Shareholders Agreement: Definition, Key Terms

A shareholders agreement is a legal contract that outlines the operation of a company, detailing shareholders ' rights and relevant rules and regulations. Such an agreement helps protect the rights of all shareholders and helps them build a relationship with the company. Let us learn more about the important aspects of a shareholders agreement below.

What is a Shareholders’ Agreement?

A shareholders’ agreement is a legally binding contract that outlines the regulations used to run a corporation. This agreement, also called a stockholders’ agreement or SHA, is used to protect the interests of each individual shareholder and establish a fair relationship within the company.

A shareholder agreement will include the rights and obligations of each shareholder, how the shares of the company are sold, how the company will run, and how decisions will be made.

To further understand what a shareholders’ agreement is, read this.

Who Needs a Shareholders’ Agreement?

When a corporation is created and more than one person will be investing money into the company, a shareholders’ agreement is essential. This document should be drafted and signed right when a corporation is formed to avoid any issues or confusion when setting up the company.

A shareholders’ agreement should be used whether a corporation has a lot of investors or just a couple. It should also be used even if the investors are family or close friends.

It can be easy to assume that if you go into business with people you know, you will not have disputes or issues. Even though this may be true, a shareholders’ agreement will protect everyone’s rights and interests and you will always have a clear, fair way to settle a dispute should one arise.

Even if a corporation has articles of incorporation that outline the company’s laws and policies, it is still a good idea to also draft a shareholders’ agreement for extra clarity and protection.

For more information on shareholders’ agreements for small businesses, read this article.

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Important Clauses Found in Shareholders’ Agreements

Every shareholders’ agreement should be clear and detailed. Although each agreement will be custom tailored to each individual business, all agreements need to include key components. These components describe how the business will be run, how to resolve issues between shareholders and what each shareholder’s responsibilities and benefits are.

Shareholders’ agreements usually contain the following key provisions:

• A preamble that lists the parties including the company name and all shareholders to be included in the agreement.
• The goals of the agreement.
• How shares will be bought, sold, or transferred (this includes both the optional and mandatory buying-back of shares by the company and what happens in the event of the death of a shareholder).
• Protections for holders of less than 50% of shares.
• Dividends.
• A right of first refusal clause.
• Fair price for shares.
• How the company will be run including information about appointing or removing directors, board meetings, management information, banking arrangements and other important financial details.
• Dispute resolution procedures

In addition to these provisions, a shareholders’ agreement should also contain the date, the number of shares issued, the percentage ownership of each shareholder, how votes are decided and how shares are created.

Other important clauses that can usually be found in a shareholders’ agreement include the following:

Clause 1: Director Structure

This clause will regulate the directors of a company. It will detail decision making policies, rights of shareholders to appoint or remove directors, and the powers of directors.

Clause 2: Buying and Selling Provisions

These are the rights and obligations of shareholders to buy or sell their shares. Some instances where shares may need to be bought or sold include insolvency, disability, death, or retirement. This is one of the most important parts of a shareholders’ agreement and should include a way to value shares.

Clause 3: Financing

This clause will include how shareholders contribute capital in the company and what happens if a shareholder can no longer contribute.

Example of Initial Funding Clause in Shareholders' Agreement

Initial contributions. Until the Initial Evaluation Date, each Shareholder shall be required (in accordance with any Contribution Notice which is served on it) to make capital contributions for the purposes and in the amounts specified in the existing Business Plan not exceeding, in aggregate, the value of the Initial Contribution Cap.

Reference :

Security Exchange Commission - Edgar Database, EX-10.2 3 dex102.htm SHAREHOLDERS AGREEMENT, Viewed May 20, 2021, < SEC Link >.

Clause 4: Restrictions on the Transfer of Shares

Restrictions on share transfers allows each shareholder to have some control over who they are doing business with. It is common to first require a director’s approval to transfer shares or to offer first rights to buy shares to existing shareholders.

Example of Restrictions on the Transfer of Shares Clause in Shareholders' Agreement

RESTRICTIONS ON DEALING WITH SHARES

(A) Transfer by a Shareholder of the legal and beneficial title to any Share, Convertible Share or Preference Share is only permitted in accordance with the provisions of clause 12 (Funding and performance tests), clause 17 (Voluntary transfers) or clause 18 (Transfer of Shares on default), or with the prior written consent of the other Shareholder.

