For startup founders

Is a shareholder agreement important for my new startup?

21 June 2018

You have successfully incorporated your new startup company and are all set to grow your business. What is one of the first things you should do? Without a doubt, if you have two or more shareholders, you should consider a shareholders’ agreement. It is easy to postpone putting a shareholders’ agreement (aka founders’ agreement) in place, but it is important. Why? Because it can regulate how changes in the company in the future will be dealt with including how decisions will be made, what would happen if a shareholder wanted to leave or became ill and, most importantly, what would happen if the shareholders had a disagreement.  

A shareholders’ agreement is a legal contract agreed by all the shareholders of the company. It regulates the way that business between shareholders is conducted and can help protect the startup from unforeseen issues between shareholders that may affect the success, and therefore value, of the company. A shareholders’ agreement does not need to be filed at Companies House, therefore the terms of the agreement remain confidential.

A shareholders’ agreement is different to the articles of association of a company. Articles of association are a company’s constitution and form the basis of a statutory contract between the shareholders and the company. A company’s articles of association must be filed at Companies House.

A shareholders’ agreement typically sets out the rights, responsibilities, liabilities and obligations of each shareholder, and outlines how the business should operate. Your shareholders’ agreement should deal with matters such as:

Reserved matters (aka veto rights)

Although the directors are responsible for the day-to-day management of a company’s affairs, the shareholders’ agreement can provide shareholders with the right to consent to specific decisions that they feel should not be left to the discretion of directors (e.g.: a total pivot of the business of the startup, amending the articles of the company, etc).

What happens when a shareholder wants to leave, passes away or files for personal bankruptcy?

A shareholders’ agreement could include a mechanism to require a shareholder to offer their shares for sale to either the remaining shareholders and/or to the company in the first instance prior to selling them to external third parties.

Shareholders' Agreements' restrictions

A shareholders’ agreement can place restrictions on an exiting shareholder’s ability to start a competing business, which would be invaluable to protect the interests of your startup and is key to preserving the value of the company.

How a deadlock in decision making of the shareholders is dealt with

The shareholders’ agreement can place obligations on the shareholders to try resolve a deadlock or refer the issue to a third party adjudicator before a deadlock mechanism kicks in. If the deadlock cannot be resolved there are a number of different types of deadlock clauses which could be included, for example a put and call option (where one shareholder may buy out another) or the chairman having a casting vote. This is not always the best way to resolve a dispute between shareholders as mechanisms such as a put and call option can throw up uncertain results. There will therefore need to be a discussion as to whether you want to include such a mechanism in your shareholders’ agreement. However the alternative would be not to have any deadlock provisions and rely on the shareholders being able to come to an agreement.

What happens if a shareholder wants to sell the company?

The shareholders’ agreement can protect the majority shareholders by including ‘drag along’ provisions. In circumstances where an offer is received to buy all of the shares in a company, ‘drag along’ provisions enable the majority shareholders to compel the minority shareholders to accept the deal. This prevents one potentially difficult shareholder from scuppering a sale. A shareholders’ agreement can also provide protection for minority shareholders by including ‘tag along’ provisions. In these circumstances if the majority shareholders have received an offer for their shares, the minority shareholders can force the majority shareholders to procure that the offer is also extended to the minority shareholders.

What happens if there is a future issue of shares?

A shareholders’ agreement can provide protection for existing shareholders by giving them the right to subscribe for further shares and therefore not be diluted.

The primary aim of any shareholders’ agreement is to protect the shareholders and the company. A shareholders’ agreement will be one of the most important legal documents that you enter into when launching your startup and, as with any important legal document, you should ensure that it meets your needs and is tailored to your startup.

For more information, read 'Articles of Association, Shareholders’ Agreements and Investors’ Agreements – what’s the difference?'

Are you a founder of a start up? Roberta Draper guides you through the start up investment process in this video.

If you would like formal legal advice on shareholders’ agreement or any other corporate or commercial issue, please contact a member of the startup investments team.

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We welcome views and opinions about the issues raised in this blog. Should you require specific advice in relation to personal circumstances, please use the form on the contact page.

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