What A Shareholders Agreement Is And Why Your Startup Needs One

Tosin Entrepreneurship, Family Business, Intellectual Property

What is a Shareholder Agreement?

A shareholders agreement should essentially be the cornerstone of any business venture between founders and partners.

It is a legally binding document that sets out the structure of the company. A shareholders agreement can be among many people, not only the co-founders but anyone who has a potential interest in the company.

The agreement should identify the rights and interests, alongside the duties of the particular parties that sign the agreement. Typically, a shareholders agreement should include clauses such as these:

  • Who is a shareholder in the company
  • Dilution rights
  • Intellectual property assignment
  • Shareholdings and classes of shares for each shareholder
  • Compulsory transfer of shares in the event of a tragedy
  • Voting powers
  • Dividend policies (startups generally have no dividend policies)
  • Responsibilities
  • Reverse vesting provisions
  • Pre-emptive rights

Why you need a Shareholders Agreement

John Wood, a partner at UK law firm TLT, has stated that,

“Spending time and attention on a detailed agreement at the outset flushes out any issues and makes founders consider whether they are truly aligned in their aspirations.”

A shareholders agreement should set the foundation for any business. Without a foundation, it is extremely hard to build any kind of structure.

Often startups and seed form businesses fail to get a shareholders agreement until it is too late.

An agreement of this kind is normally overlooked by young companies either because it hadn’t been thought of or because it is deemed unnecessary due to financial and time constraints.

Thus, the young business owners who do see the value in having a shareholders agreement put off the idea, thinking that they would have more time and money in the future to draft it.

However, as the case often is when a startup takes off the founders will be busier and have less time to set up this kind of agreement.

Ignoring the need for a shareholders agreement creates a larger risk because as with any business, problems may arise and it is important to have a game plan ahead of those situations to act as an effective guidance mechanism on what to do in those circumstances. Furthermore, a shareholders agreement acts as protection and a buffer between partners/co-founders if problematic circumstances arise and it is seen to be more efficient as co-founders will spend less time debating, arguing and litigating when in difficult situations as they have the agreement to refer back to.

A shareholders agreement has proven to be key, especially when personal circumstances outside of the business relationship arise.

This document can address what should happen in the event of a death of one of the shareholders and answers important questions on whether their shares in the company should transfer to the other founders/partners or if they would transfer to the next of kin.

In addition, if you happen to married to your business partner a shareholders agreement can map out what would happen in the event of a divorce.

The agreement may also be directed towards investors and give them the security that they need if the startup should go into liquidation.

Consequently, a shareholders agreement has proven to be crucial time and time again.

What would happen if you don’t get a shareholders agreement

In an article published by the independent newspaper,

“The main reason to put a shareholders’ agreement in place early on in the lifecycle of a company is that it is generally much quicker, cheaper and easier to do so than trying to negotiate a settlement in the event that a dispute arises and no agreement is in place to determine how such dispute will be resolved”.

Hence, if your startup doesn’t have a shareholders agreement and a dispute does happen to arise, that will be further costs in litigation and settlement negotiations than the shareholders agreement would have been in the beginning.

Usually, when founder relationships dissolve, disputes often arise as to issues such as to who owns the intellectual property and other assets. Having a shareholders agreement will prevent the dragging out of situations on these matters. This means that in the event that shareholders were to sever their relationship they would be able to move on with their lives faster.

A shareholders agreement has been useful especially because it creates a sense of commitment between the co-founders in a startup.

Not having a shareholders agreement could potentially mean that wavering co-founders will find it easier to leave the startup and venture off by themselves with the ideas and framework set up by the company.

Thus, a shareholders agreement will always be necessary and vital.

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