(B) Notwithstanding the provisions set out above, no transfer of any Share shall be registered unless and until the transferor complies with the provisions of clause 9.5(D)(ii) (Directors’ interests and fiduciary duties).

(C) Save as set out above at clause 16(A), no Disposal of any Share, Convertible Share or Preference Share or any legal or beneficial interest in any such share is permitted and the transfer of any Share, Convertible Share or Preference Share (other than in strict accordance with this agreement) shall not be registered.

Reference :

Security Exchange Commission - Edgar Database, EX-10.2 3 dex102.htm SHAREHOLDERS AGREEMENT, Viewed May 20, 2021, < SEC Link >.

Clause 5: Dispute Resolution

Dispute resolution is an important clause in a shareholders’ agreement. This lays out how to resolve any conflicts between shareholders as well as consequences for breaches of the agreement.

Clause 6: Confidentiality

Unless otherwise agreed upon, the terms of the shareholders’ agreement are normally confidential to the parties in the agreement.

Here is an article with samples on the Confidentiality Clause.

Clause 7: Shareholder and Director Meetings

Most corporations have scheduled meetings for their shareholders and directors. Laying out the meeting schedule within the agreement can be helpful for structure avoiding confusion in the future. This clause should also contain how meetings will be held with what procedures will be in place and voting procedures.

Clause 8: Protections for the Company

The shareholders’ agreement does not only serve to protect shareholders, but also the company. This clause will lay out rules to protect the company that could include limiting shareholders from being involved with competition or restrictions on shareholder’s interaction with customers.

Every shareholder agreement will be different based upon the needs and structure of the company. The most important thing to remember though is to make sure the agreement is as detailed and easy to understand as possible.

Benefits of a Shareholder Agreement

A shareholder agreement ensures that a company operates efficiently while keeping in mind the needs of individual shareholders. Here are the common benefits associated with the corporate agreement that everyone must know:

