A shareholders agreement is a legally binding contract between the shareholders of a company. A shareholders agreement determines the shareholders’ rights, responsibilities, privileges and protections. It can be used to protect investments, it creates a secure relationship among shareholders and maps out the running of a company. With a shareholders agreement there is clarity and certainty as to what can or cannot be done and most decisions are taken by consensus and discussion.
Even though it is not a legal requirement to have a shareholders agreement in place it is strongly advised to do so as it protects the shareholders from any potential conflicts.
Furthermore, a shareholders’ agreement is a private agreement and there is no requirement to file it at companies house. Thus, there is great confidentiality in what is contained in the terms of the shareholders’ agreement.
However, a shareholders agreement cannot be used in the absence of a partnership agreement according to the Partnership Act 1890.
What a shareholders agreement should usually include:
A shareholders agreement should essentially be the cornerstone of any business venture between founders and partners.
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)
- Reverse vesting provisions
- Pre-emptive rights
The results of the terms in a shareholders’ agreement should be these things:
- Shareholders can retain the right to make certain decisions
- Sense of direction
- The issue of shares and equity
- Flexible dividend policy
- Shareholder/employee relations
- Minority shareholder protection
- Majority shareholder protection
- Dispute resolutions
How do you terminate a shareholders agreement?
You can terminate a shareholders agreement in one of three ways.
The first way you can terminate a shareholders agreement is by mutual agreement. This is when all of the shareholders decide that they no longer want to comply with the shareholders’ agreement due to various reasons. The reasons can be from dissolving the company, selling their shares in the company or the company itself or it can be deciding to leave the company. In a well-drafted shareholders’ agreement, these provisions should be included.
Secondly, the shareholders’ agreement may automatically be terminated if there has been a breach in the agreement by any of the shareholders. When this occurs the shareholders’ agreement will be terminated unless there are clauses in the agreement that sets out some form of mediation.
Lastly, a shareholders agreement can be terminated if simply one of the shareholders want to leave the company. In this case, there will be certain provisions in the shareholders’ agreement to map out what should happen in this scenario.
Conflict between shareholders:
It is inevitable that conflict will arise with shareholders at some point in time in the running of the company. It does matter how well you know your shareholder, whether they are a family member, friend, or business partner it is best to have a shareholders agreement in place that you can refer to when conflict arises in your business relationship.
A lot of successful companies have been known to have shareholders with turbulent relationships. A business relationship whether it is good or bad can have a huge impact on whether a company is going to be successful or not.
A case of how a major company’s founder relationship almost cost the business is Zipcar. The cofounders of Zipcar, Antje Danielson and Robin Chase met because their children went to the same school. They decided to create a business because Danielson had an idea of having a shared car company and Chase had a business degree, therefore their collaboration seemed to be perfect. However, soon after the Zipcar started operating different conflicts started to occur between the co-founders. Chase wanted more shares and power to run the company by herself and Chase was too preoccupied with her main job as a lecturer to dedicate as much time as Chase did to the company. Their co-founder relationship ended in a devastating way. Chase ended up buying Danielson out of the company against her will as she had petitioned the boards the majority vote.
This example shows that getting a shareholders agreement is vital in order to set the right foundation for your company. Often people enter to business with their friends and family. However, it may be better to enter into a co-founder relationship with someone you do not know at all. As you would take extra precautions to protect yourself. You may think that you have a good understanding of who you are entering into business with but the reality is that peoples true colours come out when people are under pressure and you don’t see that until you are in business with someone.
In reality, a co-founder relationship should be looked at as a marriage and it should be prepared for and treated in the same way. Decisions on how to raise your company should be made the same way as how you wish to raise your children, through discussion, compromise and ultimately deciding what is best for the company.
An important factor of a shareholders agreement is when it comes to vesting shares and equity. This area of the agreement should be dealt with caution and care to create the fairest agreement between the shareholders in accordance to what their responsibilities are within the company and how much they have invested in the company.
Before we dig into the technicalities it is important to have a basic understanding of what is equity and what it means to vest shares. Equity is an asset without the liabilities attached to it. Vesting is a legal term which means to give or earn a right to a present or future payment, asset or benefit. It is most commonly used in reference to retirement plan benefits when an employee gets non-forfeitable rights over employer-provided stock incentives or employer contributions made to the employee’s qualified retirement plan account or pension plan.
The most common equity vesting structure is:
- Founder terms: 4-year vesting, 1-year cliff, for everyone, including you and your employees.
- Advisor Terms (0.5 – 2.0%): four or two-year vesting, optional cliff, full acceleration upon exit.
A vesting-share cliff basically allows you to trial a hire without immediately committing to equity. You can agree from the moment of the hire on the equity amount and vesting period. However, if they leave prior to the cliff period, (typically 1-2 years) then they receive no equity.
In 2016, new tax laws were created for share options. Now, you may not have to pay Capital Gains Tax on profits gained after the sale of shares.
If you feel like you need a shareholders’ agreement to secure the relationship between you and shareholders/co-founders Linkilaw has created a unique and substantive shareholders agreement that covers all of the points mentioned in the blog and more.