First thing to understand before explaining what a shareholder agreement is that you already have one. The activities of a Company in regard of its shareholders are defined by the Articles of Association (the document you signed when you first incorporated the company and never looked at again) and the Companies Act (something most of us have never read).
Because the Articles/Constitution are more general in nature a Shareholder Agreement supplements these and sets out the understanding of the parties as to how the company is to be managed by the shareholders and those responsible for the day to day management (the directors) - the objective of a Shareholder Agreement is to avoid future arguments.
Types of Shareholder Agreements
Shareholder agreements may be entered into by the following parties:
2 of more Shareholders | All of the Shareholders | Shareholders and the Company
One advantage of including the company in a shareholder agreement in the case that there are a lot of shareholder is that the company directly undertakes the obligations in the agreement as such the obligations to each shareholder are enforced by the Company (through its directors) and hence all issues should be consistently handled.
Why Might You Need a Shareholder Agreement?
A company constitution is often not be sufficient to cover the company’s specific business requirements especially if the company made use of the default constitution template provided by the Accounting and Corporate Regulatory Authority. There are often verbal and other agreements on how to deal with the company, these are best memorialised in a shareholder agreement to ensure common understanding.
Unlike the company constitution which can be changed through the casting of votes, a shareholder agreement can only be altered with the consent of all parties to the agreement.
A shareholder agreement is not open for public inspection and so can be used to attract investors by granting greater investor protection and specific investor rights as well as to preserve a first-mover advantage, by specifying confidentiality and non-competitive obligations.
What Terms Should a Shareholder Agreement Contain?
The contents of shareholder agreements are really the documentation of what the intentions of parties are certain foreseeable situations and a framework to avoid conflict in foreseen and unforeseen future circumstances.
Some agreements are more of a framework of principles and call for a common sense application of its terms. Others prefer to go into detail and spell out every obligation in the operation of the company. Regardless of the complexity detail on the following basic terms are normally included:
Management of the company: Who will exercise the management functions of the company?
Activities of the company (and use of assets): What the objectives of the company are (what business in what area. This is so unapproved and maybe more risky activities are not conducted.
Raising of financing: Many start ups need additional capital in early stages, a good shareholder agreement determines the methods of raising finance in sequence.
Loyalty and confidentiality: What kinds of obligations are necessary to ensure the company’s secrets are preserved? How can the founders be restricted from leaving and starting a rival company?
Return of investment: How can the founders and investors recover their investments? What is the company’s dividend policy?
Valuation method: In a share sale, how will the shares be valued?
Exit route: How can the founders and investors sell their shares either to each other or externally?
We have a template shareholder agreement we would be happy to send, just email me at jasmine@jaifin.com and you can see some of my other articles here on:
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