A shareholder’s agreement is an essential document. By doing so, shareholders are protected both from each other and from the company itself. In a business relationship, a shareholder agreement can protect both parties. Discover what they are and why they’re so important. Consider these five things when writing a shareholder’s agreement.
A shareholder’s agreement should contain five things.
Make sure you have the necessary capacity
The clauses will always be sealed by warranties and representations that each party is capable of performing as it promises. It’s simple to understand why. Parties often claim they cannot fulfill their obligations when the time comes. Instead of only a defaulting party bearing the risk, the risk could be shared among all parties to the contract. Firstly, the necessary checks can be performed to prevent this. When there is dissatisfaction, caution is taken in advance, and lawyers aren’t as expensive.
Shareholders should consult a lawyer or corporate secretary if they have any questions
Share subscriptions, cancellations, and issuances are complex procedures; lawyers and corporate secretaries are essential advisers. Improper transactions may invalidate a shareholder’s rights, dilute control, or put shareholders into limbo if executed incorrectly or in the wrong order. There are certain share transactions and company actions that are void unless Shareholder General Meetings are called. There are several procedural rules that would seem enigmatic to the uninitiated.
Prepare clauses for forced acquisitions
Two parties forming a company together have a hard time acquiring each other’s shares. Suppose the parties cannot agree on a buyout. The company may be forced to go to court for a forced sale under threat of closure under those conditions. Again, this is pointless. In order to ensure that everyone is aware of the process, both parties should take this possibility into consideration and create a mechanism for transferring shares.
Protect yourself from dilution
Existing shareholders are protected from involuntary dilution by the anti-dilution provisions. Examples include preemptive rights, which require an outgoing shareholder to offer shares to remaining shareholders before they can be sold to a third party, or first refusal rights, which require an outgoing shareholder to offer shares to remaining shareholders before they can be sold to a third party. Shareholders without these provisions may lose control of their companies or find their share of profits diluted.
How will you fund your project?
Shareholder agreements should specify how shares will be paid for. Shareholder agreements clarify whether funding is included. This is especially useful if the shareholder contributes intellectual property or sweat equity as part of their contribution. Staged funding is possible. Furthermore, shares can be issued over a period of time or vested over time.
5 don’ts when it comes to shareholder agreements
A shareholder’s agreement should not be copied blindly.
Every shareholder’s agreement is unique, and even boilerplate terms should be reviewed for consistency. Blindly copying can have disastrous consequences when it comes to determining what the contract contains later on.
Vakilsearch’s client distributed multiple versions of a shareholder agreement without notifying his lawyers. As a result, he had trouble keeping track of which versions were signed with whom. Multiple investors sued the shareholder. A conflict might have been avoided if he had understood the terms of the shareholders’ agreement he was disseminating.
Don’t rely on the company constitution to protect you
An organization’s constitution establishes some legal rights universally. The rights of shareholders are frequently drafted minimally as well. A shareholder’s agreement that is more customized will offer greater protection. Furthermore, company constitutions are accessible to the public, implying that terms are not confidential. Special meetings are also required for constitutional amendments.
A term sheet is different from a memorandum of understanding
Shareholders’ contracts are legally binding contracts between shareholders. This is not a Memorandum of Understanding (MOU) or a term sheet. A MOU is a document in which parties document their understandings that they believe should guide their actions, but don’t want to be sued if they don’t comply with them. An MOU is typically the basis of a shareholder’s agreement. A Term Sheet, on the other hand, is not a shareholder’s agreement but rather an overview of the critical terms of the shareholder’s agreement.
Shareholder agreements should not include other relationships
Shareholder agreements can sometimes be interpreted as quasi-partnerships. Fiduciary relationships and duty of care may also be included through the back door, depending on the terms. Such a relationship may impose additional duties or liabilities on the parties without their knowledge. Assume, for instance, that parties A and B are considered partners. Partie A may be sued for party B’s debts and wrongs, even if party A has done nothing wrong. Other relationships between the parties may have valid reasons. In such cases, however, those relationships should be documented separately.
Shareholder agreements should not be viewed in isolation
The shareholder’s agreement is only one tool in the toolbox of business protection. As a result, it is embedded in a complex ecosystem of laws, regulations, and the constitutions, external contracts, and internal operations of a company. An interaction between a shareholder’s agreement and one of these other factors may render it ineffective or result in unfavourable outcomes for others. For example, a venture capital deal requiring SAFEs or CAREs would require revealing any previously secret shareholder agreements. Alternatively, a shareholder’s agreement could provide for sanctions for violating the constitution of the company.