in certain decisions even when they do not have a majority stake. A shareholders agreement can have a policy mandating that some decisions require a unanimous vote. Laws like this give minority stakeholders some degree of influence over company policies and decisions.
Regulation of share transfers
A shareholders agreement can define who is allowed to become a shareholder in the company. Such regulation is crucial, especially in smaller companies, to prevent unwanted individuals from sabotaging the company unity. For example, a shareholders agreement can state unanimous approval of all board members is required before a new shareholder can be approved.
Usually, when a person dies, their shares are distributed as part of their assets. A shareholder agreement can intercept this regulation and prevent company shares from being inherited by individuals who may not be fit to make decisions for the company.
Selling of shares
At some point, shareholders may want to leave the company. An agreement is also needed to regulate any sale of shares by either majority or minority shareholders. A shareholders agreement could have a drag-along clause, which forces minority shareholders to sell their shares if the majority shareholder is doing the same.
A shareholder agreement could also have a shotgun clause. In this situation, a shareholder can offer to purchase the other shares at a particular price. Any shareholder that doesn’t accept the offer has to buy the shares of the person who made the offer at the same price.
A shareholder’s agreement can prevent a shareholder’s potential exit from becoming a prolonged legal battle.
In a situation where there is a disagreement between the shareholders, the agreement should contain a dispute regulation guide. Such regulations are crucial, especially in companies where there the shareholders have equal rights.
When Do You Need it
A shareholder’s agreement is needed under different scenarios. Here are a few of them.
- For corporations: Although this document is not a requirement for establishing a corporation in most states, corporations usually consider it to be a non-negotiable document for their operations. Corporations have shareholder agreements for protection against unnecessary legal disputes and to ease decision-making. The same case applies when you and other individuals are shareholders in a private limited company.
- If you have outside investors: A shareholder agreement is needed when a company decides to become listed and accept outside investment. Any potential investor would like to know what their role will be. They would also like to know about the dividend payment structure and any other benefits they will be enjoying by becoming a shareholder.
Most Common Shareholder Relationships
Most people become shareholders in a company due to their relationship with the founder(s). Usually, the first shareholders in a company are family members, friends, or employees.
Involvement of family members
A founder can decide to make his family members stakeholders in his company. He can do this by giving them shares. The amount of shares each family member has is proportional to how much of the company they own. To retain the majority stake in their company, founders must:
- Make sure they don’t sell too many shares to a single person.
- Not sell too many of their shares.
- Set restrictions to ensure that they remain the largest shareholder.
Involvement of employees
Employees are usually among the first people to understand the vision of the company. Most of them will be interested in buying shares and becoming stakeholders in the company. A founder can even decide to reward a loyal employee with shares. However, handing shares to employees can compromise the hierarchical structure of the company. It can bring confusion as to the responsibilities of employees who are also shareholders. The corporation must always be aware of:
- Who is getting shares
- How many shares they have and;
- The power and relationship balance
A shareholder agreement is necessary to maintain the corporation’s organizational structure. A well-written document should remove any ambiguity regarding each person’s duties in the company. Once there is clarity regarding shareholder roles and benefits, the company can run smoothly.
If there is no shareholder’s agreement or the document is not written properly, it can lead to several disputes among the employees. Without this document, an employee may not value his role and responsibilities as a shareholder the way a family member would. They may also not know how much their shares are actually worth and what to do to get the best value from their shares.
Things to Be Included in Shareholder Agreement
There is no specific format for a shareholder agreement. There are no mandatory requirements for the document to be considered valid. The details in a shareholder agreement can vary from corporation to corporation. However, some information must be part of the agreement to guarantee the smooth running of the corporation.
Some of these details include:
- The identity of the majority and minority shareholders: A majority shareholder is a person that has over 50% of the shares in a company. Minority shareholders have less than 50% of the corporation and therefore have no direct controlling stake. Any shareholder agreement must include both sets of shareholders.
- The difference between both categories: The shareholder agreement should clearly outline the difference between the majority and minority shareholders regarding their rights and influence over decision-making.
- Why it matters: The agreement should also elaborate on why this difference is required and the responsibilities of both shareholder categories.
- How to transfer shares: The document should also contain guidelines regarding the transfer of shares. It should state any restrictions on share transfers.
- Who the directors are: Shareholders can choose to appoint people to be in charge of the day-to-day running of the corporation. These people are known as directors. A shareholder can also choose to act as a director. The shareholder agreement should clearly state the identity of all the directors.
- What happens if one dies: A shareholder agreement should state what happens if a stakeholder dies. It should be clear about who is eligible to inherit their shares and any other vital decisions in the event of a shareholder’s death.
- How shares are given or sold to individuals: A shareholder can decide to sell or give out some shares to someone else. The agreement should provide guidelines defining the limits of such activities.
- New shareholder policy: The document should cover the issuance of shares to new shareholders and any other information required for incoming shareholders.
- Company buyback policy: The agreement should also include the regulations surrounding a share buyback by the company. It should state how to proceed when shares are being sold by shareholders exiting the company.
- Rules for appointment of company officers and termination of their contract: Company officers are people appointed by the shareholders to be responsible for the day-to-day operations of the corporation. The shareholder agreement usually covers the requirements for their appointment and the termination of their contracts.
- Dividend payments: A corporation usually pays dividends – a sum of money to its shareholders periodically. The shareholder agreement defines the formula for calculating surpluses and how regularly shareholders will receive payment.
- Shareholder responsibilities and privileges: The corporation usually has requirements it expects its shareholders to fulfill. Likewise, each shareholder is also entitled to certain privileges and information as a stakeholder in the corporation. The shareholder agreement should elaborate on both issues.
- Meeting schedules: The agreement also covers when and how often shareholders can meet and the conditions for calling an unplanned meeting.
Circumstances for selling shares
A shareholder can decide to sell their shares voluntarily. It could be a personal decision or due to falling share prices. However, in certain situations, shareholders have no choice but to sell their shares. These kinds of events are known as a ‘compulsory transfer of shares.’ A compulsory share transfer can happen when:
- the shareholder becomes mental or physically unfit
- there is a change in control of the company
- the shareholder or company becomes bankrupt
- the shareholder chooses to resign or retire
- the shareholder breaches the agreement
Consequences of Not Having a Shareholder Agreement
A corporation can run without a shareholder agreement. However, doing so puts the entire company at risk. Although it is not a mandatory document, not having this agreement in place has many terrible far-reaching implications:
- Investors generally want to see a shareholder agreement: Every investor would like to know what they are getting into before investing their money into a company. The best way for them to evaluate a company and make a decision is by taking a look at their shareholder agreement. Companies without this document look like a ticking time bomb to most investors, something they would love to avoid. Corporations that do not have this document risk losing out on several potential investors.
- You will lose the chance to stabilize your business in its infancy: The early stages of any company are probably the most important. Most companies don’t make it past the first five years. There needs to be a firm guideline regulating decision-making to guarantee stability. Running a company without a shareholder agreement increases the risk of failure considerably.
Download Free Templates
It is best to have a shareholder agreement to ease decision-making, encourage investments and protect your company from unnecessary disputes or misunderstandings. You can have a well-written shareholder agreement ready in no time by downloading our free templates here.
Yes, it is, as long as all the parties involved have read and signed the document. By signing a shareholder agreement, all parties become legally obliged to fulfill the terms stated in the contract.
Dissolving a shareholder agreement is a legal issue. You would need to consult a lawyer to walk you through the entire process.
Running a company is a lot of work. Having the correct documentation is vital to ensure smooth and easy operations. Shareholder agreements are not mandatory but, they are necessary for any corporation that wants to enjoy stability.