• Defines Ownership and Voting: The agreement defines the ownership percentage of each shareholder associated with a company. Moreover, it also outlines the voting rights of the people within the organization.
• Provides Minority Protection: Most shareholder agreements have provisions that safeguard the interests of all minority shareholders.
• Establishes Rules of Share Transfer: The agreement also helps establish the rules and restrictions associated with different share transfers. This includes having the approval of all shareholders before anyone decides to sell or hold the shares.
• Addresses Succession Planning: It addresses issues related to the succession planning process. Such a process helps ensure a smooth transfer of ownership and other management rights within the company.
• Enables Efficient Decision-Making: A shareholder agreement enables efficient decision-making within the company. It does so by delineating each shareholder's roles and responsibilities in essential matters. It also establishes a framework for making decisions in which all stakeholders know their roles and obligations. Moreover, the agreement provides a structured mechanism without disrupting the company's operations. This streamlined decision-making process contributes to the company's overall efficiency and stability.
• Assures Ownership Clarity: Ownership clarity is essential for maintaining a harmonious and functional business environment. A shareholder agreement plays a pivotal role in guaranteeing this clarity by explicitly defining ownership percentages and voting rights for each shareholder. By documenting each shareholder's precise stake in the company, the agreement minimizes the potential for disputes and confusion regarding control and decision-making. This assurance of ownership clarity provides a solid foundation for productive collaboration among shareholders.
• Invests in Minority Shareholder Protection: A shareholder agreement invests in protecting minority shareholders, a critical aspect of ensuring fair treatment and equitable participation in company affairs. The agreement safeguards the rights and interests of minority shareholders through carefully crafted provisions. It helps prevent any undue influence or disadvantage imposed by majority shareholders. This proactive investment in minority protection fosters a sense of security and confidence among all shareholders, contributing to a healthier corporate environment.
• Facilitates Share Transfer Rules: The agreement facilitates the establishment of well-defined rules and restrictions governing share transfers. This facilitation ensures transparency and compliance when shareholders intend to buy, sell, or transfer their shares. Notably, the agreement often mandates that the approval of all shareholders is required before any share sale or transfer takes place. Doing so protects the interests of existing stakeholders and promotes stability within the shareholder group.
• Addresses Succession Planning: Succession planning is critical to long-term corporate sustainability. A shareholder agreement comprehensively addresses this process by outlining the procedures and protocols for the orderly transfer of ownership and management rights within the company. This assurance of a smooth transition in retirement, departure, or other changes in shareholder status contributes to the company's continued success and operational stability.
• Strengthens Conflict Resolution: Conflict resolution mechanisms within the company are strengthened through the shareholder agreement. This proactive approach reduces the risk of internal disputes escalating to a point where they disrupt the company's operations or damage shareholder relationships. The agreement ensures that disputes are managed fairly, efficiently, and with legally binding outcomes by investing in well-defined methods for resolving conflicts.
• Promotes Fair Dividend Distribution: Fair and equitable distribution of dividends is a fundamental concern for shareholders. The shareholder agreement promotes this by establishing clear guidelines for distributing profits among shareholders. It ensures that dividends are allocated according to predefined rules, preventing disagreements or disputes over dividend allocations. This fair dividend distribution promotion enhances shareholders' trust and reinforces their commitment to the company's success.
• Protects Non-Compete and Confidentiality: The shareholder agreement includes non-compete and confidentiality clauses to safeguard the company's interests. These protective measures restrict shareholders from engaging in activities that would compete with the company or disclosing sensitive company information. This protection ensures that the company's intellectual property and competitive edge are preserved, promoting long-term stability and growth.
• Outlines Exit Strategies: A well-structured shareholder agreement outlines clear exit strategies for shareholders, providing a roadmap for selling shares or exiting the company organizationally. This benefits shareholders by allowing them to plan their exit effectively and ensures that the company's operations remain stable during transitions. Having predefined exit strategies contributes to the overall continuity and sustainability of the business.
• Empowers Pre-Emptive Rights: Empowering existing shareholders with preemptive rights is valuable to a shareholder agreement. These rights grant shareholders the initial opportunity to purchase shares before they are offered to external parties. By doing so, the agreement preserves ownership continuity within the existing shareholder group, minimizing potential disruptions and ensuring that shares are transferred among known and trusted parties. This empowerment enhances the overall cohesion and stability of the shareholder base.

Are Shareholder’s Agreements Legally Binding?

Yes. A shareholders’ agreement, once signed, is a legally binding contract. Legally binding contracts require four elements: offer, acceptance, consideration, and the understanding that a contract is being formed.

In the scenario of a shareholders’ agreement, consideration is essential. Generally, consideration is met by the shareholder purchasing company shares. As long as there is an exchange of value, the element of consideration has been fulfilled.

How Do I Write a Shareholders’ Agreement?

If you are starting a corporation and are in need of a shareholder agreement, it is generally a good idea to consult with a corporate lawyer who specializes in these types of contracts .

If you are considering drafting your own shareholders agreement, consider these questions:

Question 1: What issues will the agreement cover?

Question 2: What are the interests of the shareholders?

Question 3: What is the value of each shareholder?

Question 4: Who will be making decisions for the company?

Question 5: How will shareholders vote and how much will each vote weigh?

You will need to be sure that each shareholder is correctly named with their address and phone number. You should also include any officers of the company and who is going to be a managing shareholder.

Shareholder responsibilities, voting rights, and decision-making capabilities should be clearly and explicitly outlined in the agreement.

It is important to remember that unlike articles of incorporation which can be changed with a majority vote, a shareholders’ agreement requires all shareholders to agree to make any changes. It is crucial that this agreement is complete, all encompassing, and says exactly what you need it to say before being executed.

Final Thoughts on Shareholders Agreements

A shareholder agreement is important for both the shareholders and the company. It is because the contract helps outline the rights and regulations of both parties. Moreover, the agreement is deemed enforceable by law in the United States, adding to its benefits list. However, creating or drafting the shareholders' agreement alone takes work. So, it is recommended to approach a knowledgeable attorney who has already worked on such documents earlier. This person must also have relevant expertise about the corporate culture.

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